CONSULTANTS TO THE AFTERMARKET

Bill Wade

 

As Appears in Distribution Matters October 27, 2009

Dollars Off or Discount Percent?

By Bill Wade

Professors from Miami of Ohio and Indiana Universities have recently released studies of the ongoing effects of price cutting on future price expectations ... the dreaded “Shadow Effect” that restricts the ability to rebuild price levels after a promotion (or sales panic), something that is epidemic in the current downturn.

Especially at the end of a sales year or quarter, suppliers need to stimulate sales and are offering more and deeper price discounts to distributors than ever before... and in many cases, distributors are passing them on to end users.

Although offering deep price promotions may increase selection of a particular brand at the time of the promotion, such discounts may come with a heavy downside and baggage, because they can reduce post promotion value recognition.

One reason for a negative effect on future sales is that buyers may lower their expectations of future permanent prices, which in turn may threaten future brand valuation when prices attempt to return to ‘normal’ levels. This market has a long memory.

Pennies vs. Percent ... What Works? What Sticks?

In their research, the professors examined how promotion expression (‘percentage off' vs. ‘cents off’) moderates the effect of promotion depth on post promotion price expectations and longer term brand choice.

One of the research studies concentrated on whether promotion description affects:

  • Buyers’ price expectations (do they understand the deal);
  • The rate of brand choice at the time of the promotion (did the deal work).

The results indicate that for promotions of high depth (greater than 40%), a cents-off description leads to lower post promotion price expectations than a percentage-off discount of equivalent value.

In other words, discounts (or price cuts) expressed in clear monetary terms tend to stick longer than the promotion itself.

In addition to being associated with less downward price expectations, the high-depth percentage-off discount resulted in the same level of brand choice during the promotion as the high-depth cents-off promotion ... it worked just as well!

Percentages Favor Brand Valuation in the Long Pull

A second study found that the effect of promotional definition on price expectations carries through to brand choice after the promotion is removed.

Specifically, repeat choice for a brand following its use of a deep promotion was greater when the promotion was described in percentage terms than when described in dollar terms.

As with price expectations, post promotion brand choice did not differ as a functional promotional description for low-depth (less than 15%) promotions.

Interestingly, the prime source of inaccuracies in price perceptions stem from the difficulty of calculating the value of percentage-based discounts.

Specifically, difficulty doing the arithmetic:

  • Biases perceptions of prices from deep percentage-off promotions upward;
  • Makes buyers hesitant to weight the promoted price when updating price expectations.

Both outcomes help insulate price expectations from falling when consumers are exposed to a discounted price.

However, because computational difficulty drives the effect due to expression of the deal, the effect disappears for percentage-off discounts that are easy to compute ... the easier it is to compute, the closer it comes to the ‘cash effect’.

Thus, to best insulate post promotion share (while not undermining sales when promoted), managers should use percentage-off discount descriptions ... while avoiding discount values that are simple to calculate.

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