Thursday, 5 March 2009

Discounting in a downturn

Been reading a lot about retailers and brands discounting in this downturn in order to preserve sales.

Pricing is our favourite P, and all this talk of discounting motivated us to write this note.

In our view, any pricing action has to be preceded by a couple of questions:

a. are you a brand or are you a commodity?

A brand is able to distinguish itself from its competitors on the basis of being a unique and relevant differentiation. It hence charges a premium, and uses that premium to re-invest in itself and continue to strengthen its position. Michelin tires help to save you fuel, Duracell lasts longer, Ipods are sexy, Colgate gives you 12 hour protection etc.

If you have no unique distinctive characteristics that customers understand and value, you are a commodity. Go ahead and feel free to cut prices.

b. What do you want your customers to do?
Brands grow by getting in more customers or by getting its customers to consumer more. In a downturn both of these tasks will be difficult.

Brands have a core set of loyal customers and then those on the periphery that come and go. In a downturn, a brand manager must focus on keeping the core together. The core may down-trade or exit the category altogether. This must not be allowed to happen, in the long term interests of the brand.

A strong brand should however, temporarily alter the value proposition for its “core” customers to reflect the challenging financial situation. But a brand should never, never reduce prices.

We suggest to increase the value of the purchase by offering extra volumes for free. This costs less on the bottom line and has a positive impact on the consumer. At the same time, it sends out the message that because the economy is tough, does not mean the product is any worse. It signals that the brand understands the challenges of the economy, and takes the opportunity to thank its loyal consumer with the promise that it will whatever it takes to ensure that even in these challenging times, the consumer can enjoy the products he loves.

The key question is, how much is good enough? Should the brand offer 10% extra volume? Or 20%? Or 50%? There is not enough research on this ,but our understanding is that anything over 15% begins to devalue the brand.

A price reduction impacts the bottom line strongly- devalues the product, sets expectations of future bargains and limits ability to reinvest in the brand.

A 10% increase in volume (given free) has a far lesser impact that a 10% price reduction. (Please do the maths on this, its simple and very illustrative)

We do not recommend cross promotions either. Buy a HP laptop and get a printer free! Once again we apply the principle that the cost of “free gift” should not be more than 15% of the cost of the product.

On the other hand, there are premium brands like Louis Vuitton than simply never cut prices. No end season sales, no bulk discounts, nothing. These products however deal with customers exhibiting a completely different price elasticity and we shall not go into that here.

Brands take years to build, only hours to discount. We know what we wrote here may sound theoretical, but we are convinced price discounts are the surest way to kill your brands.

ritu and venkat

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