To Groupon or Not to                                               Groupon: The Profitability of                          ...
To Groupon or Not to Groupon:                 The Profitability of Deep Discounts∗        Benjamin Edelman†                ...
1     IntroductionA variety of web sites now sell discount vouchers for services as diverse as restaurants,skydiving, and ...
in anticipation of voucher usage. Finally, in Section 5, we discuss implications of ourresults for merchants and voucher s...
literature on the advertisement of experience goods, as advertising in our setting servesthe purpose of awareness, rather ...
the expected discounted future value, rvi − p + δr(vi − p), is positive, i.e. if                            max{rvi − p, r...
α + δr                                      v (p) ≡                                      ˜         p > v(p).              ...
then there is some α < 1 such that offering a discount voucher with discounted price ofαp∗ ≥ αp∗ is profitable, so long as β...
vouchers is ambiguous. For a fixed p∗ , the additional profits from advertising are higherwhen the valuations drawn from G(v...
• Population share: If many consumers come from the low-value population (i.e. if λ      is high), then it is difficult for ...
The profits from allowing the purchase of a second voucher are negative at α = 0, soif they are positive for some α and β t...
increase had it simply lowered its prices 25%; clearly vouchers play an important role inmaking consumers aware of discoun...
ReferencesBagwell, K. (1987). Introductory price as a signal of cost in a model of repeat business.  Review of Economic St...
Overly, S. (2010, December 6). LivingSocial deals draw mixed merchant reactions. Wash- ington Post.Salop, S. and J. Stigli...
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To Groupon Or Not

  1. 1. To Groupon or Not to Groupon: The Profitability of Deep Discounts Benjamin Edelman Sonia Jaffe Scott Duke Kominers Working Paper 11-063Copyright © 2010 by Benjamin Edelman, Sonia Jaffe, and Scott Duke KominersWorking papers are in draft form. This working paper is distributed for purposes of comment anddiscussion only. It may not be reproduced without permission of the copyright holder. Copies of workingpapers are available from the author.
  2. 2. To Groupon or Not to Groupon: The Profitability of Deep Discounts∗ Benjamin Edelman† Sonia Jaffe‡ Scott Duke Kominers§ December 17, 2010 Abstract We examine the profitability and implications of online discount vouchers, a new marketing tool that offers consumers large discounts when they prepay for participating merchants’ goods and services. Within a model of repeat experience good purchase, we examine two mechanisms by which a discount voucher service can benefit affiliated merchants: price discrimination and advertising. For vouchers to provide successful price discrimination, the valuations of consumers who have access to vouchers must systematically differ from—and be lower than—those of consumers who do not have access to vouchers. Offering vouchers is more profitable for merchants which are patient or relatively unknown, and for merchants with low marginal costs. Extensions to our model accommodate the possibilities of multiple voucher purchases and merchant price re-optimization. Keywords: voucher discounts, Groupon, experience goods, repeat purchase. ∗ The authors appreciate the helpful comments and suggestions of Peter Coles, Clayton Featherstone,Alvin Roth, and participants in the Harvard Workshop on Research in Behavior in Games and Markets.Kominers gratefully acknowledges the support of a National Science Foundation Graduate Research Fel-lowship, a Yahoo! Key Scientific Challenges Program Fellowship, and a Terence M. Considine Fellowship. † Harvard Business School; ‡ Department of Economics, Harvard University; § Department of Economics, Harvard University, and Harvard Business School; 1
