Groupon, the group buying site offering daily deals, has proven to be wildly popular with consumers. Great discounts are given for restaurants, retail stores, spas, theaters and much more. What's more appealing than scoring a $100 massage for $25 or grabbing a meal valued at $50 for $15? People love discounts, especially during hard times when money is tight.

Investors also are enamored with Groupon. Google famously offered to buy the site for $6 billion but got rejected. Now all eyes are on the Chicago-based firm to file for an initial public offering before the year ends. A Groupon IPO will likely generate a fortune for early investors, according to market analysts.

Launched in 2008, Groupon is a fast growing company, having transformed the world of online shopping. It has boosted the number of markets where it operates to 500 and has 70 million subscribers. It has a staff of 1,500 working at locations in cities throughout the U.S. and across 29 countries. The company is rumored to have generated $760 million in revenue for 2010, up from $33 million in 2009.

Who's not loving Groupon? It appears to be merchants. A study by Rice University's Jesse H. Jones Graduate School of Business surveyed 150 small to midsize businesses in 19 cities spanning 13 product categories. Findings revealed 66 percent of the merchants said the Groupon promotions were profitable while 32 percent said they were not. More than 40 percent of the companies wouldn't run a Groupon offer again. Restaurants fared the worst among service businesses with Groupon deals, while spas and salons were the most successful.

The real deal is that any business looking to use Groupon, or one of its competitors like LivingSocial, must have a much broader perspective. You don't want to devote a lot of your budget to these daily deal sites. Such a promotion has to be part of your overall marketing plan along with how you are using Facebook, Twitter, Google Adwords, and so on. You can make a deal as long as it's the right one for your line of business.

The problem is that businesses often go into a promotion without a good understanding of what they want to accomplish. The Rice study found that the ability of employees to handle the surge of business from bargain shoppers, for example, was critical to the success of that company's particular promotion.

The way it works is that Groupon offers different deals each day for a local good, service or event in a city where it operates. Discounts range from 50 percent to 90 percent off. The promotion is only valid if a certain number of consumers purchase the deal within 24 hours. Groupon keeps 50 percent of the revenues from each coupon deal.

"What happens is that the Groupon promotion runs and then there is a flood of customers coming to their store," says the study's author and Jones School associate marketing professor Utpal Dholakia. Business owners don't think through their costs and how they are going to make money on the promotion. "So, in turn they end up losing a lot of money. They don't recover it from customer behavior," he explains.

Take for instance a massage therapist who complained that everyone who came in for his promotion got a massage and then walked out. Most of them didn't spend anything beyond getting the freebie. He lost money on the promotion itself and there was no way to recoup that lost. Dholakia suggests that instead of promoting a particular service such as a massage or a facial, the owner should have promoted a particular dollar amount.

In other words, he might have offered $100 worth of services for $50. This increases the chance that the consumer will come in and buy more than just one item. Now a newbie might come in to get a massage but then decide to get a facial as well. "You have to take advantage of an opportunity to cross-sale other products and services. You have to prepare your staff to engage customers. You have to be careful how you structure the promotion," says Dholakia.

Groupon has its pros and cons, so, you need to decide if this is something worth your business getting into. Here are five reasons in favor of and five reasons against group buying promotions.

Dig Deeper: 4 Tips for Using Groupon Coupons


1.    It attracts a lot of consumers. You can reach new customers by appealing to those who are looking for inexpensive deals and a chance to save money. You get to charge lower prices to new customers who aren't willing to pay more. Existing customers are willing to pay full price for products or services. Dholakia says that Groupon promotions offer the most benefit for businesses in which the promotion does not cannibalize sales to existing customers.

2.    It advertises your business. A Groupon promotion can be a way to announce the existence of your business to consumers who are unfamiliar with your products or services. You get to entice potential customers to try your goods. The idea is that they are going to like it so much that they will come back and buy from you again. You must make your promotion grab consumers but at the same time increase your potential conversion rate for repeat customers, says Dholakia.

3.    It helps move inventory. Use Groupon deals to sell slow moving items in your inventory or unutilized services. Discounts seem to be most compelling for merchants with low cost of goods sold. Use price deals to promote a product that is not that expensive. A Groupon type promotion should be something that you do once in a while for a specific, narrow, limited reason, adds Dholakia.

4.    It builds relationships. Use price promotion deals for building customer relationships rather than just creating one-time buys, recommends Dholakia. Meaning, instead of a restaurant owner offering $60 worth of food for $30, parcel it out to offer $20 worth of food for $10 over the customer's next three visits. Don't offer discounts on a total bill, rather offer a specialized discount for various products or services.

5.    It generates incremental revenue. If you have a low-cost or fixed-cost structure, you can make money on promotions. Take an owner of a rock-climbing business that has existing equipment and a storefront. The operating costs don't change based on the number of people who show up. A coupon deal can actually generate some extra cash by getting more bodies into the facility. Customers paying $10 for a $20 service, still nets the owner $5 per voucher. Dholakia says each merchant must know their costs, factor in a price that draws customers, project the number of costumers that will buy the coupon, and estimate incremental revenues.

Dig Deeper: How Groupon Works for Small Businesses


1.    Deals attract low-end bargain seekers. Because the Groupon customer base is made up of deal-seekers and bargain shoppers they might not be willing to purchase beyond the value of the coupon. So, there are low rates of spending and low rates of return. One problem with price deals is diminishing returns; thus, merchants need to put a cap on the number of deal coupons that are to be sold, says Dholakia.

2.    Deals hurt the brand. The obsession with price doesn't necessarily make for a lot of brand loyalty or even brand awareness. One negative aspect of daily deal sites is that price promotions usually hurt the brand of the company offering it, says Dholakia. It makes customers price sensitive. When they get something at a much lower price, they then become less inclined to pay full price for that same product or service in the future.

3.    Deals don't generate repeat customers. Groupon has a low conversion rate for repeat customers, according to marketing experts. You may never see the person again once they use your coupon. Or that person may not be willing to buy from you again without a coupon in hand. The percent of new customers that redeem the voucher that becomes repeat visitors of the business is estimated at around 19 percent. It varies by product categories.

4.    Deals are not profitable. Another problem is the split. Groupon keeps 50 percent of the revenues from each coupon deal. If you do the math, merchants need to gross margins well in excess of 50 percent for Groupon to work for them. The promotion is very steep, usually 50 percent or more. Most businesses are built on margins of 75 percent, which means if the customer just comes in and buys the deal, the owner is going to loose money, says Dholakia. Restaurants usually have higher margins. "By offering huge discounts and giving 50 percent to Groupon, they just aren't earning enough to cover the cost of serving that customer."

5.    There are better deals out there. Daily deals sites are not the only game in town. You can run a similar promotion for less money. There are plenty of marketing programs you can use; does it make sense to use this one, asks Dholakia. For example, you can offer a discount or promotion on a Facebook fan page. It's an effective way to engage new and existing customers at a very low cost, he adds.

Dig Deeper: How Groupon Can Boost Your Company's Exposure

The bottom line is that a good deal or promotion should attract customers, give them the flavor for your company's products and services, and then let them buy whatever they want at full price.