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The Art of Discounting

By: Special Guest Author Rafi Mohammed, Ph.D
October 2010 Pricing

Activate Dormant Customers Through Strategic Discounting

In today’s erratic economy, the key to growing your business involves activating dormant customers by using strategic discounts. By “dormant,” I mean customers who are interested in your product or service, but have refrained from purchasing due to price. The “art of discounting” involves offering lower prices to attract new budget-conscious customers in a manner that minimizes the possibility of current buyers (who are paying full price) taking advantage of these price breaks. In the best case scenario, all current customers continue to pay full price and the discounts generate pure incremental profits. However, it’s more likely that some existing patrons end up buying at the lower price. Thus, for a discount to be successful, profits from new customers must be greater than the margins lost from current buyers.

Sell Through Discount Channels.

A recent news article notes the trend of upscale retailers seeking growth from outlet stores that target budget-conscious customers.( Ref. 1) Outlets have been a long time strategy for upscale retailers such as Saks (SKS) and Nordstrom (JWN), which respectively operate Off 5th and Nordstrom Rack stores. This year Bloomingdales, Lord & Taylor, and Neiman Marcus are all opening new discount-oriented stores. Outlets are generally not located in major metropolitan areas – thus they target different geographic customers as well as provide credible hurdles for current patrons to jump over – a long drive coupled with a limited selection – in order to reap discounts. In a similar vein, Morton’s (M8G) is promoting its $5 bar bites that are only offered in the steakhouse’s bar areas. Of course not all companies can open up a new outlet, however they can sell their products (and services) through distribution channels that target price sensitive customers in a manner that reduces the chances of cannibalization (current customers buying at a discount). High-end brands such as Starbucks (SBUX), Hyatt Hotels (H), and Godiva have sold discount gift cards through Costco, for instance.

Create a Discount Brand.

It’s common for companies to create a new brand to serve a price sensitive audience. Sprint (S), for instance, operates the prepaid cellular provider Boost Mobile. Boost’s $60 unlimited Blackberry package (talk, text, web, email) is considerably lower than the $99.99 “Simply Everything” plan offered under the Sprint Brand which provides the same unlimited features. And while companies can’t start a new brand tomorrow morning, they can sell their products at a discount via private labels. Just last week, Sprint announced a $300 million deal to provide service for Cricket, the discount cellular company. To protect their brand, many manufacturing companies don’t want the public to know that they are selling discounted products. With the right confidentiality contract in place, who manufactures house-brand products can remain a closely-guarded secret. The Private Label Manufacturers Association estimates that 65% of all food and beverage companies, including Sara Lee (SLE), Hormel (HRL), Bird’s Eye, and Del Monte (DLM), are involved in private label manufacturing. (Ref. 2)

Use Tried and True Tactics Such as Coupons, Sales, and Promotions.

 While these strategies are commonly used, they generally are not implemented correctly. Instead of viewing these discounts as a way to “move merchandise,” think about these techniques as avenues to activate price sensitive shoppers while keeping your current base paying full price. This involves creating hurdles (such as early morning sales on off-peak days, making customers clip and redeem coupons, etc) that allow budget-minded customers to credibly raise their hands to say, “Price is important to me.”

It’s understandably stressful if a company loses, say, 15% of its business. In these situations, it’s common to take a “slash prices and hope for the best” stance. I view this same situation differently. I prefer to focus on the fact that 85% of customers are still paying full price. The art of discounting involves maintaining current prices and implementing pricing strategies to activate dormant customers with low price options.

References

1.  Rachel Dodes, “Tony Retailers Hope Outlets Fuel Sales,” Wall Street Journal, August 9, 2010

2. Sonia Reyes, “Saving Private Labels,” Brandweek, May 8, 2006.



About the author

Rafi Mohammed, Ph.D is the author of The 1% Windfall: How Successful Companies Use Price to Profit and Grow (HarperBusiness). He has been working on pricing issues for the last 20 years. Rafi Mohammed is the founder of Culture of Profit LLC, a Cambridge, Massachusetts-based company that consults with businesses to help develop and improve their pricing strategy. He also holds the title of Batten Fellow at the University of Virginia's Darden Graduate School of Business (in residence, Spring 2001). A frequent commentator on pricing issues to the print media, Rafi has also made prime time appearances on CNBC as an expert pricing commentator. He is an economics graduate of Boston University, the London School of Economics & Political Science, and Cornell University (Ph.D.).

Rafi Mohammed
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