  3. 3. 1 IntroductionA variety of web sites now sell discount vouchers for services as diverse as restaurants,skydiving, and museum visits. To consumers, discount vouchers promise substantialsavings—often 50% or more. To merchants, discount vouchers offer opportunities forprice discrimination as well as exposure to new customers and online “buzz.” Best knownamong voucher vendors is Chicago-based Groupon, a two-year-old startup already toutinga ten-digit valuation and, purportedly, recently rejecting a $6 billion acquisition offer fromGoogle (Surowiecki (2010)). Hundreds of websites offer discount schemes similar to thatof Groupon.1 The rise of discount vouchers presents many intriguing questions: Who is liable if amerchant goes bankrupt after issuing vouchers but before performing its service? Whathappens if a merchant simply refuses to provide the promised service? Since vouchersentail prepayment of funds by consumers, do buyers enjoy the consumer protections manystates provide for gift certificates (such as delayed expiration and the right to a cashrefund when value is substantially used)? Must consumers using vouchers remit taxon merchants’ ordinary menu prices, or is tax due only on the voucher-adjusted pricesconsumers actually pay? What prevents consumers from printing multiple copies of adiscount voucher and redeeming those copies repeatedly? To merchants considering whether to offer discount vouchers, the most importantquestion is the basic economics of the offer: Can providing large voucher discounts actu-ally be profitable? Voucher discounts are worthwhile if they predominantly attract newcustomers who regularly return, paying full price on future visits. But if vouchers promptmany long-time customers to use discounts, offering vouchers could reduce profits. Formost merchants, the effects of offering vouchers lie between these extremes: vouchers bringin some new customers, but also provide discounts to some regular customers. In thispaper, we offer a model to explore how consumer demographics and offer details interactto shape the profitability of voucher discounts. We illustrate two mechanisms by which a discount voucher service can benefit affil-iated merchants. First, discount vouchers can facilitate price discrimination, allowingmerchants to offer distinct prices to different consumer populations. In order for voucheroffers to yield profitable price discrimination, the consumers who are offered the voucherdiscounts must be more price-sensitive (with regards to participating merchants’ goods orservices) than the population as a whole. Second, discount vouchers can benefit merchantsthrough advertising, by informing consumers of a merchant’s existence. For these adver-tising effects to be important, a merchant must begin with sufficiently low recognitionamong prospective consumers. The remainder of this paper is organized as follows. We review the related literaturein Section 2. We present our model of voucher discounts in Section 3, exploring pricediscrimination and advertising effects. In Section 4, we extend our model to consider thepossibility of consumers purchasing multiple vouchers and of merchants adjusting prices 1 Seeing these many sites, several companies now offer voucher aggregation. Yipit, one such company,tracked over 200 different discount voucher services as of December, 2010. 2
  4. 4. in anticipation of voucher usage. Finally, in Section 5, we discuss implications of ourresults for merchants and voucher services.2 Related LiteratureThe recent proliferation of voucher discount services has garnered substantial press: amultitude of newspaper articles and blog posts, and even a short feature in The NewYorker (Surowiecki (2010)). However, voucher discounts have received little attention inthe academic literature. To our knowledge, the only prior academic study of online voucher discounts is thesurvey work of Dholakia (2010). In that work, Dholakia (2010) polls businesses that of-fered Groupon discounts. Echoing sentiments expressed in the popular press,2 Dholakia(2010) finds mixed empirical results: some business owners speak glowingly of Groupon,while others regret their voucher promotions. Unlike the survey approach of Dholakia(2010), we seek to understand voucher discount economics on a theoretical level. Ourresults indicate that voucher discounts are naturally good fits for certain types of mer-chants, and poor fits for others; these theoretical observations can help us interpret therange of reactions to Groupon and similar services. Although there is little academic work on voucher discounts, a well-established liter-ature explores the advertising and pricing of experience goods, i.e. goods for which somecharacteristics cannot be observed prior to consumption (Nelson (1970, 1974)). The parsimonious framework of Bils (1989), upon which we base our model, studieshow prices of experience goods respond to shifts in demand. Bils (1989) assumes thatconsumers know their conditional valuations for a firm’s goods, but do not know whetherthat firm’s goods “fit” until they have tried them.3 Analyzing overlapping consumer gen-erations, Bils (1989) measures the tradeoff between attracting more first-time consumersand extracting surplus from returning