The Power of Promotions - How They Influence Customer Buying Behavior

Tis the season for discounting. Customers have been trained to expect companies to offer amazing “Black Friday”, “Cyber Monday”, and the newest comer to the promotion parade, “Travel Tuesday” deals.

In 2015 Amazon invented a new promotional day before Black Friday called Prime Day and sold a tremendous amount of product – “tens of thousands of Fire TV Sticks, 35,000 Lord of the Rings BluRay sets and 4,000 Echo devices in 15 minutes,” Amazon Prime VP Greg Greeley said. 

The pressure for vendors to oblige is strong as highlighted in this recent Forbes article “Why Amazon, Lululemon And Cole Haan Won Black Friday” penned by Jon Marino, Thinknum's Finance Editor. [Thinknum Alternative Data tracks discount pricing at the world's largest brick-and-mortar stores and online.]

“There's a great divide shaping up between retail brands that drive consumers' attention, and those that have to effectively beg on social media.”

“And as shoppers increasingly spend on deep-discount social ads and through the apps they trust with their payment information, it's becoming apparent that old-fashioned holiday strategies from big retailers aren't going to have the same impact this year.”

Vendors do their best to leverage these promotions to drive propensity to buy for their wares during the all important holiday shopping season but a blind “follow-the-leader” approach to discounting is a recipe for disaster.

This blog will explain the power promotions have on influencing a customers behavioral/pricing psychology and a guide on how to properly implement them to improve financial performance.

Promotions 101

Promotions are sales, email blasts, promo codes, discounts offered around holidays, events (back to school) or any other activity. While technically a “promotion” need not include a discount, generally today most do (you can always try experimenting running promotions such as an email blast without any discount, as a baseline).

When you have a competitor selling at a certain price, and your prices rise above that price, traditional economists would say that all demand goes to the low price seller, and anyone selling for a higher price loses the sale (assuming, of course, that there is enough supply at the lowest price). 

However, our experience with clients in a variety of industries shows that the buying behavior of consumers is more complex. For example, we saw Costco drop the price of a brand name good by 40%—with no change in conversion rate on one of our customer’s sites. How is that possible?

The reality is there are many reasons why people buy from a particular company. Leveraging data and mining consumer behavior across all of your products, monitoring the competition and experimenting: these are the keys to effective pricing and sales.

Does more than 10% of your overall revenue come from promotions? Do more than 20% of your transactions include promotional codes or other kinds of discounting? 

Promotional Pitfalls

The holiday season (in America) brings a big spike of free shipping offers right as the shipping window closes in mid-December each year.

Anything that can have a positive impact also has the potential to do harm. For example, while free shipping may be a consistently powerful bundle, it can also be the most harmful bad bundle. 

Take IdeaPaint, which includes shipping in its prices. Shipping on paint is expensive (it’s a heavy liquid) but IdeaPaint refuses to ship it any other way than overnight express. This has two major effects. First, it makes their product appear more expensive than competitors or substitutes (other whiteboard paints, or old fashioned Quartet whiteboards). Second, it angers the customer because it deprives the customer of choice. 

And this mistake isn’t limited to paint. Many coffee companies include shipping in their prices for coffee orders. The thinking is always the same: it’s simpler for the buyer. However, it has the effect of dramatically and artificially raising the price perceived by the consumer. A $19, 12 ounce bag of coffee is dramatically more expensive than a $14 bag (plus $5 shipping).

Gimmicks like “Free Shipping” or “We Pay the Sales Tax” promotions work for a reason: you’re offering a valuable bundle. They work beyond sales tax and shipping, though those are by far the most universal. Think of products frequently purchased together, that are compliments, where the discretionary second one has high margins.

Think of highly complementary goods to bundle together with high enough margin to make an appealing price point for the bundle, while remaining profitable. Whether that’s a free case for a new tablet, or bindings with a new pair of skis–things that the buyer will likely buy anyway, and in buying from you get value from. 

People overvalue the “freebie” versus the equivalent price reduction. Offering those $100 bindings free with a $500 pair of skis will likely improve conversions far more than offering $100 off skis and bindings together, even though it seems like an identical offer.

Predictable promotions can hurt your business. 

In some industries, promotions are the main purchase driver, creating a sense of urgency. It’s important to understand the effectiveness of your promotions and how your consumers reacting to them. Promotions are best if used to price discriminate: when predictable, they become less effective at discriminating.

Another example is having everything in a store on sale at one time, frequently for the same discount, it may be easier to manage but this can cost you significant revenue.

Negative impacts of predictable promotions:

  • Predictable promotions create strategic customers, so your most loyal customers will also be low-margin customers reducing the overall value of your brand and enterprise.
  • Strategic customers have learned to wait for promotions, and avoid paying full price. Promotions may perform really well at the beginning, as people have been waiting for the product they wanted to go on sale. The number of days since your prior promotion will be a very strong indicator of the success of a promotion, more than other variables. It is very hard to reverse this psychology.
  • Word of mouth will likely focus on your promotions, and strategic customers will coach their friends to also be strategic, putting downward pressure on your margins.
  • Frequent promotions can also erode brand perception. Gap, for example, due to near-constant sales has trained shoppers to think of their products as less expensive. And eventually, they’ll be forced to make cheaper products because they are paid less for them as they are only sold on sale. 

 

Optimized Promotions 

Companies must examine current sales data on promotions, focusing on the contribution margin, to make sure that when they run promotions they are positively impacting the business.  Frequently when unit sales go up, margin goes down and nobody realizes it until it is too late. Did average order value increase? Were orders profitable? Did those customers come back later and buy again? Did customers just pick off the on-sale items, and not buy anything at full price?

Determining which promotions work best requires a deep dive into your data with powerful analytics and testing via scientific simulation. It’s not a given that 20% sells better than 15%. In fact, we’ve seen the opposite. Each business is different: the only way to know yours is to explore your data using a tool like Perfect Price to determine the optimal discount for your audience.

Companies should use an appropriate and scientifically valid simulation technique to test their discounting strategy prior to pushing it live. For most, the best approach is a Markov Chain Monte Carlo (MCMC) simulation, which essentially simulates customers showing up and buying or not buying, over time. 

We encourage you to download our e-Book, “The Ultimate Guide to Pricing Strategy”, which offers a wealth of knowledge and advice for effectively implementing optimized pricing promotions.

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