One of the most active areas in online advertising is local deals. And the biggest part of that market appears to be social network-driven, deal-based discount gift certificates (or paid coupons). There are several agencies that facilitate these deals, such as Groupon, LivingSocial, and a large number of other competitors. Below is a description of how the deals work from each entity’s point of view.

Let’s start by explaining the business model of Groupon and similar firms. They are advertising and promotion agencies that focus on small customer service oriented businesses. Groupon has thousands of sales people, designers, and copywriters located in big cities in the U.S. and several international markets calling on small businesses and selling gift certificate deals. In this sense, their efforts are similar to those of direct mail companies, newspaper advertising sales teams, and yellow pages publishers.

The client firm agrees to allow the agency to sell gift certificates to customers at a deep discount, typically half off, such as $15 for $30 worth of goods. The client also agrees to pay the agency a fee for handling the promotion, typically half of the amount collected from customers, so $7.50 for each $30 gift certificate sold.  In exchange, the agency guarantees a certain minimum number of customers, most of whom will be new, will accept the deal or else the deal will be cancelled. The client does not pay anything upfront for this promotional work, Groupon and its ilk only get paid as the gift certificates are sold.

On the promotion side, these agencies maintain opt-in email subscriber lists of consumers who are  interested in receiving daily notifications of deals that are relevant to them. The agencies use recruitment techniques to grow their subscriber lists as large as possible. They encourages social interaction among the members in an attempt to increase the number of participants for each gift certificate deal and to increase the number of gift certificates purchased by each member.

There are two common attributes of the deals offered. First is that a minimum number of purchases must be made or the deal will expire. This encourages members who like the deal and have accepted the offer to solicit their friends to also purchase the gift certificate. The other is that the deal expires after 24 hours or after a maximum number of certificates is sold. This creates a sense of urgency that encourages rapid purchase decisions.

Despite the tremendous growth of group shopping, not all small businesses have been happy with the results. Part of the problem is that small businesses are often not geared to handle a large surge in customers. They underestimate the effect of long waits on profitability and on customer satisfaction. They also don’t have the customer relationship management (CRM) programs in place to convert first time visitors into long-term loyal customers.

Below are a couple of videos that describe the problem. The first one is an AP news story about a nail salon that is overwhelmed when deal seeking Groupon customers crowd out the regulars. It makes what should be a pleasant relaxing experience into a stress-filled, impersonal exercise. The second video is an interview by blogger Rakesh Agrawal that appeared in TechCrunch and has become a viral hit.

GrouponAP

Groupon impact on Crystal Nails in Chicago. Video by Associated Press

GrouponPosie

Groupon impact on Posie’s Café in Portland. Video by Rakesh Agrawal

If you want a first-hand account, you can read a Sep 2010 blog post by Jessie Burke, the owner of Posie’s Café.

AmazonLocal Launches in Seattle

Earlier this year, Amazon made a small investment in LivingSocial, one of the social network, deal-based coupon providers described above. About the same time, Groupon, the largest coupon deal provider rebuffed a multi-billion dollar offer from Google and is expected to launch an IPO later this year.

Last month, and only a day apart, both Amazon and Google jumped into the coupon deal business. Google launched Google Offers in Portland, Oregon. Amazon launched AmazonLocal in Boise, Idaho. This week AmazonLocal expanded into Seattle, where I live. For now, it appears that AmazonLocal is merely wrapping its logo around offers sold by LivingSocial (see example below).

AmazonLocal

Example offer from AmazonLocal. Image from email

I’m not drawn to mob activity, so I’ve never bid on an auction item on eBay and have never participated in a coupon deal. But lots of people find this type of buying fun. All I can say is that growth at eBay stalled after expert buyers automated auction purchases by bidding at the last second, stealing away deals from novices. Bidding at auctions stopped being fun and became a job. eBay is still looking for a new business model to jump-start growth.

Incidentally, eBay is exploring group-buying coupons too. It is testing a website called Kuponan in the Philippines and Social Shopping in India. However, in the U.S., eBay has decided to partner with Groupon for now.

Facebook is starting a group buying service called Deals on Facebook. As you can see, the barriers to entry into this market are low, which is why I am surprised that Google felt it needed to buy Groupon and that Groupon’s IPO is so wildly anticipated.

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