consumers. Meanwhile, much of the work on experience goods concerns issues of information asym-metry: if a merchant’s quality is unknown to consumers but known to the merchant, thenadvertising (Nelson (1974); Milgrom and Roberts (1986)), introductory offers (Shapiro(1983); Milgrom and Roberts (1986); Bagwell (1990)), or high initial pricing (Bagwelland Riordan (1991); Judd and Riordan (1994)) can provide signals of quality. Of this lit-erature, the closest to our subject is the work on introductory offers. Voucher discounts, aform of discounted initial pricing, may encourage consumers to try experience goods theyotherwise would have ignored. However, we identify this effect in a setting without asym-metric information regarding merchant quality—consumer heterogeneity, not informationasymmetries, drives our main results.4 Additionally, our work differs from the classical 2 For example, Overly (2010) reports on Washington merchants’ mixed reactions to the LivingSocialvoucher service. 3 Firms know the distribution of consumer valuations and the (common) probability of fit. 4 Of course, our treatment of advertising includes a very coarse informational asymmetry: some con-sumers are simply not aware of the merchant’s existence. However, conditional upon learning of themerchant, consumers in our model receive more information than the merchant does about their valua- 3
  5. 5. literature on the advertisement of experience goods, as advertising in our setting servesthe purpose of awareness, rather than signaling.5 A substantial literature has observed that selective discounting provides opportunitiesfor price discrimination. In the settings of Varian (1980), Jeuland and Narasimhan (1985),and Narasimhan (1988), for example, merchants engage in sale pricing in order to attractlarger market segments.6 Similar results have been found to motivate the use of cents-offcoupons, certificates which promise discounts on repeat (rather than initial) purchases(Cremer (1984); Narasimhan (1984)). We bring the insights of the literature on sale-driven price discrimination to bear on voucher discounting—a new “sale” technology. Likethe price-theoretic literature which precedes our work, we find that price discriminationdepends crucially upon the presence of significant consumer heterogeneity. Although our work is theoretical, perhaps most central for an empirical comparisonof our work to its antecedents is the observation that the prior theoretical literature,including the articles discussed above, has considered only marginal pricing decisions.The previous work on experience goods and price discrimination does not consider deepdiscounts of the magnitudes now offered by voucher services.3 ModelOffering a voucher through Groupon has two potential advantages: price discriminationand advertising. We present a simple model in which a continuum of consumers havethe opportunity to buy products from a single firm. The consumers are drawn from twopopulations, one of which can be targeted by voucher discount offers. First, in Section 3.1,we consider the case in which all consumers are aware of the firm and vouchers serve onlyto facilitate price discrimination. Then, in Section 3.2, we introduce advertising effects.We present comparative statics in Section 3.3. Our model has two periods, and the firm ex ante commits to a price p for bothperiods. The firm and consumers share a common discount factor δ. Following the setupof Bils (1989), consumers share a common probability r that the firm’s product is a “fit.”Conditional on fit, the valuation of a consumer i for the firm’s offering is vi . A consumer i purchases in the first period if either the single-period value, rvi − p, ortions. This is in sharp contrast to much of the previous work on experience goods, in which merchantscan in principle exploit private quality information in order to lead consumers to purchase undesirable(or undesirably costly) products (e.g., Shapiro (1983); Bagwell (1987)). 5 In the classical theory of experience goods, advertising serves a “burning money” role. Merchants withhigh-quality products can afford to advertise more than those with low-quality products can, as consumersrecognize this fact in equilibrium and flock to merchants who advertise heavily (Nelson (1974); Milgromand Roberts (1986)). In our model, advertising instead serves to inform consumers of a merchant’sexistence; these announcements are a central feature of the service voucher vendors promise. 6 In other models, heterogeneity in consumer search costs (e.g., Salop and Stiglitz (1977)) or reservationvalues (e.g., Sobel (1984)) motivate sales. Bergemann and V¨lim¨ki (2006) study the pricing paths of a a“mass-market” and “niche” experience goods, finding that initial sales are essential in niche markets toguarantee traffic from new buyers. 4
