Look at Black Friday promotions, and you will notice a troublesome trend. Retailers offer everything from Kindles to vacuum cleaners and bed linens at increasing discounts. Even more troubling is that Black Friday is not an exception. It is just a better-marketed and publicized version of what happens daily in retail.
This article discusses handling this “Prisoner’s Dilemma” and highlights the top four traps retailers fall into with their promotions.
The challenges with product promotions
Retailers are locked in an intricate, high-stakes prisoner’s dilemma. Heavy discounting and promotions are hit-or-miss, profit-draining activities. But paradoxically, no retailer can afford to stop them.
On the surface, neither option in the retailers’ prisoner’s dilemma looks attractive. Imagine a world where every day is Black Friday, and even Walmart can’t get a significant market share. This future awaits many retailers if the “price is king” strategies prevail.
The other option – a broad-based abandonment of discounting and promotions – would also claim victims. No retailer wants to break ranks and heroically free themselves from the discounting spiral.
In its simplest form, a prisoner’s dilemma puts two accused people in separate jail cells. They go free if both stay silent and do not betray each other. If only one betrays the other, the betrayer goes free, and the other gets a much longer sentence. If both betray each other, both stay in jail, but with milder sentences.
In retail, the “betrayal” is the attempt to outdo competitors with steeper discounts and more aggressive promotions. The intricacy comes in when you have dozens of “prisoners” in the game rather than just two in the simplified classic version above.
The retailers’ objective should be to soften their sentences, so to speak, amid a prisoner’s dilemma they cannot escape. The answer is to keep on discounting and promoting but to do it in a way that minimizes the financial damage.
Right now, all this discounting and promotion activity is claiming one very important victim: profit.
Few retailers seem to realize that they are exacerbating the prison sentence they have willingly accepted – in the form of lower profits or even losses.
How to run better product promotions
How do retailers reduce their sentences? Retailers should start by recognizing the prisoner’s dilemma and its implications. This means discarding some long-held and dangerous assumptions about pricing and promotions. It means getting more rigorous answers about how consumers shop and why.
Many retailers think that moving away from habitual discounting and promotions is impossible. However, heavy discounting and lower prices do not always have to lead to declining profit. Retailers must become much more selective regarding the products they promote, at what time, for how long, how deeply, and above all, what type of promotion will deliver the best return.
Our collection of pitfalls aims to help retail executives make more confident and defensible decisions when they invest millions of dollars—if not billions—in discounts and promotions.
1. Don't overpay for the sale
Retailers often give greater discounts than necessary to influence consumer behavior. These discounts most often take the form of additional depth (e.g., 30% off instead of 20% off). However, retailers often disguise the discount by linking it to other products, future purchases, or applying it in other creative ways.
The decision to offer a greater discount reflects that retailers are liable to overestimate the power of a price change and oversimplify the role that pricing plays in a consumer’s purchase decision.
Let's begin with the power of price changes. Almost every retailer has a number for the price elasticity or promotional price elasticity of different products at the category level or, better yet, even at the individual product level. This means they have a decent understanding – at least historically – of how much additional lift they may get if they offer a product at 30% off instead of 20% off.
The operative word here, however, is “historically.” What looks at first glance like a price elasticity number can be polluted by a variety of yesterday’s influences. The type of promotion, placement, discounts, price ranges, the economic climate, the number of competitors, and their power and behavior may no longer apply to today’s decision.
Taking any such price elasticity number, say -2.5, and using it to make multi-million-dollar business decisions in a new situation is dangerous. Retailers often risk oversimplifying the role that pricing plays in a consumer’s purchase decision.
The classic view interprets consumers’ responses to prices in an “action-reaction” way. You stimulate demand with a lower price, and consumers respond by buying more. The problem is that real life is not that simple. Price matters in every buying decision but is rarely the sole factor.
In many cases, it is not even close to being the most important one. Here, the “pollution” in the simple model takes many forms. How the retailer presents the discount matters, i.e., whether it is dollars off, percentage, new low price, or product ties such as buy one get one free or a discount on a complementary product.
