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In a Downturn, Discounts Can Be Dangerous

1:09 PM Thursday August 21, 2008

Tags:Marketing, Recession, Starbucks

Often the first thing companies do during a downturn in the economy is reduce prices on their products and services. Call it an economy-inspired sales promotion.

But is this a sound strategy? Do consumers always want the cheapest price? Can a price reduction actually hurt rather than help?

While it may be necessary in some cases to reduce prices, discounting has its risks. The biggest risk is that it can create a negative long-term perception of a product and a down-channel effect, ultimately leading to market-share erosion. Discounting can turn a Rolex into a Timex; a Barneys into a Macys; a Mercedes into a Chrysler. Just look at what happened to AOL when they discounted their services: they dropped their prices in some cases to zero, yet saw significant brand and market share erosion.

And discounting can also be dangerous to low-cost providers not focused on brand. Value-minded consumers have long-term memories and it is hard to retain market-share when the economy recovers and you try to raise your prices or eliminate promotions.

In some cases, it may make sense to buck the trend entirely and increase prices.
In fact, many companies--including Abercrombie and Fitch, Web.com, Hershey, Blue Nile, and Vodafone--are taking this counterintuitive approach. To be sure, many are blaming the cost of commodities and these increases will put a strain on short-term growth. But over the long-run this could build brand value. Abercrombie and Fitch recently announced they were raising prices, in part to help realign their clothes with high-quality-and their sales rose 5% as a result.

Don't get me wrong; there's no doubt that discounting and sales promotions are a vital sales technique when done correctly. It inspires excitement and creates a call to action. However, when offered at the wrong times--for no other reason than to boost sales--it can cut the other way and create brand deterioration.

Here's why:

Consumers give you their hard-earned money in return for something that meets or exceeds their perceived value. It doesn't matter if they're buying a hot dog, a handbag, or staying at a five-star hotel; consumers want to see value and quality in return for their money.

And studies have shown that in many cases, the more people pay, the more value they ascribe to their purchase. Money plays a funny role in the purchase process: it anchors perceived value. If you discount prices during adverse times, consumers may begin to question the original value.

Starbucks, which just posted its first-ever earnings loss, has begun to offer lower-priced options on its menu, such as the recently announced $1 cup of coffee with free refills. This strategy may boost sales in the short-term but I suspect it will hurt the Starbucks image in the long-term (and so does CEO Howard Schultz, who once said, "Our marketing will emphasize quality and service, not price.")

When you discount, you undo the "placebo effect" of higher prices. And this leads to a decaying belief in the value of the product offered. So it may be short-term thinking to devalue a consumer's perceived value of a product simply to move more merchandise during shifts in the economy.

There are ways around this, of course. Consider the auto industry, typically the first to discount their way out of economic woes. Chrysler recently did something to preserve their price while offering a discount for something that does not affect their brand: gas. Chrysler cleverly took discounting to the next level by offering up a $2.99 gas guarantee for three years on all new car purchases within its fleet. The idea was to subsidize the fuel that goes into the new car, not the MSRP of the car itself. They followed a hugely successful promotion from GM in 2001, which discounted the financing instead of the price of the car itself. To be sure, the auto industry has far more problems than brand deterioration, but this approach is nonetheless smart marketing during tough times.

So if you're considering discounting prices during this recession, consider the long-term consequences and the potential for inadvertently re-positioning your brand. And if you must, it may be better to focus on something ancillary--such as gas or financing in the auto industry--rather than what your brand truly represents. Because once that veil is pierced, it may be incredibly difficult to go back and reestablish the value proposition to your consumers.

See the Complete Downturn Survival Guide

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Comments

I couldn't agree more, although I suspect many marketers and corporate execs will resist this only to watch their brand value diminish.

- Posted by Jan G. 
August 23, 2008 7:11 AM

I find it a little bit unconfortable to read that the president of Web.com places his own brand along side premium recognized brands and praises how smart they are. I see a conflict of interest that tarnishes the article a bit; but good article overall.

