Will 'Net discounts gain loyal diners?

There's still no such thing as a free lunch, but new online discount coupons are slicing local restaurant prices to the bone.

While recession-weary consumers may be happy to buy a $50 dinner for $25 at websites like Groupon.com, a participating restaurant makes only $12.50 -- an unprofitable deal for the restaurant.

Groupon.com, one of several deep-discount websites doing business in the Twin Cities, claims it can help restaurants, health spa operators and other retailers reach new consumers who can be turned into repeat customers.

"You may barely break even on Groupon customers the first time," said David Rangel, Groupon's director of merchant services. "But if you bring them back once or twice, you'll get a terrific return."

One local restaurant owner called Groupon's program "borderline predatory" because it's aimed at restaurants hurting from the recession.

"They know the restaurant industry is on the ropes, and they are offering people a quick fix. ... They are preying on people's fears," said Lenny Russo, chef and co-owner of Heartland Restaurant in St. Paul, who refused to participate in the coupon program.

The coupon deals jeopardize the restaurant industry, bringing short-term revenue, though not enough to cover the cost of buying, preparing and serving the food, he said.

Others say it's too early to tell whether Groupon, which entered the Twin Cities market six months ago, will hurt local restaurants or boost traffic as promised. Restaurants can control their costs by restricting the number of coupons -- known as Groupons -- that can be sold.

Chicago-based Groupon Inc. does business in 39 other metro markets. Its competitors include restaurant.com, deals.livingsocial.com, dealstork.com and crowdcut.com.

How it works

Groupon approaches restaurants with this pitch: Offer highly discounted meals through Groupon.com packaged as exclusive daily "deals." Consumers get a short time to purchase online and must pay in advance. The deal goes through only if a specified number of consumers, say 50, opt to buy. Hence the name Groupon.

The message to consumers: Tell your friends about this so enough deals will be sold.

The deals carry a discount in the range of 50 percent. Groupon keeps half the revenue that consumers pay online, leaving the restaurant with about 25 percent.

Marketing experts say the 50 percent Groupon discount is a big departure from traditional offers, which range from 5 to 20 percent off.

"This is a new variation on sales promotion," said Dave Brennan, a marketing professor at the University of St. Thomas in St. Paul. "The money for the coupon is paid up front, and the discount is very heavy."

Some local restaurants are giving Groupon a try.

Karl Greeman, co-owner of the Minneapolis restaurant Spill the Wine, said the restaurant sold 868 Groupons in a recent offer on the website, near the maximum number of 1,000 he was willing to authorize.

Greeman and his wife and business partner, Katie, "went into it knowing what food costs and what our overhead is. You're giving a certain percentage of your bottom line away. But if that generates business and puts money on the bottom line, it will be a good thing."

Their revenue calculation assumes about 30 percent of the Groupons won't be redeemed because they'll be lost or forgotten by the purchasers -- a concept known as "breakage" in the coupon business. Because the Groupons are good for a year, and nearly two-thirds of those for Spill the Wine haven't been used yet, it will be several months before the Greemans find out if they were right.

"We've only used Groupon once, and we're waiting to see how it pans out," Karl Greeman said, adding, "If a restaurant is in financial trouble, this is not a way to get out of it."

A new business model?

The larger question is whether online deep discounters have discovered a long-term business model that will survive hard times.

Groupon says it doesn't need a recession to succeed. It promises restaurants more than a short-term burst of traffic. Groupon users, the company says, are a highly desirable group, mostly women 18 to 35 who dine out often.

Others are skeptical that deep-discount websites have staying power.

"I think it's a short-term phenomenon that has legs now because we're in a deep, long-lasting recession," Brennan said. "As things get better, restaurants will not need to do it and fewer consumers will look for it."

Larry Chiagouris, a marketing professor at Pace University in New York, predicts that "companies like Groupon will last beyond the recession, but they'll probably never be very big. If a business has a new product or location, a Groupon can bring it to the public's attention. But if a business is known and already has a good product, it shouldn't need to discount what it does."

Some investors believe in Groupon. In December, the New York Times reported Groupon had raised $30 million in venture financing, led by Accel Partners and New Enterprise Associates, in addition to an earlier $5.8 million venture round and some capital from venture "angels."

Rangel of Groupon said surveys of restaurants and consumers found that as many as 90 percent of restaurants found Groupon users can be converted to regular customers. Groupon customers typically spend 60 percent more on a meal than the dollar value of the Groupon coupon, he said.

Restaurant owner Karl Greeman said that, so far, Groupon users typically do spend more than the value of their Groupons, which helps his bottom line.

But Russo doubts Groupon's conversion claims. And he says that even if a Groupon user buys 60 percent more food and drink than the value of the Groupon, it still won't make up for what the restaurant lost on the big Groupon discount.

Marketing expert Brennan also doubts a large percentage of Groupon users are likely to become restaurant regulars.

"People are likely to use these big discount coupons wherever they can get deals," Brennan said. "The chance they will come back to a restaurant is less than with a regular coupon. Most of them are price shoppers."

Pace University's Chiagouris said that coupon users have not developed loyalties to restaurants. "I don't see any lasting value in these sorts of customers," he said.

Groupon disagrees. "We've positioned Groupon so that consumers won't jump from deal to deal," Rangel said. "We present Groupon as a way to find fun stuff, not a way to get cheap stuff."

Rangel concedes that Groupon's youngest customers may be motivated to find cheap meals, but he says the older ones aren't and are likely to become repeat customers.

"The vast majority of the merchants we've put on our website are very happy with the results, but we agree there are a few out there who think there are potential issues," Rangel said. "So it's understandable that some people want to wait and see how well it works."

Steve Alexander • 612-673-4553