  6. 6. the expected discounted future value, rvi − p + δr(vi − p), is positive, i.e. if max{rvi − p, rvi − p + δr(vi − p)} ≥ 0.For δ > 0, there is an informational value to visiting in the first period: if a consumerlearns that the firm’s product is a fit, then the consumer knows to return. As a result, allconsumers with values at least 1 + δr v(p) ≡ p>p r + δrpurchase in the first period. To consider the effects of offering discounts to a subset of consumers, we assume thereare two distinct consumer populations. Proportion λ of consumers have valuations drawnfrom a distribution with cumulative distribution function G, while proportion 1 − λ havevaluations drawn from a distribution with cumulative distribution function F . We denoteby V ≡ supp(F ) ∪ supp(G) the set of possible consumer valuations. We assume thatG(v) ≥ F (v) for all v ∈ V , i.e. that the valuations of consumers in the G population aresystematically lower than those of consumers in the F population. The firm faces demand λ(1 − G(v(p))) + (1 − λ)(1 − F (v(p)))in the first period, and fraction r of those consumers return in the second period. Thefirm maximizes profits π given by π(p) ≡ (1 + δr)(λ(1 − G(v(p))) + (1 − λ)(1 − F (v(p))))(p − c),where c is the firm’s marginal cost. The first-order condition of the firm’s optimizationproblem is 1 + δr ∗ λ(1 − G(v ∗ )) + (1 − λ)(1 − F (v ∗ )) − ((p − c)(λg(v ∗ ) + (1 − λ)f (v ∗ )) = 0 (1) r + δrwhere p∗ is the optimal price and v ∗ ≡ v(p∗ ). We assume that the distribution of con-sumers is such that profits are single-peaked, so that p∗ is uniquely defined.3.1 Discount VouchersAfter setting its optimal price p∗ , the firm is given the opportunity to offer a discountvoucher.7 Only fraction γ of consumers in the G population have access to the discountvoucher system. (Consumers in the F population cannot buy vouchers.) Through thevoucher system, these consumers have the opportunity to purchase from the firm at adiscounted price αp in the first period. If α > r, then everyone who purchases in the firstperiod will return if the firm is a fit; the minimal valuation of consumers who purchase is 7 For now, we assume the firm did not consider the possibility of a voucher when setting its price. InSection 4.2, we consider the possibility of re-optimization. 5
  7. 7. α + δr v (p) ≡ ˜ p > v(p). r + δrIf α < r, then some consumers i with vi < p will purchase in the first period but will notreturn (even if the firm is a fit). Those will be the consumers i for whom rvi − αp > 0 and vi < p. The voucher service retains proportion 1 − β of the voucher sales price, so the firm’srevenue from each discount voucher is αβp∗ . Defining v ≡ v (p∗ ) and v ≡ α p∗ , we see that ˜ ˜ ˆ roffering discount vouchers yields the following change in profits: ∆π(p∗ ) = ((1 + rδ)(p∗ − c)(G(v ∗ ) − G(˜)) − (1 − αβ)p∗ (1 − G(˜))) v v α > r, γλ ∗ ∗ ∗ ∗ (2) (p − c)(G(v ) − G(ˆ) + δr(G(v ) − G(p )) − (1 − αβ)p (1 − G(ˆ)) α < r. v v The first term of (2) represents the increased profits from the gain in consumersG(v ∗ ) − G(˜); the second term measures profits lost by lowering the first-period price vfrom p∗ to αβp∗ . Note that γ affects the magnitude of the change in profits, but not thesign.8 The following result is therefore immediate.Proposition 1. If it is profitable to offer the voucher discount to one consumer (randomlydrawn from the G population), then it is more profitable to offer the voucher discount toall such consumers. When α = 1, introducing the discount voucher does not affect consumers’ purchase de-cisions (v ∗ = v ), as consumers are offered no actual “discount.”9 Meanwhile, if consumers ˜who use discount vouchers have the same distribution of valuations as other consumers(F (v) = G(v) for all v), then the first- and second-order conditions show that the changein profits is maximal at α = 1, so if α < 1 then vouchers are unprofitable. Conversely, ifthe distributions of valuations are well behaved and G is to the left of F , then there issome α < 1 such that offering a discounted price of αp ≥ αp can be profitable. This isbecause the firm wants to offer a lower price to consumers from the G population; settingα < 1 brings the firm’s price to the G population closer to the optimal price for thatpopulation. We formalize these observations in the following proposition.Proposition 2. If F (v) = G(v) for all v and min{α, β} < 1, then the introduction of adiscount voucher yields a decrease in profit. By contrast, if F (v) < G(v) ∀v ∈ V, 8 By contrast, λ affects p∗ and can therefore affect the sign of ∆π(p∗ ). 9 If β < 1, then vouchers decrease firm profits when α = 1 because the voucher service keeps a cutof revenue. But this case is degenerate: if—as we have assumed in this section—the only benefit ofvouchers is price discrimination, then certainly the firm will only use vouchers if they offer actual pricediscrimination opportunities. 6
