What Deals on Facebook Means to the Group-Buying Coupon Business

Facebook dipped a big toe into the group discount waters on Tuesday, launching a five-city test of its Deals on Facebook service and pitting it against industry stalwarts Groupon and LivingSocial, as well as host of other smaller players. But though it's starting small and coming late to the game, analysts and merchants say they won't be surprised if the social networking titan soon poses a viable threat to market leader Groupon.

Facebook offers merchants a far greater number of potential customers than competitors with its more than 500 million users, and its technology makes it easier for merchants to account for folks as they redeem their coupons, analysts and merchants say. That doesn't bode well for Groupon or its investors as it eyes an IPO.

"Facebook made quite the momentous announcement," says Karsten Weide, an industry analyst with IDC. "It has a lot of distribution to users for its service, so it'll be challenging for Groupon. Facebook has a lot of traffic that they can drive to a deal offer that Groupon doesn't have."

Deals on Facebook was rolled out in Atlanta, Austin, Dallas, San Diego and San Francisco, with plans to potentially expand the test to other cities later.

Groupon declined to comment for this story.

Selling the Experience, Not the Discount

For local merchants that also engage in online sales, Facebook's large network of users should be a major selling point. It was for Christine Tran, owner of Artisan Wine Depot in Mountain View, Calif., one of the retailers participating in Facebook's Deals launch.

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Other issues that contributed to her decision included Facebook's technology, which allows her to use her Facebook account to track customers who sign up for the discount in real-time and then click on their names as they redeem it. She noted other group-buying websites tend to use a paper-and-pencil approach, sending merchants a document that requires them to scratch off customers' names as they redeem the discounts.

The clincher for Tran, however, was Facebook's approach of defining and emphasizing a customer experience in its advertising, rather than focusing on the size of the price cut. For example, the 25% discount Artisan offered for its limited-production wine tasting is displayed in smaller type than the headline that touts the tasting itself.

"Discount deals like Facebook's are a loss-leader for us," Tran says. "I consider this part of our advertising budget, but I also want to attract customers who'll want to come back later, not just for the deals. Facebook seemed interested in building our customer experience."

An Offer That's Right on Target

Pete Katz, managing partner of Counter Intelligence, expressed similar concerns when signing on for the launch of Deals on Facebook. Katz's company operates six franchises of The Counter, a gourmet hamburger chain, in the greater San Francisco Bay area and near Sacramento.

"One of the first questions is who is going to see this ad, are they in the right demographics and will they be new or existing customers using this coupon," Katz says. "We've used smaller, targeted group-buying [Web sites] in the past, and have had mixed results on getting repeat customers. We decided to participate because it would part of Facebook's Deals launch and we felt we would be targeting an audience that appealed to us because we're going for the more upscale customer base, and we were launching with similar companies, rather than just the coupon chasers."

Both Counter Intelligence and Artisan Wine Depot noted they had been approached by Groupon and other broad-based group-buying websites previously, but had declined because they didn't see them as a suitable fit. Katz said he has preferred to work with more niche group-buying sites and may continue work with Facebook after the launch depending on the results this offer gets. Tran, meanwhile, says she wanted to experiment with Facebook's program before branching out, and doesn't want several discount programs going simultaneously, given that she -- like most retailers -- is using her group-buying discount as a combination of advertising and a loss leader.

Merchants note that group-buying offers can be a double-edged sword. By offering their products and services at a large discount, they may generate a lot of traffic. But the discounted prices that are paid are usually split down the middle with the group-buying website, almost certainly meaning the coupons are sold at a loss. In other words, merchants can't make up their losses by pushing more volume in sales. If they don't generate repeat business, the offers don't work.

Consumers, in some cases, are also feeling poorer despite all the savings, given that discount frenzy can drive many to overspend on products and services that they would otherwise pass on.

Groupon's Biggest Challenge (and It Isn't Facebook)

Meanwhile Groupon, Facebook and their competitors face a challenge in the group-buying business too, and perhaps not the one you'd expect: For them, the real difficulty lies in finding the right merchants to host on their group-buying sites, says Sucharita Mulpuru, a principal analyst with Forrester Research.

"The greatest challenge is not attracting customers but is merchant acquisition," Mulpuru says. "Groupon's biggest challenge day after day is finding great, compelling deals." Facebook, with limited resources and a limited ability to service advertising clients, may end up relying on partners to handle Deals on Facebook clients, she says -- or it move to a self-service model where local merchants handle ad placement themselves.

But a self-service model could bring host of other problems, Mulpuru says. "You then get a lot of junky deals on the site and not very good merchants."

Facebook's entry into Groupon's backyard is not the biggest challenge the group-buying pioneer is facing, she adds. "If Groupon doesn't get renewals every year, it becomes harder for them to do business," explains Mulpuru. "They will either have to reduce their profit margins and take less from the merchants, or spend more to increase the size of their sales team ... an investor should be questioning this."