ClickZ reported on a denim jeans company that that sold 2,000 Groupons in the New York City area by 5 p.m., with seven hours still left in the campaign. They hailed it as a success.

The discount was set at 60 percent, which equated to $75 off the retail price. $75 X 2,000 = $150,000 in lost revenue. Tack on another $50,000, which is the amount Groupon made from the total sales, and the loss comes to $200,000.

As I pay more attention to this burgeoning industry, group coupon buying, the more push back I’m hearing from small businesses who decided that the deals offered by Groupon and similar services aren’t worth the effort.

In my last post on the topic, I talked about Posies Cafe in Boulder, CO. The owner, Jessie Burke, called it the “worst decision ever.”

New York smoothie shop Xoom used Groupon to sell 1,300 deals. Problem is, the “effort failed to produce repeat customers,” according to the owner Jennifer London.

Groupon founder and CEO, Andrew Mason, defended his company and the business model in a recent blog post.

“There have been a handful of stories lately documenting the struggles of cupcake shops running out of batter or sushi restaurants who don’t have enough rice to meet the demand brought on by their Groupon feature. We haven’t written about those stories here because it’s not a common experience – the vast majority of businesses we feature, while certainly busy, do just fine. 97% of the businesses we feature ask to be featured again, including many of the businesses mentioned in the stories.”

I think Mason did an eloquent job of addressing the issue, while at the same time making his case for Groupon.

Of the many readers who left comments in response to the post, this one stood out:

Andrew,

How do you know that Groupon is really good for small businesses?

While I appreciate your openness, the argument you’ve made here is largely anecdotal. Have you really looked at the profitability of running a Groupon for small businesses?

In my mind, there are two key questions that Groupon cannot answer (or has yet to):

1) How many new customers from a Groupon return to an small business for make a repeat purchase, and how often?

2) What is the profitability of those repeat purchases, ie. the lifetime value of a Groupon customer?

I suspect most small businesses run Groupons at breakeven or a loss on a unit basis, in order to bring new customers in the door.

Most small businesses lack the ability to answer these two questions for themselves, so we may even see a wave of small businesses go out of business in the next 6 months to a year, because they ran a Groupon.

Unless you can provide data to support these two critical questions, I have a tough time believing the blanket claim that Groupon is “great for small businesses.”

Alex

I think I’ve established the argument that group coupon buying deals are not great for every small business. What, then, should a small business who is considering using this tactic consider before biting the apple?

Determine how much money they can afford to lose. This is a form of advertising and it’s a given that the deal will be a lost leader.

Create a customer retention strategy. The key to profitability is in getting these new customers to return. That is going to be an additional investment, so factor that in as well. At the very least, get the new customers email and mailing address, so you can follow-up. Once they walk out the door, they may never come back.

Have a product or service worth returning for. If your’s is a commodity product that customers could get just as easily in their own neighborhood, what would motivate them to return? Even if your business is unusual, once the customer has had the experience what guarantees they will want to experience it again?

This young business model is growing more quickly than the maturity needed to make it work effectively can keep up with, which explains the reason for “casualties” like Posies.

One question comes to mind: Should Groupon and others assume responsibility for helping businesses create an effective follow-up strategy?