Sunday, April 13, 2014

There is a Law of Discounting…

Ever had a conversation like this in your house? Your partner comes home with a bag of expensive-looking shopping.

You:                 Hey, what did you buy?

Partner:           I picked up this fantastic dress / suit (insert product of your own choice here).

You:                 Looks great. How much was it? 

Partner:           It was 50% off

You:                 Great! (No major damage to the credit card balance then, you think to yourself)

There is no doubt that we now live in a discount world. In his book "Bargain Fever" Mark Ellwood finds that the average discount offered in the USA 10 years ago was around 15% - 20%. Today, that average is closer to 45% which, being an average, means there are discounts much higher than 45% included in that figure. Anecdotally, the same trend is occurring here in Australia. But one thing is for certain: many companies can no longer be guaranteed that customers will pay full price.

Although Pricing is part art, part science, the (very common) conversation above breaches what is known as the Weber-Fechner law. Adapted to Pricing (and Behavioural Economics) from psychophysics research conducted by Ernst Heinrich Weber (1795 - 1878) and later Gustavo Theodor Fechner (1801 - 1887), the law states that the difference between two physical stimuli is proportional to the magnitude of the stimuli. So by not providing one stimuli (i.e., full price), the attractiveness of the discounted price, or the magnitude of the discount, cannot be properly evaluated and assessed.

In the above conversation, because we don't know the full or list price of the dress or suit, the partner doesn't know whether the purchase is a good deal or not. The same applies to the actual purchase by the customer. After all, there is a difference between 50% off a $2,000 dress or suit, versus 50% of the price off a $200 dress or suit.

Sounds perfectly logical doesn't it? And yet, I still see many companies still ignore this simple law.

A couple of years ago, while walking down Oxford Street in London, I picked up a brochure from a basket outside a telco’s store, which simply read "£20 Off". Once again, £20 off may be a great deal, but it didn’t say what the full price was and whether it was off a call plan, a handset or something else. The brochure didn't assist in evaluating the attractiveness of the offer.

More recently, there were two enormous billboards, side by side, on Platform One. At North Melbourne station. The first billboard read "Energy Bill Confusing?" Well of course they are, as anyone who has looked at a utility bill, or contemplated switching providers, will attest to. Ask someone what price they pay for energy, whether it's gas or electricity, and they won't be able to tell you. They will be able to tell you what their average bill is though.

The next billboard read "Ours is simple. Pay on Time and get 10% off". Feeling less confused? Hardly! The Weber-Fechner law has once again been ignored. Ten percent off what? Well that depends on what plan you are on, so while 10% off may reward you for good behaviour, it doesn't remove the confusion.

So what are the key lessons or take-always from this discussion? In many industries today, and particularly in B2C markets, a discounting strategy needs to be an integral part of any pricing strategy. The "base" or full price will come from your pricing strategy, but the price the customer pays, and your revenue maximisation opportunities, will increasingly be found in your discounting strategy.

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