  8. 8. then there is some α < 1 such that offering a discount voucher with discounted price ofαp∗ ≥ αp∗ is profitable, so long as β is sufficiently close to 1. The conditions of Proposition 2 are sufficient for the result, but not necessary. Indeed,whenever F and G are such that the firm’s optimal price for consumers from the G pop-ulation is lower than the firm’s optimal price for the combined distribution of consumers,there are some α, β < 1 for which the discount voucher is profitable.3.2 Advertising EffectsIn addition to offering consumers discounts, vouchers may also serve to inform consumersabout the existence and details of affiliated firms. We suppose that fraction κ of consumers know about a participating firm, but fraction1 − κ do not. The uninformed consumers may have high valuations for the firm’s product(conditional on learning about the firm), but they cannot purchase without first beinginformed of the firm’s existence. If the probability of knowing about a firm is constant across consumers (independentof valuations), then a firm’s profits absent an online voucher are given by πκ (p∗ ) ≡ κπ(p∗ );the optimal price p∗ is unchanged from that defined by (1). In that case, if a firm offersa voucher, then all consumers receiving the voucher learn of the firm’s existence. Theimplied change in profits is: ∆πκ (p∗ ) = (αβp∗ − c + δr(p∗ − c))(1 − G(˜)) v α > r, κ∆π(p∗ ) + γλ(1 − κ) ∗ ∗ ∗ (3) (αβp − c)(1 − G(ˆ)) + δr(p − c)(1 − G(p )) α < r. v Because uninformed consumers do not purchase absent the voucher, no profits areforegone by offering those consumers discounted pricing. Thus, so long as the discount isnot so big that losses in the first period outweigh gains in the second period, the secondterm in (3) is positive. A sufficient (but not necessary) condition for this to occur is thatthe firm’s per-voucher revenue is larger than its marginal cost: αβp∗ ≥ c. (4)This condition (4) is not sufficient for voucher profitability absent the advertising effect—it does not guarantee that ∆π(p∗ ) is positive. However with advertising, as long ascondition (4) holds, vouchers are always profitable for “sufficiently unknown” firms asthere is always some κ > 0 such that the second term of (3) dominates the first.Proposition 3. Suppose that αβp∗ ≥ c. Then, there exists some κ > 0 such that offering ¯vouchers is profitable whenever κ < κ. ¯ Unlike in the pure price discrimination case, when vouchers provide advertising benefitsthe effect of the difference between the distributions of valuations on the profitability of 7
  9. 9. vouchers is ambiguous. For a fixed p∗ , the additional profits from advertising are higherwhen the valuations drawn from G(v) are higher (smaller difference between distributions).However, changing G(v) changes p∗ , so that the net effect of changing G depends on theshapes of F and G.3.3 Example Comparative StaticsTo obtain closed-form comparative statics, we consider the case where valuations areuniformly distributed in each population, but the population means vary:   0 v < 0  0  v < −µ F (v) = v v ∈ [0, 1] G(v) = v + µ v ∈ [−µ, 1 − µ]   1 v > 1, 1 v > 1 − µ.  Here, µ parameterizes the difference between the two distributions: it measures theamount that G(v) is “shifted to the left” relative to F (v). For F and G so defined, the optimal price p∗ is given by: 1 (1 + δ) p∗ = c+ (1 − λµ)r . 2 (1 + δr)In this expression, (1 − λµ)r = ((1 − λ) · 1 + λ · (1 − µ))r is the weighted average of 1+δthe maximal valuations of the two consumer populations. The multiplicative factor 1+δrrepresents the premium consumers are willing to pay because of the information value ofpurchasing in the first period. For simplicity, we consider the case in which β = 1 (the voucher vendor charges no fee),α > r (the proportion of the price paid with the voucher is greater than the probability offit), and κ = 1 (there are no advertising effects). With these assumptions, the minimumdifference between the distributions necessary for a discount voucher to be profitable,denoted µ, is given by (1 − α)(r(1 + δ) + c(1 + δr)) µ= . (1 + δ)r(2(1 + δr(1 − λ)) − λ(1 + α))The comparative statics of µ are intuitive. • Patience: The change in firm profits increases in δ, the discount factor, while µ decreases in δ. This is consistent with the interpretation that discount vouchers let a firm accept losses (decreased profits) in the short run in exchange for increased profits in the future, a benefit more valuable to patient firms. • Costs: Increased marginal costs lower the change in profits and raise the thresh- old for profitability. Since offering a discount voucher increases quantity sold and decreases per-unit price, it is more profitable for firms with lower marginal costs. 8
