Marketing, Pricing and Value: a Black Friday Story

This is a guest post by Gerado A Dada, an excellent data driven business leader I met through my blog. Gerardo has been at the center of the web, mobile, social and cloud revolutions across more than 15 years of driving business strategy and product marketing for leading technology companies including Rackspace, Bazaarvoice and Microsoft. Gerardo is the author of the blog www.theAdaptiveMarketer.com and is on twitter at @gerardodada.

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Line at UGG Factory Store (1)Like most people in the US, during Black Friday week my inbox received an onslaught of promotional emails from every company I have done business with. All of them, without exception were promoting sales and discounts.

“When a marketer’s creativity runs out he defaults back to price discounts. “ (link: http://wp.me/pkYTD-6h). Creating a promotion or a sale is the default way to generate sales in the short term. Even though we know, deep down, that short term discounts erode value and train customers to expect discounts as JC Penney learned the hard way (link: http://www.fool.com/investing/general/2013/04/09/3-reasons-jc-penney-is-living-on-borrowed-time.aspx )

It was Black Friday and we decided to stop by the Factory Outlet in San Marcos – my daughter had an eye on a pair of UGG Boots that I was hoping to get at a good price. This is what I found:

(picture with a line of shoppers outside the store)

It was not that surprising to find a line outside a popular store, especially on Black Friday, but there were a couple facts that made this experience interesting for me as a student of marketing and consumer behavior:

UGG Australia was not offering any significant discounts. Many models were being sold at list price. A few had a small discount. I did not see any pair of boots being sold for under $175. A few feet away, a store had a big sign promoting 60% + an additional 30% discount on everything. You could get a high quality pair of booth for about $50. The other stores with long lines were Coach and Michael Kors.

These are my observations in relation to the experience:

  • Customers buy based on emotions. How can you explain customers lining up to pay over $450 for a bag made of PVC plastic? (optional picture) – by the way this product was backordered at the time I am writing this post.

  • The value of the product is not in its specifications, quality of the materials, features or benefits. The value is in how it makes customers feel. When you wear UGG boots and a MK bag, you feel like you belong, you feel fashionable, you feel successful. The product is the experience.

  • It’s not the price, or the discount, but the feeling that you are getting a good deal that counts. The shoppers in line felt good, even if they really did not get a good deal. The end price was not as relevant as the feeling that they were getting a good deal. After all, who likes paying list price?

  • Even premium brands need to provide the feeling of offering a good deal. It does not have to be a discount, though: sometimes free shipping, personalization or an accessory could do the trick.

  • All the talk about brands going away? Nonsense. Brands are, and will continue to be, extremely valuable. You can probably get a handbag of similar quality and similar design for 1/10th of the price at Target, yet customers happily stand in line and fork out their hard-earned cash for a brand.

My call to action to you: before you start you next price promotion, think about how you can build a brand, an experience, that makes customers feel great, and makes them happy to spend more money with you.


Product – Price Promotion Fit

I saw a Groupon promotion from BlockBuster Express that gives away $5 worth kiosk movie rentals for $2. The deal, at the last check,  had sold more than 25,000 Groupons. For more than one reason, many of which I explain in my book, this is a very good use of Groupon by BlockBuster and in general a very good use of price promotion for a product.

Product: This is a basic utilitarian product that competes on price. Regular rentals go for $1.   The rental choice is likely limited, only so many DVDs can be stocked in a kiosk. The rental period is also limited – just one night. This is a convenience product, something people hire when they run out of most options. It is by no means a premium product.

Customer: There is no direct contact between the customer and customer service reps. It is a vending machine – as impersonal as it can get. There is no reason whatsoever to worry about customer experience and delighting customers. The customer mix and whether or not the new customers will fit the brand’s target segment is not a concern. Even without the promotion, customers choose this product for price not anything else.

Costs: The costs are all sunk once BlockBuster decides to place one and stock it with DVDs. If there are DVDs sitting in it, they are not making money. The marginal cost is close to $0, (it is the opportunity cost of not serving a full priced customer).  It makes sense to put these idle DVDs to work by encouraging  rentals.

Capacity: BlockBuster has many such kiosks and the offer is valid at any of them. So they are not risking over crowding in any one location. By the general rules of random distribution, we can assume that all kiosks will be utilized uniformly. This is a great improvement of capacity utilization of kiosks – making sure DVDs do not sit idle. Even if a kiosk runs out there are no downside risks – no customer backlash, customers either come back another day or move to next kiosk.

Bring in new customers: BlockBuster is struggling to hold on to its current store customers, as more and more are switching to Netflix. On the low end they are behind Redbox rentals. They are new to the rental kiosk business. Before this Groupon promotion, many customers did not even know about BlockBuster Express and even if they did they may not stop to try it.  A $2 for $5 deal is great way to bring them to the kiosk and create awareness.

Repeat Customers: This is a convenience product, not a premium product. There is a specific job this product is hired for. So the logic of people falling in love with service etc do not apply here. Even if only very small percentage of these customers come back, it is a better option than any other available customer acquisition option.

Groupon Fees: A brand like BlockBuster  may have negotiated a better fee for Groupon than the usual 50% small businesses pay. Even if they did not, this is a good application of Groupon as a  Marketing and Sales channel.

Overall the price promotion aligns very well with the product and the target customer segment.

What about your business and your product?

 

How Discounting Affects Product Value Perception?

It is fair to say everyone loves a discount. There is data to support the claim from years of Black Friday discounting that not only makes customers skip sleep and stand in cold weather for hours but also generates considerable revenue for the retailers. Then there are the group buying discounts made popular by GroupOn.

At the individual customer level, previous research done on customer preference for discounting point to both rational economic and emotional reasons.  Kahneman and Tversky showed, customers prefer discounts even if they saved lower amount in absolute terms.

