Groupon. LivingSocial. Gilt Groupe. There are few advertising options that garner as much praise and poison at the daily deal provider. They’re heralded as traffic generators in one breath, and small business destroyers in the next. What is their attraction? The most obvious benefit to the daily deal is traffic generation. Overall, almost 80 percent of daily deal traffic comes in the form of new customers, even for business owners running who have run multiple deals. The second reason is quick, upfront cash. So what’s the deal, are they an intelligent investment, or a perilous pitfall?

Daily Deals are good and bad for the same reason – traffic generation. When business is new, slow or at a plateau, it’s a great way to get people through the door to try your wares. But when too much traffic comes through the door in too short a time period, there is a devastating effect on cash flow.

1. The deal itself is an exchange. You trade a certain amount of profit, by deeply discounting select products and/or services to be offered in a limited time promotion, in turn for volume sales.
2. Most daily deal sites have millions of subscribers that visit their site or receive emails daily, looking for a great deal on various products and services.
3. When you run a daily deal, the vendor advertises you for a fixed time period to this audience, inviting them to try your wares, and processes customer “sales requests” or “purchase orders”.
4. Once a certain amount of sale requests is received, the deal is activated, payment is collected by the daily deal vendor, and a purchase certificate or product is sent to the customer. The customer has a time limit on redeeming the purchase certificate at your establishment, typically a year before it expires.
5. The daily deal vendor takes a percentage of sales and provides the remaining funds to you either in one lump sum or broken out into several payments over the beginning of the redemption period. A breakout is typically done on deals requiring purchase certificates, to help ensure that vendors who run a deal do not take the money without honoring the purchase certificates.
6. All the terms of the deal – the vendor, the price, the number of requests needed to activate the deal, the maximum amount of certificates to be sold, the expiry date and the revenue split, are all negotiated upfront between you and the daily deal provider. And if you don’t do the math, you can run into trouble.

The demographics can vary considerably between daily deal providers. For example, the Groupon audience tends to be younger, and more income challenged, Gilt appeals to the high-end, luxury buyer, LivingSocial is somewhere in between. If you’ve heard a fellow businessman complaint about the cheapness of the buyers sent his or her way, consider that they may have chosen the wrong partner.

Don’t expect your daily deal vendor to know your business better than you. You need to know your average daily, weekly and monthly cash flow, physical capacity for customers, and your current staffing levels. Calculate the maximum expense you want to take on to be comfortable and can take on, to stay in business. Assume that most people will cash their deals immediately and that you could potentially have days were 80%-100% of business is from the deal certificates. Make sure that the (deal price x max number of purchase certificates) / days will not put your ability to pay bills or provide minimum customer service levels in danger, or worse yet, put you out of business. Don’t forget the credit card processing fee!

Do not assume that traffic will come in equally over the life of the deal. The likely scenario is that the majority of people will redeem their deal in the days or weeks immediately following receipt of the certificate. Traffic will dwindle as the expiry date nears. Take this pattern into account for inventory levels, staffing and other cash flow considerations.

Also, if you’re thinking of running a daily deal, and you’re working with other funding sources, such as a merchant advance provider, let them know if you’re planning on running a deal, and consider the math. You will want to make sure that the deal includes the cost of covering these payments and they should be able to offer sound advice on your daily deal revenue structure.