Consumer perception of price thresholds and price fairness also play a role. So do price anchors, relative price differences, and even the channel the consumer chooses to buy. Assumptions about the power of price changes and the role of pricing lead to unnecessarily high discounts because retailers apply what looks like a pure number (a historical price elasticity) in a polluted environment that mutes the actual effect the price change has.
Many retailers have begun using increasingly advanced analytics to model potential lifts more precisely. Pursuing such precision matters. Being “slightly off” with a promotional strategy can yield a profit swing of tens or hundreds of millions of dollars.
Retailers have access to so much detailed information to process and so many products to make decisions on. The amount of information has grown exponentially, as has the complexity. But the amount of time to take decisions hasn’t changed at all. Retailers don’t have enough time to optimize everything.
Instead, they focus deeply on a few critical items or categories and then rely too heavily on anecdotes, history, or, in the worst case, emotion for the rest of their decisions.
Finally, the worst cases of excessive discounts are those attached to products that probably should not be on promotion at all. Not every product or product category in the store is a traffic driver. Every retailer will have products, especially luxury, specialty, or niche items, that consumers reasonably expect to pay full price for.
But these products still find their way into retailers’ circulars, presumably to support a retailer’s overall perception of being competitively priced.
An inherent danger of excessive promotion is its training effect on consumers. Former Supervalu CEO Craig Herkert described this phenomenon well in an interview with The Wall Street Journal in 2009, when he said that “in too many cases, we’ve trained our customer only to buy certain goods when they’re on promotion because we’ve allowed the gap between the promotional price and the regular price to become too great.”
2. Don't overestimate promotional lift
Remember our comments about using historical price elasticity estimate to help calculate the lift for an upcoming promotion. If you use a relatively robust number such as -2.5 or -3.5 for price elasticity, you can model a promotional lift that can look almost irresistible to a decision-maker.
Why are the lifts in such models usually too good to be true? Think of a market structure typical for many stable product categories in mass merchandisers, clubs, food and grocery, drug, and dollar stores. There are two or three major national brands, maybe one or two discount brands, some private labels, and an overall low to modest growth for the category.
If a retailer does get a lift of 20% or 30% from a promotion, it is mathematically impossible to attribute that lift to incremental demand. Such promotions do not stimulate demand. They steal it. And where do they steal it from? Suppose the retailer’s goal was to steal it from competitors. In that case, their enthusiasm might diminish when they realize they stole a lot from themselves, either by encouraging consumers to trade down within the store or pulling forward future demand. Retailers must also account for shifts across channels, including shifts to online from in-store buying.
Finally, a promotion's cost also matters when measuring success. Aiming for perfect execution is both hard and expensive. It also stretches beyond logistics, merchandising, and consumer communication. A recent example is the effort to offer “price matching” guarantees around Black Friday and the weeks leading up to it.
If an associate on the sales floor has several hundred items in their department, how much effort is required to make sure that they can verify a consumer’s claim of a lower price elsewhere? How can they correctly decide to accept or refuse the request? How much effort is required to ensure the associate does this efficiently to minimize the risk of customer frustration?
Trying to improve, perfect, or even ensure consistent execution may quickly eat into the incremental gains expected from the promotions in the first place.
3. Don't get too creative with promotions
We've already mentioned that price changes – and price itself – do not always play a large enough role in consumers’ purchase decisions to warrant retailers' high discounts. The field of behavioral economics has begun to offer useful insights into both the role of price and the role of other factors in a purchase decision.
People do not always behave rationally, which helps explain why consumers are notoriously bad at redeeming discounts, rebates, or rewards in the future. Smart phone companies, appliance manufacturers, and consumer electronics makers have capitalized on this well-established and proven tendency for years.
The same thinking underpins many retailers' “shopper marketing” activities. These creative promotions communicate additional discounts to consumers at a lower cost to the retailer because the discount does not come off at the register. The retailer expects the rate of future redemptions to be low.
