The Problem With Fake Discounts

By Scott Francis on Pricing Strategy, discounts / Post a Comment

canstockphoto9386491_boy_magnif_glass.jpgDonald Trump likes to call any reporting critical to him or his presidency Fake News.  While that is a thin-skinned reaction to the stories, the President often has a legitimate point that the reporting was written in a style designed to get a specific reaction.  Somewhat similarly, we often see pricing strategies anchored on very high “List Prices” plus large discounts.  The discounts attract customers for a while; however, customers eventually realize these are Fake Discounts which run out of steam and that causes more problems than they are worth.

Although I frequently write that price is often not the most important factor in determining where a customer buys a product or service, it is important.  People want to feel like they receive a good deal on whatever they purchase.  Knowledge of that customer preference for a deal, has led some sellers to inflate their list prices, then offer large discounts to get the sale.  It appears to me that this practice is increasing.

My email inbox has been bombarded this holiday season with offers for large savings.  I can remember when 20% discounts attracted my attention, but this year I have seen much larger discounts.  Target offered 30% off on clothing, $25 off a $75 purchase (33%) on holiday décor, and 40% off home goods.  Lands’ End offered 50% off sweaters and 40% off everything else.  Omaha Steaks offered 50% to 70% off a wide variety of combos.  Jos.A.Bank offered 70% off for the Thanksgiving weekend.  Those are all substantial discounts and make you wonder how the retailers can make money with them.

It is not just retailers who are following this discounting practice.  I recently read an article, Discounts do not equal cheaper power bills, Victoria’s energy watchdog warns, which observed that consumers in Victoria Australia were paying more for energy despite higher reported discounts.  Similarly, Grainger has been known for many years to set list prices at very high levels, often 50% - 80% higher than competitors, then offer regular customers very large discounts. 

We see the same phenomenon in healthcare.  Although it is very difficult to find prices before buying any health service, the insured patients eventually see a claims statement that shows a very high price charged by the medical provider, offset by a large discount negotiated by the insurer.  Drugs are often the most extreme example of this.  I had a prescription filled earlier this year where the list price was $80, and I paid $2.16.  As a result, patients realize that nobody with insurance pays full price for healthcare.

In the case of Grainger and the health insurers, one of their key marketing pitches has been – we offer the highest discounts.  These large-discount pricing strategies often work for a period.  Much like we are more attracted to huge-jackpot lotteries than small ones, we (consumers) feel like we are getting a better deal when discounts are large.  The potentially large savings can induce many customers to try a new seller.  Unfortunately, those discounts condition customers to wait for more discounts before buying anything.  If customers don’t like the price of something today, they know they can simply wait for the discount to arrive before buying.  Additionally, when the list prices are too high, customers will refuse to ever buy anything at full price.  At that point, they realize the discounts are fake discounts, and often leave.

If you are a seller employing the large discount strategy, you should analyze your transactions to see what proportion of your sales are transacted at the full list price.  If only 10% to 15% of your sales are at list price, it is pretty clear your customers recognize the fake discounts.  Unfortunately, it is not an easy problem to fix.  Most companies who go down that path become addicted to the perceived lift they get from higher-than-average list price increases.  They also know their customers won’t buy from them without the discounts.  If they lower their list prices to be more reflective of the actual value of the product or service, they will find it extremely difficult to lower their discounts by corresponding amounts.  Their customers are equally addicted to them, and will not invest the time in analyzing all the prices to ensure they are no worse off. 

Grainger is a good example of the difficulty of changing.  Early in 2017 they announced that they would systematically begin to lower the list prices on many of the 400,000 SKUs they carry.  Through nine months this year, sales are up 2% (basically in line with market growth) but gross margins are down 2%.  They have been unable to lower the discounts enough to offset the list price reductions. 

The bottom line from all that is to resist the lure of the fake-discount pricing strategy.  There could be short-term gains from it, but also long-term pain.  It is still important to segment your customers and charge more where the value you provide is greater, but focus on the net prices you are charging across all segments.  You should compete for business on the value you bring including product assortment, service quality, convenience, speed of response, etc., as well as price; and avoid too-good-to-be-true pricing.

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