Death Spiral

Right now consumers are pushing companies — many large, smart, companies — down a death spiral, a race to the bottom. Groupon, LivingSocial and coupon sites are the catalysts that have set this trend on fire, but it all started with the consumer “free” mentality.

The idea that companies are making too much money screwing over the “little guy” with high prices.

Increasingly $0.99 has become too much money to pay for things that others spend a non-trivial amount of their life creating. Not just iPhone apps, candy bars, or soda — food, haircuts, tours, clothing — the consumer wants it all for free, or at least 80% off.

It is a recession after all.

Groupon of course is just one of many sites that offer steep discounts on goods and services, but they are the most popular, so I will pick on them a bit.

Oh, yes, the creators of these products, and the proprietors of these businesses, opt-in to these wholesale oriented sites — but the real question I have is whether it is bad business practices or the consumer that forces this hand.

Do you think Groupon would be as big as they are today had it not been for the recession we currently are in?

Do you think restaurants would be willing to forgo all profit for one night — in the hope that repeat business comes from it?

Of course we know the answer to that last question: hell yes. And that’s just a bad business decision.

It’s a Two-Fold Problem

On the one hand consumers are “forcing” business owners to make the tough call of “liquidating” product/services via sites like Groupon — and make no mistake about it, this is a liquidation service. On the other hand Groupon is helping to make successes out of companies that are either: not profitable, or are just a bad idea. 1

Before you email me, let me explain what I mean.

Say you open a cupcake shop in a busy area — an area with many other cupcake shops 2 — and business pretty much sucks for you. Your prices are in line with your competitors and in your mind the product is comparable.

You turn to Groupon as a last ditch effort to your failing business. You offer a 60% off special for one day only with Groupon.

That “Groupon day” your sales are through the roof. Astronomical even. Customers were lined up and all you worry about is where you will store all your cash come tomorrows repeat customers — a day that probably won’t come.

Your business picks up, it’s not quite break-even yet, but it is 30% higher than it was before the Groupon deal.

You are ecstatic.

You now have false hope, the deadliest kind.

This false hope will cause second mortgages, cashing out retirement funds and many other irrational moves to keep the hope of that one day alive.

This is the hope that digs you a financial hole that you won’t get out of for another 10 years.

What Groupon has showed you is that your business can work if you continue down the unsustainable path of selling products at a loss. That’s not the consumers fault — they are being smart — that’s the fault of the business owner.

Let’s use an example a little more close to tech nerds hearts: the TouchPad.

TouchPad Example

For all intents and purposes the TouchPad was bad product 3 that fell flat on sales, then with the help of liquidation (a $400 price cut on a $499 product) good sales lead to a stupid decision that will likely cost the company more money — all chasing that same false hope.

HP decided to kill off the TouchPad. They decided that they needed to clear the retail channels of products and liquidated it for $99, again down from $499. They decided (wisely, perhaps) that it was not the business for them. They sold the product in record time, in record amounts (for this product at least) during a liquidation-get-me-the-hell-out-sale.

Just as with our cupcake proprietor HP thought: “sweet! money!”. Of course it should have ended there for a company as smart as HP, but it didn’t. They were blinded. Instead HP decides that they should manufacture, or complete the manufacturing of, all existing materials to sell the TouchPad again.

So where’s the problem?

The problem is that the consumers bought the TouchPad not on the merits of the product, but solely based on the price — the deal — same with the cupcakes. When you discount a product as heavily as HP did to the TouchPad, the sales that the product garners during such a period has no bearing on what sales will be after discounting ends.

If HP comes back with the TouchPad at $499 or even $399 — will it once again be a sales success? Likely not, we’ve already seen what those sales are like and it’s less than great. Consumers bought it at $99 because that was an absurd price, not because they had been longing for the device.

Further if HP comes back selling the tablet at $99 — they essentially will be selling it at a loss 4 — what sense does that make?

Two things could then happen because of the false hope HP gained during a fire sale:

  1. HP will come back with fire sale prices again, thus losing more money.
  2. HP will come back hoping for a bump in sales at the original product prices. Only to be disappointed, thus holding another fire sale. The end result of which is losing more money.

Massive Liquidation is Bad Business

Deborah L. Cohen reporting on a comment from Ellen Malloy:

If a business needs to drive traffic with discounts, she said, it often means there are underlying problems.

These models are all about building a business off of bad, inaccurate, data and hiding that fact with sales surges spurred by nothing more than slashing prices below a sustainable level.

Time again there has been one business model that has proven to be successful, as stated recently by Marco Arment:

[…] the traditional style of spend less than you make.

That’s the only way to make money, short of fooling someone into buying your company for more than it’s worth. 5 It’s the model that all business should start off with and guess what flies in the face of such a model: selling products/services for less than it costs you to make/serve those items.

Groupon liquidations are dangerous to business because they promote a race to the bottom. This is only exacerbated by more and more Groupon deals being “targeted” to specific areas, which is just a stupid way of saying the deals are not coming from giant companies, but from mom and pop companies in local areas.

These types of business are prone to this type advertising because they are inexpensive. Small business don’t have money to spend on traditional advertising, so what’s cheaper in the mind of these business owners:

  1. Taking money out of their personal savings or getting a loan to advertise? Or…
  2. Taking in less money for a day?

It’s always option number two and that can work, but you have to be willing to ignore the results of that one day — which is near impossible when it is your business.

It’s hard to ignore that data point for the same reason people balk at the notion of paying someone $50 an hour to paint a wall when they can do that themselves — which is the entire reason Home Depot exists. Or paying someone to un-clog a drain when corrosive, often pipe ruining, Drain-O is $10 a bottle at Home Depot.

Business owners often don’t value their time, the same way that homeowners don’t value theirs.

Note to Consumers

This is not to change your mind as a consumer — if a business is stupid enough to fall for these traps then you should, by all means, take advantage. A deal is a deal.

You should note however that a company willing to sell you “unlimited” storage for $10 a month, when it’s primary competitor has decided they cannot do that at that price — well perhaps that new company won’t be around that long. Buyer beware.

To Businesses

This is a memo to all business owners large and small: pull your heads out of your asses and stop racing to the bottom. You cannot make a sustainable business by selling goods and services at a loss. You must — completely — ignore sales data gained by holding fire sales, that data is irrelevant to your normal operations.

I started thinking about this with this very blog and the income streams that I use to pay for the costs and my time. I have the small Fusion ad and the RSS sponsorships.

I don’t know the practices that Fusion uses to fill the ad spots, but I do know RSS sponsorships and just how hard they are to fill from time to time. It takes work, but could easily be filled if I dropped prices.

In the past few months a ton of blogs have implemented these types of income streams — all at different prices and values to potential advertisers. Filling spots continues to get harder, but — luckily — most sites are steadfast in their pricing, thus avoiding a dreaded race to the bottom as I outlined above.

Such a race is one I will never compete in. One that you shouldn’t compete in too.

  1. Of course, exceptions to every rule — and such.
  2. For the life of me I will never understand the appeal of such places.
  3. I the sense that it simply did not sell, and thus consumers voted with their wallets that they did not want it.
  4. Even if you argue that it is better than paying penalties, HP now has to support the device for more customers than they would have had. My guess: the cost of breaking contracts is about the same as the cost of supporting a money losing device.
  5. Often called: potential for profits.
Originally posted for members on: September 14, 2011
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