Discounts are one of the most widely used pricing strategies, but many businesses use them far too often. The most common goal of this is to boost sales and acquire new customers. Some of the main reasons for employing promotions include:
- Move stock which hasn’t been selling well
- Free up shelf space (e.g. for new season’s clothes)
- Meet a sales target
- Meet demands of trade partners (e.g. supermarkets)
- Make it easier to sell something
Their popularity is driven by the globalisation of sales events like Black Friday, daily deal sites such as GroupOn, and affiliates who live off discount codes. If someone is looking to buy a fridge online, and doesn’t like the price they see on the website, they know that another website is just a few clicks away.
This has put immense pressure on price competition and profit margin – put simply, they are a very expensive tactic. The pervasiveness of discounts is highlighted by the rise of websites such as GroupOn in recent years.
That warm fuzzy feeling you get when you see sales spike during is misleading. This post will discuss why discounting can kill your business, when discounts can be used, and how you can generate growth without resorting to the discount code.
Price is important, but it’s not everything. Focusing your marketing on making your business more physically and mentally accessible is a more sustainable, effective way to grow your business.
The recurring promotional high is an addiction which all levels of management – not only the proverbial finance director – find difficult to kick.
Ehrenberg, Scriven, Barnard
6 Ways Discounting Can Damage Your Business
#1 Destroys Business Profitability
When you run a discount promotion, the people most likely to take up the offer are your existing customers. Seeing as people
don’t like paying more than they have to, why wouldn’t they take up the offer? Studies by the Ehrenberg Bass Institute found that running a promotion had no after-sales impact on the business. No sustained increase in sales. No improvement in brand awareness.
If you’re trying to hit a sales target, you’re just bringing sales forward and creating a problem for yourself later down the road.
You might boost short term revenue and sales numbers, but this is at the expense of business profitability. Not only that, but many promotions cost more than they earn – your business may actually be losing money! After running a 75% discount deal on GroupOn, a London bakery wiped out it’s profits for an entire year, after they lost $19,500 on the promotion!
Black Friday saw a huge uptake in the UK in November 2014, leading to Andy Street of John Lewis warning that retailers need to reign in their promotions.
#2 You Encourage Delays in Future Purchases
If you regularly offer discounts, you encourage customers to wait for the next discount before buying again. This creates a vicious circle. Customers delay buying until there’s an offer, leading to a drop in sales. The drop in sales leads to a promotion in order to boost sales, and it starts over again.
Discounts create expectations in the minds of your customer, and they expect you to deliver on those expectations. These expectations change buyer behaviour, and can damage your business.
#3 You Start a Price War. Maybe One You Can’t Win
If you run a promotion, especially online, the chances are it won’t take long for a competitor to notice. You wanted to boost sales, but instead you get a price war as competitors react to your promotion with one of their own. Your profit margin heads into a downward spiral, and you face a decision: do you decrease your price more and lose profitability (and risk another competitor reaction), or do you accept the loss of sales to a competitor?
On 6 September, 1993, Rupert Murdock’s The Times newspaper cut prices from 45p to 30p, sparking a 10 year price war. This cost newspapers millions of pounds. In the year to June 2014, it’s reported that The Times lost £40.1 million. That decision on 6 September led to 10 years of profit erosion, and it’s hard to believe that the news readers got better quality as a result.
A price war is a lose-lose situation, and destroys market value.
#4 Lower Perception of Quality
I’d like to introduce a concept called ‘reference price’. This isn’t a specific number, say £19.99, but rather a range of prices which a consumer finds acceptable. If you’re product is above the reference price, people will view it as overpriced. On the hand, if it’s priced too low, consumers begin to suspect the quality. Why wouldn’t they? When the price of a newspaper drops from 45p to 20p (as The Times did over time), you wouldn’t expect the quality to remain the same.
Why aren’t supermarket own brand labels the market leaders? They almost always have the lowest price, yet bigger brands lead the market. Part of this will be to do with availability (supermarkets won’t stock competitor labels), but it’s also down to perception – consumers think the quality is not as good. At the same time, awareness of own-brands isn’t as high.
#5 Most New Customers Won’t Come Back
It’s a common assumption that running a promotion will lead to more new customers, but that’s not the only factor to consider. Once you acquire a new customer, you need to factor in cost per acquisition, their lifetime value, and the time horizon for your investment. Use this data to analyse the performance of a promotion, and you may find that it’s going to be a long time before you see a return on your investment (if you do see one).
Most of the acquisitions won’t buy from you again. One of the reasons for this is that they only bought from you because you were running a promotion. They may buy from you again when you run another promotion, but then you still wont make a profit. Link this back to the concept of the reference price. When someone first buys something at a 75% discount, the original price now seems too high!
If you insist on using discounts to acquire new customers, take an analytical approach to it so you know how much you’ve spend acquiring them, and how much profit you’re getting back.
#6 Help! We Can’t Cope With All These Sales!
The big increase in sales that comes with a promotion could be more than you can handle. The case of the London bakery earlier in the article is one example – the owner had to bring in temporary staff to deal with the pressure and make 102,000 cupcakes!
But even big businesses like Marks & Spencer in the UK can struggle with the demand. They had to delay deliveries of online orders by up to two weeks and stop next-day delivery because of the demand created by Black Friday. Many websites crashed because of the number of visitors to their website, with some creating an online queue to enter their website.
The demand can be difficult to forecast, so many businesses who run promotions are unprepared for the ensuing onslaught of demand.
Where Should You Invest Your Budget?
Discounts and promotions can be extremely expensive. Of course, there will be some situations where a promotion may be appropriate. But when a promotion doesn’t provide a long-term sales increase, and doesn’t increase brand awareness, where should you be investing your marketing budget?
I’d like to introduce you to two more concepts, which I came across in Byron Sharp’s How Brands Grow book:
- Physical availability. This refers to how easy it is to physically access your store. This could refer to the number of miles to ASDA/Walmart. When thinking about ecommerce, you can think of this as your accessibility through websites where your target market is located. If you’re not at the top of Google, it requires more work for a searcher to find you. They may have to scroll down the page or click to page two to find you. If you’re not on the first page, you are much less physically accessible than other websites.
- Mental availability. You don’t want to simply be physically accessible, you want to be recognisable. If customers remember who you are, they are more likely to buy from you again. Instead of going to Google and searching ‘women’s dresses’, they’ll go to ASOS and search for it instead. Better mental availability could increase your site conversion rate, and increase metrics such as click through rate in search.
Why am I talking about physical and mental availability? These are the two areas where you should be investing your marketing budget. Improving these is a sustainable way to grow your business, without resorting to discount promotions which destroy value. Promotions are undoubtably one of the easiest ways to boost sales, but that does not mean they’re the best way to build your business.
There are plenty of legitimate reasons to use a promotional pricing strategy, but businesses over-relying on discounts to grow their business more than ever.
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