In theory, the premise seems sound. But behavioral economics also tells us that some consumer segments will start weighing their perception of a future reward against their strong preference for instant discounts. This presents a formidable challenge to the retailer, especially when these promotions involve brands that are household names.
With potentially hundreds of millions of dollars at stake, how does the retailer calibrate these discounts? And what evidence proves that this promotion is more effective in driving sales than a more conventional promotion?
The more consumers need to think about price or “do the math” about a price decision at the shelf in one of these shopper marketing campaigns, the more sensitive they become to price. This is another example of the training that former Supervalu CEO Herkert mentioned. The more you teach consumers to think about price, the more they will think about price.
Do consumers see value in gift cards, coupons, discounts on multiple products, or being entered into a sweepstakes? The answer is yes and no. Not every customer will respond to such incentives, and those who do will not all respond to the same degree or frequency.
Customers do not comfortably fit into broad classifications, such as the pervasive “cost-conscious consumer” nearly every retailer wants to attract nowadays. Retailers have to move toward consumer-driven promotions rather than continuing to create promotion-driven consumers. They must know what drives consumer behavior and, above all, what is overkill when they promote a product.
4. Don't try to meet too many conflicting objectives at once
We mentioned that profit is the biggest victim of the retailer’s prisoner’s dilemma right now. Increases in discounts and promotions help explain the declines in gross margin at many retailers. But this is a symptom of a deeper-seated, unavoidable conflict at the retailer’s highest management levels: what tradeoffs they want to make and why.
To begin a discussion about these tradeoffs, we often present executives with four alternatives: increasing market share, revenue, gross margin, and profit. We asked them which one they would prefer most. The most common response is “yes.”
But these executives know that in most markets—especially ones with low or modest growth—it is extremely difficult for a company to achieve all four alternatives simultaneously in a sustainable way. In other words, a decline in profit dollars or gross margin can reflect a conscious temporary choice rather than poor performance or execution.
A retailer has chosen to invest in higher volumes or higher revenues in that quarter or half-year period. These tradeoff decisions have inherent conflicts. Slowing down a decline in gross margins will likely mean a slight loss of market share, triggering a desire to repurchase the share at some point.
In each cycle, the price takes another beating, directly or through heavier discounts and promotions. This reinforces consumers’ focus on prices, as they become more conditioned to pay attention to deals and prices.
This cycle brings the retailers’ high-stakes prisoner’s dilemma back into focus. If a retailer wants stability and consistency in pursuing financial objectives, it cannot stop discounting and promoting.
If you can’t eliminate them, you have to calibrate them better. In a prisoner’s dilemma, one “prisoner” will usually try to guess what the other will do. But a “prisoner” or competitor must try to divine many rivals' intentions in the retail sector. Many companies think their company is currently involved in a downward price spiral. They also believe that a competitor – not them! – started that downward price spiral. In other words, when discounting and promotional activity intensifies, it’s always the other guy’s fault, not the retailer’s own.
Game theory suggests that all retailers should continue to “betray” and keep on discounting (the Nash equilibrium). In the real-life dilemma that retailers face, they have no escape. But the high stakes “game” these retailers play daily is also far more nuanced. It requires them to have the best understanding of what drives their consumers' behavior. That will help them understand what would be overkill when they promote a product.
Given the money involved, this knowledge represents a significant competitive advantage. The better and brighter the retailers plan and execute their discounting and promotions, the lighter their sentences will be.
How Simon-Kucher can help
Our experts at Simon-Kucher assist retailers in developing and executing effective promotion strategies to enhance sales and customer engagement.
We offer tailored solutions to help retailers effectively promote their products or services. We analyze market trends, customer behavior, and competitor actions to identify the most effective ways to promote offerings and differentiate retailers.
Whether through targeted sales promotions, special offers, or innovative marketing campaigns, we provide retailers with actionable insights and strategies to keep customers engaged and drive sales growth.
