Discount Madness Is Back – Be Smart With Your Price Reductions!

September 05, 2018

Discounts - price reductions

Too many companies have forgotten how to handle discounts, particularly in the automotive and furniture industries. Fortunately, there are still a few good role models out there.

In the media, we often hear that “discounts on cars are bigger than ever.” And let’s be honest, when we go to buy a new car, we automatically expect it to come with a sizable price reduction. Why is this? Because we have been conditioned by the automotive industry. The same is true of furniture retailers – they bombard customers with special offers. Anyone planning to buy a new kitchen will be offered a discount without even asking for one. This shows that many companies that were previously cautious in designing their discounts have now forgotten what to do.

However, there are several good role models. These include IKEA, which follows a very narrow discount strategy. A field test was conducted to find out how companies would respond to a prospective customer looking to buy a fitted kitchen. The result was that while many other furniture stores offered reductions of over 20 percent, IKEA didn’t grant any discounts. Instead, the Swedish chain focuses on designing well-thought-out promotions. For example, at the start of this year, it placed an advertisement for a baby bed in a magazine with an integrated pregnancy test. If the test was positive, the expectant mother received a discount on the bed.

In the automotive industry, car manufacturer Tesla is a textbook example of a “zero-discount strategy.” Company founder, Elon Musk, believes it is essential for the integrity of the Tesla brand that new cars fresh off the conveyor belt are never sold at a reduced price. However, vehicles used for test-drives or damaged before being delivered aren’t included in this rule. According to Musk, justified price reductions are an important component of an effective pricing strategy.

Looking specifically at companies that handle discounts well, we see they tend to follow four key principles – principles that apply to almost any industry.

Principle 1: A consistent price strategy

The keyword here is integrity. Customers get used to paying a particular price and consider that price fair. When a company starts offering discounts in an uncontrolled way, it can unnerve customers, resulting in lasting damage to the company’s brand and image, as happened to Praktiker, the former German home improvement retailer. When Praktiker decided one day to halt its aggressive discount policy, its customers left in droves. Continuous discounts had given customers the impression that the normal prices were too high, and these higher prices didn’t offer them any better service. It’s clear how the story ended.

A lack of a proper discount strategy can even unsettle competitors, convincing them they need to take action in what they perceive to be a price war. These developments have the potential to cause a downwards spiral in prices across an entire industry.

Principle 2: No discounts without a quid pro quo

Price reductions should only be offered when there is a good reason. Deviations from the normal price should only be considered for customers that will generate more value for the company through different means, such as by buying a wider variety of products or services (cross-selling), increasing their purchase volume, or by being strategically important. However, it is always important to proceed with caution. For example, many machinery manufacturers make the mistake of granting discounts on services, software, or updates that are much too high, or even offer them free of charge. As software and service-based business models are becoming ever more important, these companies are shooting themselves in the foot.

Principle 3: Time-restricted promotions as a steering tool

Price promotions shouldn’t be predictable or go on forever. If customers know when promotions are likely to be launched, there is a huge risk that the company's regular business will be negatively affected. The aim should always be to use promotions as a way of steering customers. For businesses where high rates of capacity utilization are crucial for their survival, promotions may be a way for them to proactively increase the utilization of their machines instead of having to pursue customers reactively, often by offering even larger price reductions. Furthermore, using predictive algorithms enables companies to estimate shifting levels of supply and demand more accurately, reducing the risk of machines standing still.

Principle 4: Strict monitoring

Price reductions of any kind should always be closely monitored. KPIs should match the company’s overall objective and need to be evaluated regularly. In addition to the usual measurement criteria, e.g. revenue growth and profit, special cross-effects, such as changes in demand for other products or purchase sequence (e.g. panic buying) should be assessed in as much detail as possible.

Smart discounts have a stabilizing effect

A strategic, targeted way of handling price reductions isn’t just a sign that a company follows a careful business approach, it also ensures stable market conditions across the industry.