Caution: Discounting could be your worst pricing strategy right now!

Discounting could definitely be your worst pricing strategy coming out of lockdown.

Many businesses are looking to discounting to regain the momentum and sales volumes they have lost during lockdown. 

So why is discounting so popular?

Well, to be honest, most effective discounting is used at the retail level to attract or drive shopper behaviour and not necessarily driven by the independent brands on discount.  Retailers have strategies around using some products at discount to attract customers, who are then likely to purchase a basket of offers whilst in-store, and the retailer can then regain their profit through these other items.  So yes, if you have a range of offers available, it is useful to have lower priced items (these need not necessarily be on discount mind you) that can attract customers who you should then sell other things to.  Another use of discounting which is also used regularly by retailers, is to ensure stock rotation and thereby release cash for more profitable items.  When an item does not sell quickly enough, and may even be at risk of expiring, it is better to get some cash for them than risk nothing at all.  Basically the risk here is making a total loss, so the items get discounted so that they can free up some cash to buy other items that will sell.  These slow items are then not likely to be purchased for selling on again.  It is this retailer behaviour, and the resultant influx of customers, that has got us believing discounting is a valid option that works very well.  It seems logical that when you reduce price you encourage volume, but…

…the hidden costs almost certainly outweigh the benefits.  Let me show you how…

When you discount, you NEED an equivalent increase in sales volume just to make the SAME amount of profit.  If I discount my offer by 20%, I need an increase in sales volume of 20% to make up for the 20% I would have usually made at the old sales volume.  Only if my discount results in an increase of sales of MORE THAN 20% will I make more profit.  Think about it.  So don’t discount if you don’t have data to support the fact that your volumes will increase disproportionately more.  Definitely don’t discount if your profit margins are already slim and you are battling to make ends meet. There are more risks to consider too…

The next issue is WHERE those increased sales volumes will come from?

If they are coming from existing customers who are likely bulk-buying at the reduced price, then you may be merely forfeiting future sales which would have been made at the normal price.  Your customer’s purchase behaviour will likely move back to normal at the return to the normal price.  Jim normally buys 1 pack a week, but on discount special he buys 3, and then doesn’t need to buy for another 3 weeks.  What you may hope for is that your customer’s consumption patterns change, that they get used to increased consumption over the discount period and then don’t return to their normal consumption patterns again.  This relies on your in depth knowledge and research of consumption patterns in your market and of course, the general behaviour of the category you are in – information which most of us don’t have at our fingertips  You can also , of course, encourage increased consumption in ways other than discounting.

If your increased discounted volumes are coming from new customers, you have to ask yourself:  How many of those new customers will continue to purchase once you return to your normal price level?  You may be giving customers who normally cannot afford you a chance to sample your offer at a reduced price, but their income levels won’t necessarily change when you go back to the normal price, and they may just return to your lower priced competitor.  You just dropped your profits for people who can’t afford you anyway.  Granted, you may get some of them used to your offer and they may not want to return to their cheaper alternatives again, BUT, they became your customers at a lower price level, a price expectation they will hold forever for your offer.  Their perception of the value of your offer actually reduces when you put the price back to normal.  It’s like getting into satellite TV at one price and then they hike the price up suddenly. You’re setting yourself up for some very unhappy customers!

Effect on existing customers

The other effect of bringing a whole lot of new customers into your offer is the effect it has on the perception of your offer from existing customers.  When existing customers, who may have built up a brand perception of your offer already, suddenly see lower income demographics moving into their perceived category with them, their perception of exclusivity is diminished.  How exclusive is a Rolex if everyone is now wearing one?  What’s more, your customer experience and service levels may be affected if you are suddenly dealing with a higher influx of customers, and your previous loyal customers may not be able to get the service they were used to.  You then risk losing these previously loyal customers, possibly brand ambassadors within their higher income markets, who were happy to pay full price, to customers who already think you a bit too expensive.  And remember, your loyal customers likely provide the bulk of your sales volumes anyway.  This is the marketing equivalent of throwing out the baby with the bathwater, or biting the hand that feeds you.

