So, You Want Loyal Customers? Is Groupon The Answer?

Once the initial firestorm of excitement cooled, a real question started to emerge about the power of "daily deal" sites like Groupon and Living Social: can they actually create customer loyalty?

The premise behind massive merchant discounts is simple: use cost-savings to get customers in the door, and then let the quality of the products make them keep coming back.

Banking on the power of free samples, quick-service Chinese food and cinnamon roll stands successfully apply this discount model in mall food courts across North America. And, if they can do it, why would those merchants who effectively use Groupon to do the same thing on a massive scale not experience similar success? Why would giving customers an inexpensive crack at their high-quality goods and services not turn them into repeat buyers?

Unfortunately, the nature of daily deal discounts creates a vastly different scenario for those merchants who get involved. Instead of giving customers a "tease" or "taste" of the product, they are often giving an entire offering away, often at an unsustainable price point. And instead of capitalizing on existing product demand, they are often using these attractive price points to artificially create demand—demand that often only drives a one-time (or short-term) consumption.

When sites like Groupon and Living Social first started to click, deals related to services like hot air balloon rides and helicopter lessons generated significant attention. These deals were often based on the opportunity to enjoy exciting, one-time experiences at a non-prohibitive price point, rather than the opportunity to find a better alternative to a product one consumes on a regular basis.

With that philosophy, the deals were particularly attractive to those least likely to become full-time, loyal customers; to people who would never consider paying for flying lessons or laser teeth-whitening if the price were not so enticing.

Even in the case of merchants with products more-typically demanded by customers, such as restaurants, e-tailers, cinemas and playhouses, the deal itself—not interest in discovering a new favorite place to shop or eat—might be the only motivator for customer participation. If the unique "attraction" of that deal goes away, so, too, might customer interest. Four friends who give a Groupon merchant $20 for a large pizza-pie and 4 beers are not necessarily looking to determine whether that meal should constitute a $50/night Friday ritual—they might just want to enjoy the one-time, super-cheap experience.

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Similarly, to the extent that the $20 price point gives them sufficient food and drink, they might not be prompted to spend a single extra cent at the restaurant. If the restaurant broke even or even lost money on its daily deal and the customer spends nothing more, there was absolutely no reason to entice the customer in the first place.

Insofar as the daily deal model sells stand-alone experiences and events, merchants cannot blindly approach it as a means of getting customers to sample their products.

And so enters the key challenge companies like Groupon face in sustainably attracting quality merchants to its service: proving that those who purchase daily deals can be consistently be converted into recurring (or at least return) customers.

In response, a number of daily deal sites have begun investigating and introducing initiatives centered on creating customer loyalty.

Just a day after daily deal site BuyWithMe launched its Merchant Connect program to track the ROI and customer loyalty created by its servicecomes news that Groupon is unveiling Groupon Rewards, a loyalty program that rewards customers when they hit certain spending thresholds at the merchants.

"Consumers earn rewards at participating merchants simply by paying with the credit or debit card they have on file at Groupon.com. After spending an amount set by the merchant, the consumer unlocks the ability to purchase a special Groupon for that business," the company explains in a blog post.

Customer temptation will come from the fact that the rewards can carry steeper discounts than the initial Groupons. Merchant appeal, meanwhile, exists in the fact that customers are now primed for upsell opportunities, which will increase the ROI of the money invested (sunk) in the initial deal.

Groupon Rewards also adds valuable context to the engagement between the merchant and the customer. If a customer is willing to spend money beyond the initial coupon for the opportunity to get another deal, it is far more conceivable that he likes the product and can be converted into an actual, loyal customer. And, even if that person remains "deal-motivated," any merchant confident in its offerings would have to believe that the more a customer experiences, the more likely he is to be convinced.

Further, for those still skeptical about the initial "daily deal" concept, Groupon is allowing merchants to only utilize the rewards program—effectively establishing itself as a third-party customer loyalty vendor.

As the customer rewards concept has received ample praise recently—companies like Rite-Aid and Discover credited their rewards programs for favorable earnings results—Groupon’s entry into the rewards space should prove helpful in keeping the brand powerful ahead of its desired IPO. It also provides a direct answer to criticism about the daily deal service’s inability to create loyal customers.

What will be interesting, however, is to see how the original daily deal program transforms in the coming months. Touted as the "customer acquisition" component of Groupon’s "trifecta" (which also includes on-demand traffic via Groupon Now and the new Rewards program), will the daily deal concept remain attractive to those who, when focused on customer acquisition, only really want customers who can be converted into recurring, loyal ones? Or, will they all flock directly (and exclusively) to the Rewards program?