I absolutely hate discounting.
While it might seem like a quick way to bring in more revenue, the reality is you are cheapening your product and reducing your brand’s worth and value.
Of course, there is a time and a place for discounting, but generally speaking it’s something I tell most business owners to avoid. (More on that over here).
Instead, here are four alternatives to discounting that actually work – that are even backed up by science.
In this article:
Add more value for the same price
When you focus on value, you can promote your products without damaging your brands’ worth. Take the classic promotion BOGO – or “Buy One Get One Free”. This is a classic tactic used by retailers because it works, and it’s backed by science.
The power of “free”
Imagine you’re in a shopping centre indulging in a bit of retail therapy. You’re hungry for a chocolate treat and are given a choice: A Hershey’s Kiss for $0.01 or a much higher quality Lindt chocolate truffle for $0.15. Which one would you choose?
Behavioural economist Dan Ariely ran this exact experiment in 2008.
In his book Predictably Irrational, he reports that 73 per cent of people chose the pricier Lindt chocolate.
However, when he changed the price of the Hershey’s Kiss from $0.01 to free, 69 per cent opted for the Kiss.
By introducing the word “free”, this not only reduces the cost, but makes us believe that the benefits of the free item are higher.
When confronted with a purchasing choice, we typically run an internal cost-benefit analysis, weighing potential satisfaction against price. That one word – free – has entirely reversed the outcome of the study; suddenly that inferior Hershey’s Kiss is the finest chocolate known to man.
This is what we call the “zero price effect”, a phenomenon whereby our demand for an item drastically increases when it is free.
So, what’s the lesson here?
Instead of discounting, use this behavioural flaw to your advantage and offer something free instead. This ethical sleight of hand will actually increase your product value and protect your margins.
Offer a gift card
Gift cards or vouchers are an excellent way to provide value to new customers without having to discount your brand value. They not only incentivise your customers to make future purchases from you, but from an economic perspective it’s also a win-win.
The economics of gift cards
Providing gift cards or vouchers with a purchase is essentially deferring a discount to a future item. In other words, you are taking the full profit of the full-priced item now and applying a discount to a future purchase.
Most customers who receive a gift card are quick to put it to use. (More than 70 per cent of all gift cards are redeemed within six months of purchase, according to one survey).
But after that first 180 days, the rate of use tends to stagnate. At the one year mark, just under 80 per cent of gift cards are redeemed – as more time passes, there is less and less chance of them ever seeing the light of day.
At any given time, 10 to 19 per cent of gift card balances remain unused. From an economics perspective, this percentage of unclaimed gift cards are essentially discounts that are never actually realised.
Why? Well… people forget about them, which means that is money in your pocket.
As the name suggests, price transparency gives your customers all the information around how your products are priced in the market compared to similar products.
In the fashion industry, nobody does this better than Everlane.
Everlane adopt a “radically transparent” approach to their business model, by cutting out the middlemen from traditional retail, and passing those cost savings and margins directly to the consumer.
Everlane uses their product page content to convince customers that their prices are already as cheap as possible. This builds brand trust from the very beginning, which automatically positions their product differently compared to other retailers.
Everlane doesn’t need to discount, because their customers are already convinced they are getting the best and fairest price.
A membership program
Costco is a truly fascinating business. It has been around for almost 40 years, and is one of the largest wholesale retailers globally.
Costco is known for its rock-bottom prices and basically sells all of its groceries at break-even, but makes all their profit from membership fees.
With an already established reputation of being a low-cost supermarket, Costco has gained pricing authority – so much that customers don’t even look at the price because they know it’s going to be the cheapest.
From a financial perspective, Costco’s gross profit margins are only 11 per cent – which is incredibly low. For example, if you buy a 100 pack roll of toilet paper for $10, it costs the company about $8.90.
Now compare that to its competitors. Target’s gross profit margin is 30 per cent; Walmart’s is 25 per cent – you get the idea.
The real business behind Costco
Costco’s gross profit margins of 11 per cent are terrible – but it is all intentional.
That’s because Costco doesn’t make a profit from groceries. It makes a profit through annual membership fees.
Here’s a breakdown of Costco’s financials for the 2016, 2017 and 2018 financial years, as summarised by financial analysis company, Investing City.
In this example, Costco’s net profit forms 99 per cent of their membership fee income. Costco is in the business of memberships, not groceries!
So what can we learn from Costco?
If you’re operating in a commoditized industry, or selling low-value-high-volume products, consider memberships or loyalty programs.
By owning this narrative you can avoid falling into the discount trap, build long-term brand value with your customers and make up your margins with zero marginal cost revenue.
Discounting is often the default tactic used to increase short-term sales. But while it has its purpose, it can be detrimental to your financial and long-term brand value.
Remember, there are other tools in your kit to improve sales and provide value to your customers.
Use what’s at your disposal.