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Un-casting the discounting spell

For many companies promotions and ridiculous discounts are easy actions to attract more customers and increase sales – it almost seems magical. But it's not! Read here how discounting ruined an entire industry and how you can escape the curse.

“Spirits that I’ve cited My commands ignore!”

German furniture retail has been famous for constant price promotions and ridiculous discounts for some time now. Adverts with savings of 50%, 60%, or even 80% on sofas, tables, and barbecues – they are as familiar to a German’s ear as the famous lines in Goethe’s poem about a junior wizard’s ill-fated attempt at using magic to make things work in his favor. 

But this is not where the comparison ends: Just like the Sorcerer’s Apprentice, Germany’s furniture retailers are attempting to shake off a spell they have cast on themselves. We can learn valuable pricing lessons from these attempts.

Discounting is a failure to learn from one’s masters

At one point, Germany’s furniture retailers must have thought that heavy discounting was the right strategy for a profitable business. At that, they were well ignoring the fact that the most profitable furniture retailer, IKEA, never gives any significant discounts.

Putting discounts in the center of a pricing strategy has never been creative nor successful. Home-improvement giant Praktiker failed to learn that lesson some years ago. They gave 20% discounts regularly—without reason and in an entirely predictable manner. Margins were razor-thin, revenues kept shrinking, and management eventually killed their 3 billion EUR revenue and 20,000 employee company in 2013. It took some years for the other big furniture retailers to learn from that failure.

Attempts at stopping the discounting wizardry

Recently, Segmüller, one of the largest furniture retailers in Germany, decided to also turn its back on heavy discounting. They are now advertising “honest” and “real” prices, bidding farewell to “baseless” discounts and random exclusions—this is their new “price promise”.

We should all follow with interest what will happen to this pricing strategy. We bet that—sooner rather than later – they will return to the discounting bonanza. There is nothing wrong with an “honest” pricing strategy: It is a worthwhile strategy to pursue. We bet Segmüller and the likes will return to their old ways because discounting always has tempting short-term positive effects: Like spellbound, customers flock into the store, and revenue is boosted immediately.

The real cost of discounting comes delayed and can be fatal: Customers will adapt their price acceptance and will only visit the store when high discounts are promised to them. Price, as such, will lose its value as a quality indicator. Retailers then effectively replace having an actual pricing strategy by pumping out discounts. Having killed off their margins, they will—at some point—start scrambling for an alternative to inflationary discounting

Some of them, such as Segmüller, might want to “change the game” they have been playing in the past. They try to do a “pricing U-turn”, and most of them give up eventually:

  • Germany, 2011: Electronics retailer Saturn has been advertising with slogans such as “Tight is Right.” Meanwhile, Media Markt, Saturn’s sister company, tried to kill their discount-focused advertising strategy, proclaiming “the end of pricing-madness” in a huge national campaign. Sales dropped dramatically, and they stopped the campaign very quickly.
  • USA, 2012: US retailer JCPenny announced that “fake prices” would disappear and be replaced with “fair and square” pricing. After sales dropped by more than 30% during the all-important winter holiday season, they swiftly returned to a discount- and promotion-centered strategy. They have not been able to recover entirely from the episode till date.

Behavioral Pricing shows that there is nothing magical about discounting

Why did companies like Segmüller fall into the discounting trap to begin with?
Classic pricing theory endorses it by providing a convincing model. The rationale to give discounts is because “customers want it.” The prevailing misconception is that customers have a certain willingness to pay (WTP), which is a fixed amount limit they will not go beyond for a specific product. If a company reduces the price by discounting, it will attract additional customers with a lower WTP.

However, if they stop giving discounts, customers with a lower WTP stop buying, while the ones with a higher WTP keep on buying. Does that sound like magic? Not really. Discounts are just a tool to create a temporary boost in demand.

This boost is only temporary though.

