The Price Cut Game is a Race to the Bottom

I bought a Groupon for a facial last week for $50. I thought it was a great deal. Having worked in marketing strategy for large corporations for over 15 years, I started thinking about how this sort of discounting would mean for small businesses.

It is counterproductive. The way Groupon works is that they encourage deep discounts, often over 50% off listing price. Then, Groupon would split the proceeds with the merchant 50/50. This means that the spa would receive only $25 for the hour facial that I bought. Subtracting the salary of the esthetician and overhead, what is left for the spa would be quite meager. Why do small business still do this? An easy answer is that small businesses are attracted to the exposure that platforms such as Groupon and Living Social bring. However, does exposure translate to the right kind of customers?

In large corporations, we adopt a practice called customer segmentation. With complex analytics, we discover that about 80% of profits come from only 20% of our customers. So finding the right kind of customers is critical. What one would hope to achieve is to use a discounted price to get the customer to “try out” the product or service, and hopefully they like it so much that they would return. What most small business owners do not see is that the customers they attracted from platforms such as Groupon and Living Social are not the right kind of customers, i.e. they will not be returning customers. They only gain “deal seekers.” Once the deal is over, those customers will disappear. Moreover, the small business’ competitors can always cut the price even lower. The questions then becomes, “how low will you go?” It is a race to the bottom.

How, then, can small business gain repeating customers? The answer is two fold: keep promotion cost down, and offer distinguishable packages. There are a number of platforms that do not charge upfront advertising fees. I recently found an interesting platform called Gainko.com. Unlike other similar sites, it is free to list and even to own a virtual storefront. So far, it is completely free for small businesses. Small businesses should take advantage of all the freebies that current technology has to offer.

Offering distinguishable packages requires a bit more thinking. Most small businesses underestimate the power of bundling. When bundling, small businesses can increase the size of the profitable customer segments and less discounting is required. Additionally, superior customer service will give the business a leg up over their competitors. Whatever the business is, there will always be ways to distinguish its products and services in highlighting specific features that drew past customers. All the business has to do is looking into the past purchase behavior from them.