Effect on brand image

This brings us to a deeper and more long lasting issue of discounting, which refers to damage to your brand equity or brand image.  By using discounting as a tactic over a longer period, you create 2 deep seated issues: one is a market that expects discounts and then only buys when you are on discount, which is in essence a “fake”, lower income market (with fake consumption habits and volumes) and likely to transfer to a competitor who discounts more at any moment.  Customers bought by price are just as easily lost by price and regaining them can only lead to very unprofitable price wars.  The other is a shifting of the quality or premium perception of your brand.  By discounting regularly (or sometimes even sporadically) the expectation of the quality or premium of the offer that can be maintained at the lower price will surely drop.  Where your customers may have believed a certain premium or quality was underscored by extra effort, or higher quality inputs, when you discount, that belief is challenged: “How can they be giving me the same quality at a reduced price?  Something in the quality has changed!”  Furthermore, customers may also deduce that if you can survive or continue to operate on reduced pricing, that you may have been charging extraordinary premiums previously, i.e. they were being ripped off.  Thus discounting can severely undermine the trust customers have in your offer and brand, which is the fundamental building block of brand equity, taking massive time, effort and cost to establish in the first place, but even harder to rebuild.

So what CAN we do if we desperately need to encourage customers to buy again and regain our sales volumes?

We’re going to take a step back here and look at some of the fundamentals of pricing.  My simplified view of price is that it is the monetary value associated with the expected utility of an offer.  Pricing has replaced bartering, where we would match the utility of one item with another.  The word utility is of course equated to usefulness, and how useful I perceive or expect this offer to be in meeting my need.  Utility, I might add, is hugely subjective to the buyer, indicated by the words “expectation” and “perception” used.  A glass of water to someone in a desert has a whole different utility to a glass of water to someone sitting in a fresh mountain stream.  “Good Value” is perceived by the buyer when the expected utility meets or exceeds the price.

We can think of this in terms of an equation below where Value is created (i.e. value is 1 or greater) when utility is equal to or greater than cost/price:

But I prefer to look at it in sense of a balance of scales as per below, where value is created when utility is equal to or outweighs cost/price:

So whilst discounting looks at adjusting the price to affect the value, there are many ways to look at adjusting the utility of an offer to improve the perception of good value, which we commonly call a “value-add offer”.  A price discount could also potentially be classed as a value-add, as it improves the value of the offer by reducing the expected cost, but it already has its own term “price discount”, so we will continue using the term “value-add” as referring to efforts to tip the utility side of the scale whilst the price stays constant. 

Why adjust utility and not price?

  1.  You don’t affect the affordability perception of your offer– what customers could afford previously, they can still afford as price hasn’t changed, so you are still effectively talking to customers in the same price bracket as before. 
  2.  Utility is subjective, so a benefit in utility cannot be objectively quantified.  Improving utility can have a bigger value effect for some buyers than others, where a change in price is immediately a standard value change for everyone, which brings us to the next, and most important point… 
  3. Others can easily replicate price but not utility.  Improving the utility side of the scale makes it more difficult for your competitor to copy or beat an offer.  In fact utility is often where your competitor advantage lies and can be improved upon.

How do we improve utility to improve value?

We mentioned utility is where your competitive advantage sits and this is true because your specific skills, advantages, and experience can be used to increase the utility of your offer to specific markets that value those characteristics.  By focusing on utility to drive value, you automatically differentiate yourself from competitors and the generic item, price, becomes less of a deciding factor in buyer choice.

Even though utility is a subjective concept, many utility factors can and do have a price implication, as the market price for such factors may be well known. However many utility factors don’t have a direct price correlation and in fact have different utility values for different markets.

There are so many categories and ways of improving utility to create better value , I’m not sure why businesses would resort to the one means of offering value that everyone can replicate and which comes with so many risks, which is price discounting.

Here are just a few value-added options off the top of my head that would drive utility up:

One utility value-add offer related to convenience that was pertinent during lockdown was home delivery.  Even though home delivery often has a perceived price value, offering free or reduced cost delivery tips the scales down on utility, as it just made it easier or even possible to access offers during lockdown.  Offering free delivery for a certain period does not affect the price perception of your core offer, but as many customers know the usual cost of delivery, they add that back to their value calculations.  When you return to charging normal rates for delivery, the value perception of your core offer is not altered, but the utility of the whole transaction experience returns to normal.

Closing thoughts…

I hope you have now realized the risks of discounting and seen that there are a whole range of other ways to increase the value perception of your offer, which provide further benefits without the risk or direct cost of discounting.

If you have any examples or stories to share about discounting or suggestions on more successful value-add options we can add to our list I’d love you to comment below so we can all see them!

Best Regards,

Peter Flemmer