Avoid the Discounting Death Spiral

By Steve McKee

You get what you pay for. Don’t be penny wise and pound foolish. A cynic is a man who knows the price of everything and the value of nothing. All truisms. And all too often ignored in business.

In his new book, Bargain Fever: How to Shop in a Discounted World, Mark Ellwood reports that retailers sold 40 percent to 45 percent of their inventory at a discount in 2011, more than double the percentage of a decade earlier. Lingering economic anemia will do that to you. As much as Americans love to buy stuff, we simply don’t have the confidence to toss cash around like we did 10 years ago. But statistics are funny things; as impressive as Ellwood’s numbers are, I find their flip side equally compelling: More than half of all retail transactions are still made at full price.

Why are we in business so often preoccupied with customers who want a deal? Simple—we fear losing sales to the other guy. Unfortunately, that can lead to self-inflicted (and sometimes deadly) wounds, because we misunderstand the nature of pricing in purchase decisions. Many (most?) small businesses consider pricing a game not to lose rather than a game to win. But prices are not something to be ashamed of or to whisper about; they’re powerful tools a smart business can use to achieve its goals. And higher prices may be more persuasive than lower ones.

In a recent study of more than 18,500 people in the U.S. and overseas, Ipsos, one of the world’s largest market research firms, found that nearly half of respondents were willing to switch to a higher-priced brand if they perceived it to be of better quality. The numbers are even more heartening with respect to consumers whose influence is amplified by being active in social media—a majority of them will choose higher quality over lower price.

It clearly pays to demonstrate the quality of your product or service. Regardless of your business type, there are a variety of cues you can use to signal that your offering is better than those of your competitors. For a product, physical characteristics play a big role—weight, heft, materials, texture, workmanship, packaging. Service levels make a difference, too, from faster delivery to more helpful associates. Reviews also play a role (especially in service industries where the experience can’t be assessed in advance), whether formally through Consumer Reports or on Yelp or informally from friends and acquaintances. Branding also plays a part; we’re more likely to value a product or service that’s attached to a name we know and trust (see “The Case for Brand Accretion”).

But price also sends a powerful signal; it’s an indicator of value, not just a reflection of it. People pay more for branded milk than generic, even when it comes from the same cows, dairy, and processing plant. A diamond will be valued more if it comes in a blue Tiffany box than from a run-of-the-mill jeweler. And a 2008 Caltech study demonstrated that the more expensive people believe a wine is (regardless of its actual price), the more they’ll enjoy it.

Attempting to beat bigger competitors at the discount game can be a recipe for disaster; if you were a basketball coach facing a faster and more athletic team, rather than trying to run with them, you should slow the game down. Don’t think that economies of scale are tied to quantity alone; margin-selling can lead to higher margins just as volume-selling enables higher volume. Unless you’re in a dominant position in your industry, you’re unlikely ever to be able to out-volume the big guys. But you may very well out-margin them.

In fact, you may have to. Companies that continually discount can be forced to make up for lost margin by cutting corners. That means they risk entering a death spiral of offering less for less. But those that charge more can focus on enhancing their product or service experience, creating a virtuous cycle of reinvestment and profitability. It’s more challenging to find ways to enhance value than to cut a quick deal, but it’s the path to sustainability.

Find some quiet time to get with your team and work on this blue-sky exercise: How could our products or services be of greater value if we charged 5 percent more? What if we charged 25 percent more? How about 100 percent more? Don’t be afraid to explore the possibilities—the simple act of envisioning your options won’t drive any customers away. But by thinking about pricing creatively – giving yourself more options and greater flexibility rather than fewer and less – might unlock an entirely new way to differentiate your offering.

Only a handful of companies (Walmart, Priceline) can consistently win the low price game; in their cases, cheap isn’t a strategy, it’s the strategy. Quit playing by their rules, or you’ll follow in the footsteps of such dying brands as Sears and J.C. Penney. Instead, explore how you might charge more so you can deliver more. Research shows that a majority of potential customers will be willing to give you a shot.

Originally published on Bloomberg Businessweek

Steve McKee

Co-founder and author, Steve specializes in addressing the most meaningful problems. Call Steve when you want to change the world. He’ll have a thought (and some research) on that.

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