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The psychology behind the LivingSocial-Starbucks deal

After last week's record-setting LivingSocial-Starbucks deal, rumors are flying about why Seattle's coffee king went in for the daily deal gimmick.
Clean cut Starbucks baristas work hard to never mess up your coffee

Clean cut Starbucks baristas work hard to never mess up your coffee Wikimedia Commons

LivingSocial, the online daily-deal site that's in a tooth and nail battle with Groupon, might return to offering half-off teeth whitening services next week, but last week the site scored a huge deal with Starbucks: a $10 gift card for $5. Preceded by plenty of buzz on Facebook and Twitter, LivingSocial "sold" 1.5 million ot the cards in less than a day. It was the best-selling offer in the four-year history of the daily-deal industry. 

Normally, the site would split the money with the merchant, keeping between 30 and 50 percent for itself. Let's do the math: 1.5 million times $5 means LivingSocial should have collected $7.5 million total. Of that Starbucks could expect to receive between $3.5 and $5 million.

That may not be the case. An industry site called FastCasual.com claims Starbucks got just over $5 million, which would be a 70 percent share of the proceeds, at the high end of what merchants can typically negotiate for daily deals

When reached for comment, Starbucks' PR firm Edelman declined to say anything about its split with LivingSocial. A spokesman for the company said LivingSocial doesn't comment on its contracts with merchants. FastCasual.com's reporter didn't respond to inquiries. 

The question remains: Why would LivingSocial want to do such a costly deal? Probably because it is is desperate for customers, for names to add to its mailing list. Groupon has 30 million names, LivingSocial only half as many. So LivingSocial forked over as much as five million beans in return for 1.5 million addresses (not all of which, by a long shot, are new names). 

Five million bucks (or beans) certainly isn't chump change, but why would a well-established company like Starbucks "demean" itself by doing a daily deal? Starbucks CEO Howard Schultz was on the Groupon board of directors until May of this year, and his Maveron investment firm was an investor in Groupon. Adam Brotman, Starbucks' chief digital officer, told Reuters that the company's decision to work with Living Social shows that daily deals still work for some merchants. 

To which we can only say, sure: if you get 100 percent of the proceeds. Or even 70 percent, as appears to be the case in this particular deal. For Starbucks, that's a reasonable split. It already has between 40 and 50 million store visits a week, and a promotion like the one with LivingSocial adds more customers to that stream. 

The trouble is, for smaller establishments, daily deal sites are a race to the bottom. Savvy merchants understand that you won't ever convert a bargain-hunter into a full-price customer, so they offer only lower-cost goods and higher-margin services. Less sophisticated merchants are either overly optimistic or overly cynical, only eager for the quick financial bump from a daily deal. That's because the publisher of the deal forwards the merchant's share of the proceeds within 30 days. 

It's a recipe for disaster: most merchants have long since spent the money, but now have to feed or service the parade of coupon-wielding customers for free for the full term of the deal. Sadly, many merchants who rely on daily deals to drive their business find themselves out of business before the deal expires.

The coupon-holder's recourse, should the business be shuttered before the coupon is redeemed, is to request a refund from the original daily deal site. Groupon, for one, is under fire for not properly accounting for that possibility. That's only one reason the company has lost 80 percent of its value since its much ballyhooed IPO last year.

A financial analyst at VentureBeat did the math six months ago and called Groupon a "receivables factoring business." He warned that Groupon's share price would soon fall into single digits; it is now under $5. 

With Starbucks though, things are a little different. According to Melody Overton, publisher of a blog called StarbucksMelody.com, fully a quarter of all in-store transactions use Starbucks cards. The great advantage of proprietary gift cards for the holder is that they never expire. For the merchant, it gets even better: some cards get lost, many cards don't get fully used. If you're a mom-and-pop, that's a potential disaster, but if you're Starbucks, the world's most frequented retailer, it's nothing but opportunity. 


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Comments:

Posted Fri, Sep 14, 9:43 a.m. Inappropriate

I'm offended by the headline on the email page "Did Living Social Bribe Starbucks."

"Is Crosscut receiving under the table payments to write certain positive stories in a desperate effort to stay afloat?"

That's pathetic journalism. I could read Faux News if I wanted that kind of trash.

Goforride

Posted Fri, Sep 14, 5:32 p.m. Inappropriate

As the writer of the story, Goforride, I'm offended by the suggestion that there were any payments to anyone. It's neither a positive nor a negative story but a "critical" one, in that it analyzes how daily deals operate, how Groupon is in serious trouble, how Starbucks is the kind of company for whom daily deals can be seen as positive while small merchants are crippled by them.

Posted Fri, Sep 14, 11:41 a.m. Inappropriate

I can vouch for StarbucksMelody's observation, as I spend most of my days making use of Starbucks' free Wi-Fi (which is worth about what I pay for it, but that's another subject).

I registered a gift card and got the smartphone app, so between that and their generous refill policy (free with a registered gift card), I get way more stuff for free from Starbucks than LivingSocial could ever give...

orino

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