The 4 alternatives to discounting in your Ecommerce business
As discussed in Parts I and II of our Ecommerce discounting series, discounting can be a destructive financial lever in your business.
So, what can you do instead?
Below are a set of widely used practices for merchants to consider as an alternative to discounting.
1) Add more value for the same price
‘Buy One Get One Free’ or BOGO or is the classic tactic to promote products without damaging brand value.
It’s a tactic used by retailers because it works – and it’s backed by science.
The power of ‘free’
Imagine you’re at the mall, indulging in some retail therapy. You’re hungry for a chocolate treat and you are offered a choice: A Hershey’s Kiss for $0.01, or a much higher-quality Lindt truffle for $0.15.
Which would you go with?
In his book Predictably Irrational, behavioural economist Dan Ariely ran this exact experiment and found that 73% of folks chose the pricier Lindt.
BUT, when he changed the price of the Hershey’s Kiss from $0.01 to free, 69% opted for the Kiss.
Source: Predictably Irrational, Dan Ariely
The introduction of that one word — free — entirely reversed the outcome of the study.
When confronted with a purchasing choice, we typically run an internal cost-benefit analysis, weighing potential satisfaction against price.
But, Ariely concluded that when the word ‘free’ is introduced, it not only decreases the cost but makes us believe the benefits of the free item are higher.
Suddenly, that crappy Hershey’s Kiss is the finest chocolate known to man.
As a result, we fall victim to the zero price effect, a phenomenon whereby our demand for an item dramatically increases when it is free.
“The moment something involves ‘free,’ we get overly excited,” explains Ariely, “we no longer think rationally.”
So what’s the lesson here?
Instead of discounting, use this behavioural flaw to your advantage and offer something free instead.
This ethical sleight of hand will actually increase your product value and protect margins.
2) Gift Cards
Gift Cards and vouchers are an excellent way to provide value to new customers without having to discount your brand value. It not only incentivises your customers to make future purchases from you, but from an economic perspective it’s also a win/win.
The economics of gift cards
Offering a gift card or voucher for a purchase is essentially deferring a discount to a future item. In other words, you are taking the profit of the full priced item now, with the discount being deferred to a future purchase.
Most consumers who receive a gift card are quick to put it to use: More than 70% of all gift cards are redeemed within 6 months of purchase, according to one survey.
But after that first 180 days, the rate of use tends to stagnate. At the one year mark, just under 80% of cards are redeemed — and as time passes, they are less and less likely to see the light of day.
At any given time, 10% to 19% of gift card balances remain unredeemed.
From an economics perspective, that 10% to 19% of gift cards that are unredeemed are discounts that are never actually realised. Why?
Well, people forget about them…
This is money in your pocket.
3) Transparent pricing
As the name suggests, price transparency gives your customers a straight up way of how your products are priced in the market compared to substitute products.
In the fashion space, nobody does this better than Everlane.
Everlane adopt a ‘radically transparent’ approach to their business model. Their business is built by cutting out the middle men from the traditional retail model and passes those cost savings and margins directly to the consumer.
The brand uses their content to convince customers their prices are already as cheap as possible.
This positions their product differently compared to other retailers because trust is established at the beginning.
Everlane don’t need to discount because their customers are convinced they are already getting the best, fair price.
4) A membership program
Costco has been around for almost 40 years. It’s one of the largest wholesale brands globally and is known for its rock bottom prices.
Costco is a fascinating business. Where most supermarkets make their profits from groceries and staple products, Costco has a different approach.
It basically sells all of the groceries at break-even, but makes all it’s profit from membership fees.
Because it has built its reputation as the lowest cost supermarket, Costco has pricing authority – so much that customers don’t even look at the price because they know it’s going to be the cheapest.
From a financial perspective, Costco’s gross profit margins are only 11% – which is incredibly low. So, if you buy a 100 pack roll of toilet paper for $10, it costs the company about $8.90.
Costco’s gross profit margin:
Source: Investing City
Compare that to its competitors:
- Target’s Gross Profit margin is 30%
- Walmart’s is 25%.
You get the idea!
Costco’s Gross Profit margins are terrible
11% gross profit margins are terrible. At SBO, we recommend DTC retailers to have gross profit margins of at least 40%+
But 11% gross profit margins work for Costco.
That’s because Costco doesn’t make it profit from groceries.
It makes it through the annual membership fees.
Here’s a breakdown of Costco’s financials for the 2016, 2017 and 2018 financial years.
Notice how the net income (net profit) basically forms 99% of Membership fee income?
Costco is in the business of membership fees, not groceries!
So what can we learn from Costco?
If you’re operating in a commoditized industry, or selling low value, high volume products, consider memberships or loyalty programs.
Owning this narrative to your customers can help you avoid falling into the discount trap, build long-term brand value, and make up your margins with zero marginal cost revenue.
Discounting is often the default tactic used to increase in the short-term sales. Whilst it has its purpose, it can be detrimental to your financial and long-term brand value.
Remember, there are many other tools in your toolkit to improve sales and provide value to your customers.
Use them at your disposal.
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