A Behavioral Pricing perspective reveals the true dangers of discounting:

In Behavioral Pricing, customers do not have a certain predefined WTP. They develop price acceptance mostly in reaction to what is offered in the market (see our post on WTP versus Price Acceptance). With heavy discounting, the customer’s price acceptance will fall. They start to expect discounts as they learn only to buy when prices are slashed. People want discounts because they have been offered that in the past but not because they intrinsically desire them. Behavioral Pricing sees the cause-and-effect relation of discounting versus classic pricing theory. This is why we say, “Price Acceptance is not a tank you drain but a muscle you train.” Giving discounts will weaken that muscle, leading to the delayed costs of discounting mentioned above.

The Master’s discounting lessons: Take charge of the spells that haunt you!
Understand your role in managing Price Acceptance

The first lesson Behavioral Pricing teaches us when it comes to discounting is: Companies never only passively react to a certain WTP that exists in the customer base. Instead, they actively create or destroy price acceptance. Those who want to kick the discounting habit should start by recognizing their power. Just as the apprentice in Goethe’s poem who was complaining about the witch he summoned, many retail managers complain about the very customer behavior they created.

Understand the risk concerning value perception

The second lesson goes hand-in-hand with the decay of price acceptance due to unreasoned discounts. However, it refers to the value perception of the offered products or services: People hate dissonance. They care about things being consonant and in plausible balance. Thus, discounting a product without any further explanation other than “now it is cheaper” will eventually result in a devaluation of the offered products and services for the customer. How else could it be explained that the seller is now offering the same product at a lower price? Inevitably, it must have been too expensive and less valuable in the past to justify the initial price tag. Especially with products or services that have no clear reference price or market value, the risk of psychological devaluation is significant.

Realize the impact on the “psycho-logics” of decisions

There is a third lesson that can be learned from Behavioral Pricing that companies, who are tempted to follow a discount strategy, should be conscious about. The long-term consequence of discounts and promotions are not only quantitative (loss in price acceptance and perceived value) but also qualitative regarding the psycho-logic of the customer’s decision-making process. Discounts and promotions will selectively attract “bargain hunters,” or—even worse—train customers to become Bargain Hunters. Other decision-types, such as the Risk Avoiders, will also be scared off.

For them, high discounts always trigger doubts about the quality and fairness of the offer (see our short video for a description of the five distinct GRIPS-decision strategies).

A discounting and promotion-centered pricing tactic is changing the effective decision strategy in your customer base. This is an even more fundamental issue. An attempt to change this strategy to another is likely to fail as the customer base is fully attuned to discounts they have been offered in the past. Segmüller, JCPenney (and the like) are trying to achieve three near-impossible things at the same time: First, they are trying to train higher price acceptance, which is not possible in the short-term.

Second, they are trying to re-position the same products and services at a higher value. And as if that wouldn’t be challenging enough, they are targeting new decision-types that have been scared away in the past. “Fair and square”-pricing is, in fact, most attractive for “Risk Avoiders.” However, those are the very customers who are notoriously wary of offers by companies famous for giving ridiculous discounts and may not trust the sudden change. At the same time, the existing base of Bargain Hunters stays away, hunting sales elsewhere.

Behavioral Pricing teaches us how to un-cast the spell

Goethe has his Sorcerer’s apprentice rescued upon the return of the old Master. In pricing, unfortunately, the solution is not as simple. Starting with the right approach in pricing, however, we can start turning around the profit-slashing pricing strategy.

Long-term costs of discounts

Behavioral Pricing teaches us to be much more sensitive about the long-term effects of discounting and promotions. Training our customers in the right direction from the beginning is always much easier than trying to re-train them later.

Justification of discounts

Discounts and promotions are less harmful if they are connected either with clear and believable reasoning (e.g. “new designs are coming in and inventory needs to go”) or with a commitment that the customers have to bring to the table (i.e., buying more items). In other words, even discounts and promotions need to be “fair” and reasonable to the customer. Only then are they reversible and have less disastrous side effects on the perception of the product value, and the long-term price acceptance will not suffer.

Strategic dimensions beyond price level

We are not limited to price level alone. In fact, you have to manage more dimensions in your pricing strategy. The GRIPS-types have different sensitivity to different price levels, price advantages, price usages, price fairness, price control, etc. All of these are crucial dimensions of a strategic and tactical price image management (see Price acceptance, not willingness to pay – a concept for better pricing) to avoid falling in a trap that – essentially – you  have created ourselves.

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