Which is mightier, the Ad or the Coupon?

Location-based services have been all the rage ever since the smart-phone revolution kicked off three years ago with the original iPhone. Since then, upstart web services companies have tried eagerly to explore the space, looking for a viable user/business model. Companies like Yelp, Groupon, and FourSquare all hold a piece of the puzzle. In an article yesterday, a guest columnist on TechCrunch explored what would be possible if we could combine the respective strengths of Yelp, Groupon, FourSquare and Facebook.

Part of Groupon's success has been attributed to the "no upfront payment" angle of their model. Unlike ads, participating merchants don't need to worry whether their ads are showing to the right audience and what percentage is converting. Instead, they only pay on conversion (when the customer shows up at the door). But coupons present a whole different set of challenges for marketers that are quite different from those of advertising.

If marketers design coupon campaigns the same way they would approach ad campaigns, they're going to be in for a rude awakening. Let's look at some of the differences between ads and coupons. From a marketer's perspective, coupons can be used to accomplish one of three objectives.

First, they can be used to draw in a new customer. In this case, the incentive should be sufficiently compelling that it compensates the target customer for any perceived risk of trying out a different vendor/brand/product. Groupon is currently targeted primarily at this objective.

Secondly, coupons can be used to shape the consumption pattern of existing customers, either getting them to consume more or to consume more frequently. This is similar to using advertising to maintain a customer's share of mind.

Thirdly, coupons are one tool that allows customers to effect price discrimination. While published prices are identical for all customers, effective prices differ depending on the coupon each customer has in hand. This allows the marketer to tailor the pricing to reflect the willingness to pay for each customer (or at least, each customer group).

But there are some clear challenges. You really don't want to give a discount to a customer who is already willing to spend a certain amount of money at your store. Doing so would just result in margin erosion. If a customer can pull out their smart-phone and search for a discount right before paying the check, than you're going to see some serious profit leakage. The power of search engines makes using coupons for price discrimination and attracting new customers a much harder problem.

One possible solution lie with social networks. If discounts are non-transferable, that might help block the problem posed by the search engines. Also, it might be possible to take a page out of the social gaming playbook and allow users to send coupons to friends, except that the friend might receive a different discount value than the sender. For instance, if Sue was targeted as a new customer for the Osha Thai restaurant, she would receive a special offer through FB for 25% of her first visit. However, if she forwarded the offer to Charlie and Charlie was already an existing Osha customer, he would only see a discount of 10% on his next visit.

Could this work? It does pose a bit of a risk of angering your existing customers. Imagine if Sue forwarded the discount to Charlie and highlighted the surprising 25% discount offer. If I was Charlie, I'd be a little miffed.