Having lunch with a colleague the other day, I heard an interesting story about how his wife has been using daily deal sites such as Groupon, LivingSocial, etc.

A long-time member of the same gym, she has repeatedly seen attractive coupons on daily deal sites for other gyms in New York City (where they live). A typical deal would be something like a 30-day gym pass and 5 personal training sessions for $45. This is cheaper than the monthly fee at her current gym, which also doesn’t include any training sessions.

So she decided to quit her gym, and jump from place to place each month using coupons purchased from these sites. Considering how many competitors Groupon has spawned and the fact she is in a major city, it hasn’t been a problem finding the deals in advance.

This doesn’t bode well for local businesses.

Why Businesses Play Ball
Daily deal sites typically look for offers that are 50% or more off of the original price. They then take a 50% cut of the deal offered, leaving each business with about 25% of the original price. So why would they agree to such a deal?

Primarily because of the belief (promoted by these sites’ sales teams, of course) that this is a great source of new customers. A user will try your gym for 30 days, love it, and become a member. Or someone will visit your restaurant they found on Groupon, and then continue to return. You might take a hit on the first visit, but it’s all in the name of building repeat business.

Whose Customers Are They?
The big question is: who owns this customer? Do they truly belong to the restaurant or gym, or does their loyalty lie with the deal site? Many retailers are finding out that it’s often the latter. When users start to focus on the deal site first, the local business loses. Want to go out to dinner? Instead of visiting an old favorite, why not see what restaurant has a recent Groupon? Need a gym? Why pay full price? Just hoard a few different discount codes to use in the future. Suddenly, instead of driving new regulars, these sites will become a primary source of price competition.

The Cost of Retention
My wife recently tried a spa that had a great LivingSocial deal. After looking at the full price of services, she decided not to return. However, they recently contacted her, offering a package at the same price of the original deal. It turns out that most of the LivingSocial customers weren’t willing to pay full price, so the spa decided to extend the deals (indefinitely?) to keep them coming.

Did the daily deal bring the spa new customers that they otherwise wouldn’t have? Sure. But at razor thin margins compared to their other customers. And any word of mouth generated by this customer base will bring with it an expectation of the same low prices. It’s not difficult to see how this will continue to erode profit margins for these businesses.

The New Walmart?
It’s impossible to overestimate the effect Walmart has had on the world of retail. Since Sam Walton opened his first store in 1962, the company has reduced retail profit margins and dramatically lowered prices industry-wide. Other retailers are forced to keep their prices as competitive as possible.

Daily deal sites could have the same effect on local business. Instead of being a loss leader to acquire new customers, they could instead just drive prices down, making once loyal customers more price-conscious and harder to retain.

Be Cautious
What once seemed like an opportunity could become a major threat. Local businesses would be wise to consider what else may come through the door when they open it for a daily deal. Successful businesses aren’t just built on more customers. They also need to be the right customers.