reDesign

This is another graph that caught my eye from the study posted by Harvard and Boston University researchers:

This bears out what I’ve been hearing from Groupon insiders.

In the latest amendment to the S-1, Groupon also reported that its revenue per sales rep declined from $172,000 in 1Q2011 to $138,000 in 2Q2011.

Groupon’s model is heavily dependent on its salesforce. To the extent that each deal brings in less revenue, selling expenses alone will become an even bigger problem for the company.

A recent study by researchers at Harvard and Boston University confirm statistically something that I’ve long suspected: Running a Groupon can destroy your Yelp ratings. I generally recommend that restaurants and service businesses avoid running Groupons because the short-term economics are terrible. This study suggests that the long-term economics may be just as bad.

Some quotes from the report, which looked at 6 months of Groupon deals in 20 markets:

Our analysis shows that while the number of reviews increases signicantly due to daily deals, average rating scores from reviewers who mention daily deals are 10% lower than scores of their peers on average.

We find that reviewers mentioning daily deals are signicantly more negative than their peers on average, and the volume of their reviews materially lowers Yelp scores in the months after a daily deal offering.

An average drop of 0.12 suggests a significant number of merchants may lose a half-star due to rounding. This could have a potentially important effect on a business; a recent study reports that for independent restaurants a one-star increase in Yelp rating leads to a 9% increase in revenue.

Although the analysis doesn’t go deep into the reasons for lower ratings, based on numerous conversations with merchants and consumers the lower ratings are a result of a number of factors:

• Persnicketiness of Groupon customers. Some Groupon customers haven’t tried services or these price levels before. They have higher expectations than consumers who normally frequent a business. The owner of a spa in Germany told me that his Groupon customers were much more demanding than his full-price clientele.
• A crush of demand that is hard to service. Groupon and LivingSocial generate a crush of demand that can vastly exceed the service capabilities of restaurants and small businesses. In extreme cases, 2-3 years worth of business will be sold in a 24 hour period. More commonly, 6 to 12 months of business will be sold. Many of these customers want to use the service right away. One consumer told me he bought a house cleaning deal on LivingSocial to use the next weekend. When he called to schedule the cleaning, he was told the next slot was in 4 months. Restaurants will find that they are slammed for the first 2-3 weeks of a Groupon run and toward the end of the run. Under such circumstances, it’s hard for any business to perform up to its normal service levels. This has another side effect: many consumers tell me that they now avoid their regular places right after a Groupon run because they don’t want to deal with the crowds. The restaurant ends up turning away full-price customers to serve customers at deep discounts.
• Breakdown in communications between Groupon, the merchant and staff. Many merchants don’t understand the rules of accepting Groupons, such as the fact the mobile app is valid and a paper voucher isn’t required. Staff aren’t adequately trained on acceptance procedures. They also are unaware of the legal requirements related to gift cards and expiration dates.
• A negative feedback loop. This is a very common one that I hear from both sides. Merchants complain that Groupon customers don’t tip well, are picky, etc. After a few weeks of this, they treat Groupon customers like second-class citizens. Groupon customers then complain because of the way they are treated and this reinforces lack of tipping.
• Confusing terms and conditions. As merchants wake up to the economics of daily deals, many are adding terms and conditions to balance demand or in hope of generating some profit from a deal. Customers either don’t read these terms or deliberately choose to ignore them, figuring they can browbeat the merchant in to accepting the voucher. I’ve heard from merchants that they’ve been threatened by Groupon customers with bad reviews if they didn’t accept a voucher that the customer wan’t entitled to use.

All of this is exacerbated by the fact that Groupon has great customer service. Even if you have the flimsiest reason, Groupon will give you a refund for the price you paid for a deal. (I had a terrible experience with Groupon Getaways, but they immediately offered me a full refund.)

Although this is definitely great for consumers, this makes the merchant look like the bad guy and the merchant gets slammed in Yelp. I’ve even heard of cases where Groupon customer service made disparaging remarks about the business, apologizing for not adequately vetting the business.

Yelp has become the de facto standard for restaurant ratings in the United States. Dropping from a 4-star rating to a 3.5-rating can have a negative long-term impact on businesses. I, for example, won’t eat at places rate less that 4-stars on Yelp; there are just too many other options out there. As mobile Yelp usage continues to explode, I expect this effect to become more pronounced as people will rely even more on the average rating than reading individual reviews.

Once your rating is damaged, it can be very hard to recover. Groupon delivers so many customers at once that the sheer volume of ratings they submit will take time to overcome.

Although I recommend against running Groupon for service businesses and restaurants, if you choose to run one, here’s my advice: treat Groupon customers as if they were your best customers.