Thaler in his work on Mental Accounting and Consumer  choice provide evidence of emotional (non-financial) reasons for why we may be motivated by discounts.

So we all value deals for rational and irrational reasons. But how much do we value the product after the initial buying decision? More specifically, since we do not know the absolute values, how much relative value do we place on a product bought on a discount vs. an identical and substitutable product bought without the discount?

There are three distinct possibilities.

Hypothesis 1: If we treat our customers as rational (ignoring the contradiction), once they bought the product at whatever price, the costs are sunk. How much relative value consumers get from each product should depend only on its own merits and independent of initial discount. At the very least, the choice between the two should be no different from  a random choice.

Hypothesis 2: If we treat our customers consistent with their previous action of seeking discounts for non-financial reasons, we should expect them to value the product bought at a discount higher than that of the one bought at full price.  This hypothesis is further reinforced by endowment effect and cognitive dissonance (I must really value this product, otherwise I would not have stood in line for it).

Hypothesis 3: Customers value the full price product more than the one bought at discount (remember the preconditions – identical and substitutable products).

So I conducted an experiment. The data and analysis show that  the last scenario, Hypothesis 3, is more likely than the other two.

The experiment was designed to get customers to reveal their preference by asking them to give away one of the two identical products of same price:

  1. One they bought at full price
  2. Other they bought at 50% discount

As it turns out, customers are more likely to keep for themselves the full priced product and happily give away half-priced identical product.  So while discounting may bring in customers, it may hurt by depressing the relative value of the product to the customers.

What does this mean to you as a marketer?

  1. Think again before running 50% deals on any group buying site or allowing your product to be bundled and sold at a discount by other channels.
  2. Attracted by large user base from giving away your product for free? Consider loss in perceived value to the customer.
  3. Know the customer’s end use of the product. If they are predominantly buying it for their own use, discounting most likely will not help improve lifetime value of the customer.  If they are buying it for others, discounting helps.

Want more actionable insights? Talk to me.

Further readings:

Kahneman and Tversky – Choices, Values and Frames, American Psychologist,  1984

Thaler – Mental Accounting and Consumer Choice, Marketing Science 1985

Note on the Experimental Method:

I relied on convenient sampling and applied Bayesian hypothesis testing. Compared to conventional, run of the mill hypothesis testing, say testing for statistical significance at 95% confidence level using Chi-square test for this case, Bayesian Hypothesis testing allows to test multiple hypothesis at the same time and help state the results in terms of probabilities instead of as absolute truths.

Results are subject to sampling errors, and do not take into account segmentation differences. This is also stated preference study and not a revealed preference study.

Where To Allocate Your Promotion Dollars?

You have $X dollars to be used as promotional discount to increase your product uptake, i.e., maximize number of subscribers rather than maximize profit. You have two versions of your product, Silver priced at $19 and  Gold priced  at $49. How will you allocate the promotional dollars to drive most uptake? Will you discount your Silver version, Gold version or split between both?

Sidebar: I understand I have  consistently advocated about profit maximization and not using price to drive volume. But let us assume you have a very good reason to do that and it is not permanent price drop but a controlled price promotion. May be you have a freemium model with a Bronze version at $0 and want to move most free customers to paying customers.

Consumer behavior research says, based on Prospect Theory (Kahneman and Tversky 1979), you are better off spending the promotional budget on discounting the lower priced version than the higher priced version. While rational economics states (assumed?)  a $5 discount is the same regardless of the price, consumers look at $5 with reference to the base price. Consumers value $5 discount on $19 version more than then do the discount on the $49 version.  So  discounting your silver version maximizes new customers.

However there is an exception – when customers’ reference price (the price they expect to pay for similar products regardless of their economic value) is lower than the price you charge. Here the effect is reversed so you should discount the Gold version. If you are interested in understanding this case please write to me.

In either case, you are better off allocating the promotional budget to just one version and not dividing between two versions.

What is Price Realization?

JCPenney Pricing Waterfall

JCPenney Pricing Waterfall

It is time to give some definitions of pricing terminologies, specifically definitions of Price Realization, Price Leakage, Pocket Price and Pricing water fall.  I will explain these concepts in the B2C context (a retailer), for a B2B explanation see this. Seen above is a picture that shows the pricing for a queen mattress at a JCPenney store. The prices and discounts are taken from a store visit. (Note that I did not consider interest income earned from credit card balance.)

List Price: Price is the method to capture value added by a product. The most common way to indicate prices to customer is the list price, be it price tags in retail or invoice price in B2B transactions.

Price Leakage: Unfortunately, both in B2B and B2C scenarios, a business is unable to get the customer to pay the list price. Due to sales pressures, competitive offerings and other macro-economic factors, the prices are marked down. Different discounts applied to the list price are referred to as Price Leakage. In the figure above, price leakages are show in color red. Last week JCPenney was running a 50% off sale with an additional 15% customer appreciation coupon. On top of these if a customer were to open a store credit card they gave an additional 10% off. JCPenney is also running a frequent shopper program called JCPRewards that gives back $10 for every $250 spent.

Pocket Price: The pocket price, the price finally collected after all applicable discounts, is significantly less than the list price. This is still not profit, because it does not include sales commission (if any) and marginal cost of the item sold.

Pricing Waterfall: The picture says it all.

Price Realization: Price realization is about decreasing price leakage, increasing pocket price  and hence keeping a higher proportion of the list price that flows directly to the bottom line (profit).   Price realization can be in the form of  higher list price, fewer discounts, additional charges or decrease in service offered (see Cadbury’s methods on this).

Effective price management is about moving away from price leakage to increasing the pocket price through price realization.

But is JCPenney leaving money on the table or is there more to this than it meets the eye?