  10. 10. • Population share: If many consumers come from the low-value population (i.e. if λ is high), then it is difficult for the voucher service to be profitable for firms. When λ is high, voucher users’ valuations significantly affect the base price p∗ so that, for a given α, price discrimination is less profitable. • Discounted price: Although the effect of α on the change in profits is ambiguous, increasing α unambiguously decreases the threshold µ. This is intuitive, as the less of a price decrease the voucher represents, the less heterogeneity across populations is required in order for the discounted voucher to be profitable. • Probability of fit: Like with α, the effect of a higher probability of fit r on the change in profits is unclear, but increasing r unambiguously lowers µ.4 Extensions4.1 The Possibility that Consumers Might Purchase Multiple VouchersSo far we have assumed that each consumer can purchase at most one voucher, a re-striction which lets us model the discounted price αp∗ as being available only in the firstperiod. However, if consumers can buy multiple discount vouchers, then they can enjoythe discounted price in both periods. If all discount vouchers must be purchased in the first period (as is the case withGroupon and similar voucher vendors), then a consumer i with valuation vi only finds itprofitable to buy a second voucher if the expected value of second-period consumption isgreater than the present voucher cost, that is, if δrvi ≥ αp∗ .Consumers with valuations vi ∈ [ α p, rδ p] buy a discount voucher and do not return. r α αConsumers with vi ∈ [ rδ p, p] only return if they can buy two vouchers (and the firm is amatch). Consumers with vi > p return whenever the firm’s product is a match. The profits in the first period are the same as when consumers only purchase a singlediscount voucher. However, if consumers are able to purchase multiple discount vouchers,then some consumers who would normally return at full price instead return with a secondvoucher. It follows that allowing consumers to purchase multiple discount vouchers is onlyprofitable if the firm seeks to offer starkly different prices to the two consumer populations.Proposition 4. Suppose that there exist α and β such that it is profitable, relative tothe possibility of allowing each consumer only one voucher purchase, for a firm to allowconsumers to purchase two vouchers. Then, there exist α and β with α β < αβ suchthat it is profitable to offer a single voucher at rates α and β , but allowing consumers topurchase an additional voucher at those rates decreases profits. 9
  11. 11. The profits from allowing the purchase of a second voucher are negative at α = 0, soif they are positive for some α and β they must cross zero at intermediate values of α , β .Since the profits from allowing the second voucher are lower than the profits from initiallyoffering a voucher, it will still be profitable to offer a single voucher at those intermediatevalues.4.2 The Possibility that the Firm Might Re-optimize Its PricesIf the firm can adjust its posted prices to account for the presence of discount vouchers,then the firm will re-optimize to set a new price p∗ maximizing ˜ γλ(αβ p∗ − c + δr(˜∗ − c))(1 − G(˜(˜∗ ))) ˜ p v p + (1 + δr) λ(1 − γ)(1 − G(v(p))) + (1 − λ)(1 − F (v(p))) .Pricing at p∗ raises the profits from a discount voucher promotion and lowers the required ˜minimum difference between distributions required for voucher profitability. The prospectof adjusting prices places new importance on γ: the sign of the change in profits nowdepends on γ because the proportion of consumers receiving the discounted price affectsthe firm’s re-optimization. Even with the opportunity of price re-optimization, discount vouchers are not prof-itable when the two populations are identical (F (v) = G(v) for all v). Under the assump-tions of Section 3.3, for λ sufficiently large, µ is