Monday, February 22, 2016

Category Management Series: The Negative Impact of #Promotions On #Pricing

We often discuss about the promotions topics on this blog. Promotions have been the last few years the magic word to develop sales, market shares and secure volumes. This is the reason why we have seen in the retail business promotions blossoming with higher and higher discounts.

Most of those discounts are based on yearly earnings, so most of the time disconnected of any profitability aspects. You may know what you lose when you promote an article with no margins, but you also know that you may lose way more if you don't go hard on the discount.

But there are other side effects to these promotions, even far more dangerous: it kills the price perceptions.

"Consumers who were offered free bread sticks as a promotion from a pizzeria said they’d be willing to pay $5.06, on average, for them once the promotion ended, only slightly less than the amount consumers were willing to pay when there had been no promotion, say Mauricio M. Palmeira of Monash University in Australia and Joydeep Srivastava of the University of Maryland. By contrast, people who were offered the bread sticks at a discounted price of 50 cents were willing to pay just $2.76 once the promotion was over. "

“Since consumers believe the value of a free product is likely to be consistent with the value of the purchased product, pairing a free product with a high-end product may very well increase perceptions of its value,” write authors Mauricio M. Palmeira (Monash University) and Joydeep Srivastava (University of Maryland).

 These days, companies often offer bonus products for free or at a low discounted price with a required purchase. For example, high-end cosmetics companies like Lancôme or Clinique offer free gifts with the purchase of a full-priced product. 

In one study, participants were offered a free or discounted package of spaghetti with the purchase of a jar of organic tomato sauce for $8.95. They were then asked how much they would pay for the spaghetti individually. People offered free spaghetti were willing to pay an average of $2.95 for it, but those offered the spaghetti for $.50 were only willing to pay an average of $1.83. 
When a free product is paired with an expensive product, consumers assume it is worth more than if it was offered at a low discounted price. 

For example, if a luxury jeweler offers a free bottle of wine with a purchase, consumers assume it isn’t cheap. But, according to the authors, customers might assume the same wine is cheaper if the jeweler offers it for $1. “Promotions with low discounted prices devalue products more than free offers. In fact, free offers may not devalue products at all when they are paired with an expensive purchase, as consumers will use the price of the focal product to estimate the value of the supplementary product,” the authors conclude. “If Mercedes-Benz promotes a car with a free GPS system, we expect the GPS to be high quality,” the authors explain. "

When you see discounts over 50% off the price tag, how could you consider the standard price tag? You expect to buy your product 50% off. And once you fell in the promotional trap, you are doomed. It is very unlikely you would be able to get out of it.