Is Groupon Changing What People Are Willing to Pay?

How much does a spa treatment cost? A skydiving adventure? A sailing lesson? Price isn't what you or I think it should be -- or even what a merchant wants it to be. To paraphrase of the musings of Randall Tex Cobb as the "Mad Biker of the Apocalypse" in the epic film Raising Arizona, price is what the market will bear. Merchants who set prices too high go out of business. Merchants who set prices too low do the same, after running themselves ragged trying to keep up with customers.

So are group-buying website Groupon and its many competitors setting prices too low for many of their merchant users? This question is of particular importance as the group-buying phenomenon swims local, where merchants are customers' neighbors and first impressions are truly forever.

As I wrote in on DailyFinance last month, America is in a group-buying frenzy. The rapidly growing craze has spawned hundreds of clones and threatens to overwhelm many people's mailboxes with "Daily Deals." Hot startup and market leader Groupon just announced it plans on personalizing deals down to zip codes and has hired a programmer from Netflix (NFLX), the king of personal recommendations. That means Groupon plans to offer a multitude of deals each day targeted at different people, although individual offer recipients will only see one per day.

Between personalization and clones, group buying is spreading so rapidly that it's easy to predict that soon, pretty much everyone will be touched by the trend. What's far harder to predict is what the impact will be on how shoppers perceive fair value in a world saturated by group buying. By fair value, I mean a fair price paid for services rendered: a meal prepared, a night spent in a hotel, etc.

What's an Empty Hotel Room Worth?

Hotel companies already know this issue particularly well. They constantly face the problem that group buying addresses: a need to move expiring inventory that otherwise will be worthless shortly. A hotel room that sits unused is worth nothing. Similarly, a massage table at a San Francisco spa that sits unused for half the day is worth exactly half as much as it would be with patrons getting oiled up nonstop. The easy way to fill those extra rooms or empty tables would be to lower prices.

However, hotels are loath to do that. Why? Because when they cut prices, customers quickly grow accustomed to the new prices, after which raising rates again becomes exceedingly difficult. That's why hotels use all sorts of tricks to disguise the actual price paid for a room, ranging from extra-night-free deals, restaurant credits and offloading chunks of room inventory to travel agencies that package the rooms with flights and rental cars. They don't want customers to be able to easily figure out the "average" price because that would screen out people willing to pay more.

Not surprisingly, almost no one is willing to pay the full rate for hotel rooms. Now translate that same problem to the rest of the small-business world in the age of group buying. In the past, I assumed that if I wanted to go to a good Italian restaurant in San Francisco, I would need to pay the price on the menu. Now I'm awash in a flood of discount offers from pretty good Italian restaurants. If one impresses me with its cuisine, I might return and pay full price. But I also might wait until another deal from that restaurant appears. My perceived value of Italian dinners in San Francisco has, to some degree, been semi-permanently reset.

The Risk of Diluting Your Brand

How many other people have had their perceived values of various goods and services permanently reset by the growth of the group buying trend? I'd imagine it's a fair number. There is, after all, a very fine line between a "discovery engine" and a discount machine. The mom-and-pop merchants who dominate the group-buying scene already have fairly small profit margins, so a broad shift downward in the perceived value of their products could cause many of them serious problems.

I spoke to several merchants who had used group-buying services, and they generally praised such deals but expressed wariness that using them would dilute their brands. Several said they would offer discounts only through the sites once or twice a year. In my own in-box, I've noticed recently that more and more deals have had earlier expiration dates and stricter terms: stipulations such as "first-time user only." Spa offers appear increasingly restricted to lower-value or easier-to-deliver services. And restaurant deals are more and more broken up into multiple vouchers of smaller denominations that can't be used for the same meal.

Bbased on my unscientific observations, which are primarily confined to San Francisco, the merchants have likely recognized their perceived value problem and are hedging their bets. The more restrictive deals increase the likelihood that the purchased coupons will never be redeemed -- a huge windfall -- and the those coupons that are won't be for discounts that are as juicy.

Watered-down offers will inevitably result in watered-down interest, because customers aren't stupid. But small-business owners aren't either, and they're the ones who must find the balancing point between deals good enough to lure customers in, and deals so good they make customers rethink their idea of fair value.