decreasing in γ. In this case the firmwould prefer to set different prices for the two consumer populations, it can do this moreeffectively when more of the G consumers may acquire vouchers (i.e. when γ is large).When γ is low, the firm is limited in the extent to which it can raise the price faced byconsumers from the F population because many G-population consumers face the sameprice.5 Discussion5.1 Implications for MerchantsOur results offer practical advice for firms considering whether to offer discount vouchers.Our discussion in Section 4.1 indicates that a firm might want to disallow purchase ofmultiple discount vouchers. But as argued by Friedman and Resnick (2001), firms facesubstantial practical difficulties in implementing this restriction. What stops consumersfrom creating multiple accounts and purchasing one voucher through each such account? To date, it appears that few firms have adjusted prices in anticipation of many con-sumers using discount vouchers. However, we did notice a sharp price increases at onelocal restaurant that offers frequent discounts through discount voucher services. Visitingthis restaurant, our experience has been that at least half of consumers come bearing dis-count vouchers. Vouchers have noticeably increased the restaurant’s traffic, yet at prices(net of voucher services’ fees, even bearing in mind the price increase) that surely reducethe restaurant’s margins. We doubt the restaurant would have enjoyed a similar traffic 10
  12. 12. increase had it simply lowered its prices 25%; clearly vouchers play an important role inmaking consumers aware of discounts. Yet with voucher services retaining as much ashalf the consumer’s prepayment, heavy reliance on discount voucher marketing comes ata significant cost. Firms would do well to assess whether their voucher-using customers have alreadyvisited and previously paid full price. Firms should also measure how many voucher-using customers later come back without vouchers. In principle, credit card systemscould track this information with little harm to customer privacy or data security. Butin practice, most firms currently lack the tools or expertise to run such analyses.5.2 The Future of Voucher ServicesOur model reveals that a discount voucher service is more likely to be profitable for af-filiated firms, all else equal, if customers using that service have valuations substantiallydifferent from (and in particular, below) those of other customers. But notice the difficultyas the voucher service grows: As more consumers use vouchers, voucher-users necessarilycome to resemble average consumers, so the use of a voucher comes to convey less infor-mation about a consumer’s valuation. Thus, as voucher services grow, their affiliates willhave to rely on voucher advertising rather than voucher price discrimination. Currentvoucher services’ profits and recent growth may therefore not be good predictors of thoseservices’ future values. Meanwhile, we are struck by the large fees that leading discount voucher services cur-rently charge to participating firms. Groupon charges 50% of voucher price: if a restaurantoffers a $20 voucher for $40 of food, Groupon retains $10—a large fee relative to Groupon’smarginal costs of voucher provision (Groupon (2010)). As our results in Section 3.1 indi-cate, such large fees may impede firms’ usage of discount vouchers. However, competitionamong discount voucher services may drive down these fees.10,11 Recently, Groupon has begun to unbundle some of its services. As of December, 2010,Groupon is charging just 10% to a firm which only wants its offer to appear followinguser searches, while continuing to require the 50% fee for Groupon’s traditional service offeaturing a merchant in a daily email to all consumers in a given city (Groupon (2010)).On one view, the 10% fee might look like a bargain to firms—10% is certainly far lessthan 50%. However, if Groupon’s low-priced service only gives a firm access to consumerswho already know about that firm, then it provides no advertising opportunities—onlyprice discrimination. 10 Small voucher services may charge fees as low as 10%. Yet small voucher services cannot providesubstantial advertising benefits. As a result, despite lower fees at small voucher services, many firmsprefer the larger services. 11 Another issue of competition in the voucher market is the possibility that a well-positioned competitor(such as Google, Facebook, or Yelp) could develop a similar service and promote that service to its existingusers. 11
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