- Posted by Gustavo 
August 26, 2008 5:30 PM

I would like to add one point to this analysis:

The problem is that managers can easily see the short term effects of discounts in terms of immediate sales and therefore discounting becomes a self-reinforcing activity. It is much harder to see long terms benefits of brands and as a consequence people end up discounting these long-term benefits.

- Posted by Dan Ariely 
August 29, 2008 8:47 PM

Hi Nice article, however, this scenario may well work only with a differentiation strategy where price pressure is not so onerous.

Consider then in a low cost leadership strategy where price is everything and the competitors are biting at your heels with over-capacity and an economy that is also biting hard. In this scenario it may be best to seek the Blue Ocean Strategy to return to differentiation until that is, your competitors fight back and start to erode your brand value with me too offerings.

Do we believe in D'Aveni's Hyper-competition approach or Porters 5 forces model? Brand is only sustainable whilst it offers a clear value proposition but once others have an alternative, it won't be long before price pressure reigns. How long then can you ignore investor returns, whilst protecting your brand value?

Just a thought....Mike O

- Posted by Mike Ormesher 
September 1, 2008 5:04 PM

In most of the organizations, the targets are topline and not bottomline. During recession, if companies switch over to such a system, then, automatically marketers will be more conscious of their decisions.

- Posted by Pramod 
October 7, 2008 10:14 AM

In the times of recession , from a retail perspective, who is hit hardest?
I think this applies to customers who are not that price sensitive rather value sensitive. There is another class of consumers specially in developing countries for whom value is synonymous with price ...they are very price sensitive.

Your hypothesis applies to high end customers and products but not all segments...overall interesting read...

- Posted by Raj AIM 
October 13, 2008 2:59 PM

Why would you want to lower the utility (value) of your product during an economic slowdown? I believe its a knee-jerk reaction to the uncertainty that a recession brings. I see how reasonably increasing prices can create greater value and would be a great tactic that would support your overarching strategy.

If BMW or Rolex cut their prices in half because of this economy, then the value of my BMW or Rolex can now be obtained by my neighbor! Who wants that!? I'm more inclined to say "adios BMW / Rolex" and move on to bigger and better because the value of my possessions just dropped.

You have to understand the fundamentals of your company before you even touch the price of your products.


- Posted by Kevin James 
October 28, 2008 1:13 AM

prework for conference

- Posted by Steve 
November 25, 2008 6:19 PM

Keeping prices high, may increase perceived 'brand equity'- but in the case of Abercrombie & Fitch - the results to top line have been NEGATIVE. Despite the claim in this article that their prices were increased due to quality improvement (vs higher cost of goods and the need to raise retail prices) - the claim that their sales improved by 5% is NOT because of prices increases- its in fact because they have more stores to sell their products than the year before. The standard to measure a retailers performance is "comp" sales - in other words - excluding new stores and only comparing stores that were open in each of the like periods. Using that universally recognized metric for evaluating retailers - Abercrombie in fact recorded a 7% DECREASE in the July period. In the most recent time period (october 2008) - ANF has held their prices as well; their comps were NEGATIVE 20%.

- Posted by Allan 
November 26, 2008 12:50 AM

regardless of the pricing pressure - the smarter long term strategy is to understand and manage your price point.

consider taking a grp approach
count the frequency and reach at which a discounted price point is made available to the market
trend and index against the regular price 'grp' level
in the end you'll have a good barometer of whether you are sending too many discount price signals

if your pricing strategy is not yielding the results you need - consider value enhancements
P&G have mastered disciplined price management
the Chrysler approach of discounting a companion item is also appealing
cheers

- Posted by miro slodki 
December 12, 2008 8:26 PM

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Jeff Stibel

Jeffrey M. Stibel is an entrepreneur and brain scientist. He studied business and brain science at MIT Sloan and Brown University, where he was a brain and behavior fellow. Stibel has authored numerous academic and business articles on a variety of subjects and is the named inventor on the US patent for search engine interfaces. He is currently President of Web.com (NASDAQ: WWWW) and serves on academic Boards for Tufts and Brown University, as well as the Board of Directors for a number of public and private companies. Stibel is the author of Wired for Thought: How the Brain Is Shaping the Future of the Internet, being published by Harvard Business Press in September 2009.

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