Amazon's success phasing out list pricing is exactly where JCPenney failed

There's an article in the New York Times entitled Amazon Is Quietly Eliminating List Prices. List prices, or manufacturer suggested retail price (MSRP), serve two main purposes. First, it's illegal for a company that sells goods to a distributor or retailer to dictate the price of an item. A clothing brand can't tell a boutique how much to sell a dress for. That's price fixing and is illegal. The brand can, however, "suggest" a retail price, which is how we end up with list prices and the "suggested" in MSRP.

Second, list prices serve as an anchor, which is a technique that takes advantage of the human tendency to put extra emphasis on the first piece of information regarding a decision. Let's say Bob wants to sell a pair of shoes to John for at least $200. If he's smart, he will start by saying the shoes will cost $300, anchoring the negotiation above where he wants to end up. John is looking to buy the shoes, and he now has to negotiate down from $300, which is much harder to do than if John had started the negotiation by saying he would pay $100. Like a literal anchor, anchoring puts a stake in the ground and the negotiation or decision reorients towards that point.

List prices follow the same path. If someone wants to buy a sweatshirt, seeing a list price of $100 and then a real price of $20 makes it seem like a very good deal. 80% off! The list price anchored the decision at $100 and then the real price of $20 is always compared in reference to the list price of $100.

Amazon phases out list prices

Amazon was by no means the first to use list prices, but the company leveraged them to build its brand and expand into the company it is today. Amazon built its business on the core idea that it would always be cheaper or as cheap as its competitors. List prices were a traditional signaling tool used to show the company's pricing advantage over "the rest."

The Times article posits that Amazon's weening off of list prices is the result of various lawsuits that have taken aim at bogus lists prices that inflate the actual savings passed onto a customer. (From the example above, some retailers would say that the sweatshirt list price is $100 when the original brand sells it for $20. It's easy to see how this can get out of hand). These lawsuits might have factored into the company's decision, but there's something much more interesting about the move to phase out list prices: Amazon no longer needs them. Amazon has built a brand strong enough to exist on its own. The company has built itself into a brand that, by definition, means the destination for the best prices. It no longer needs a gimmick such as list prices to imply this claim; Amazon embodies it to the fullest degree.

This might seem unexceptional until you consider how hard it is to change consumer behavior and expectations that are core to a brand's promise. Just ask JCPenney, the department store that, after decades of using pricing gimmicks and always-on sales, tried to phase out these mechanisms in 2012 under the leadership of newly-appointed Apple retail god Ron Johnson. Only a year later, JCPenney struck financial ruin and had to abandon the entire plan.

JCPenney's plan focused on reversing the race-to-the-bottom promotions that made it successful in a previous era. From an excellent Fortune tell-all on JCPenney from 2014 that summed up the changes under Johnson:

When Johnson eventually unveiled his strategy, it centered on a few points. The biggest, perhaps, concerned Penney’s incessant price-slashing promotions — 590 in 2011 alone. The new JCP would have virtually none. There would be three prices for an item: the original price, which was far below the typical marked-up price; a month-long value price for certain items; and a twice-monthly “best” price for things that needed to move. No more clearance racks, no more mess, just an honest — or as a later slogan put it, “fair and square” — relationship between the customer and the store. In a retail world full of illusory market-share gains based on which retailer offered the lowest clearance prices, it felt like a welcome way to stop the madness.

The comparison between JCPenney's failure and Amazon's success is worth unpacking. Ron Johnson started and failed to break the department store's addiction to pricing gimmicks in the span of sixteen months, where he quickly turned from a savior into an enemy, with the company losing over $1 billion in cash during his first year as CEO.

This will not happen at Amazon. The company with Jeff Bezos at the helm succeeded phasing out list prices for two reasons—both of which JCPenney itself failed to do: 1) Amazon built a stronger, more trusted brand; and 2) Amazon took their time to phase list prices out, backed by an immense amount of testing and learning.

Amazon's brand vs JCPenney's brand

The strength of Amazon's brand is quite incredible, especially given the degree that consumers trust it. List prices are not inherently bad, but Amazon's success in getting rid of them comes down to a simple fact: Amazon used list prices to establish its promise of the lowest prices, while JCPenney used list prices as a trick to make it appear as if shoppers were getting the lowest prices. Amazon is able to stop using list prices and suffer no brand dilution because it continues to keep its promise of offering customers the lowest prices. Amazon doesn't use coupon codes, special discounts or hidden offers. Instead, it always shows you the lowest price by default. The company is infinitely more transparent than its department store counterpart.

List prices didn't matter that much as long as the company was always offering the lowest prices, which Amazon does either by using its scale to buy products for less or by scraping the web and adjusting prices dozens of times to make sure it has a competitive edge. It likely won't matter that Amazon gets rid of list prices since the brand is established and its core promise remains. Most importantly for Amazon, the company has figured out a way to sustainably offer the lowest prices and the best experience, without relying on gimmicks like list prices, coupon codes and flash sales that were driving JCPenney into the ground. Amazon built up the trust and no longer needs one of the mechanisms it used to build it.

JCPenney, on the other hand, used mechanisms like list prices to trick customers into thinking they were getting a good deal. List prices were just one of many hacks that made up JCPenney's house-of-cards pricing policy. It makes perfect sense why abandoning these charades created such an upheaval: customers shopped at the department store as a result of this exact trick. It was core to JCPenney's promise.

Amazon is probably the biggest threat JCPenney has ever faced, since it's able to offer both low prices and a better customer experience. JCPenney was able to get by on a race-to-the-bottom pricing model for years until Amazon figured out how to beat the department store while not driving its own business into oblivion. Amazon made a better promise and continues to keep it. JCPenney didn't.

Testing, learning and taking its time

Consumer behavior and expectations do not change on a dime. Amazon is keenly aware of this, as proven by the transformative effect Prime has had on millions of customers. The company's move to rid of list prices follows the same trajectory. Amazon knows that customers internalize change over time; abrupt change does not sit well. Amazon is currently in the process of phasing out list prices, which might take many months to complete. The company wisely did not flip a switch and get rid of list prices like JCPenney did. Instead, Amazon likely experimented with removing list prices for months, analyzed the data, and adjusted its efforts. The decision to remove list pricing was also the result of loads of testing and learning, in addition to using its unique expertise in consumer shopping behavior. Customers probably acted in ways that no longer made list prices a necessity, and Amazon took a cue from these actions, as opposed to acting first without looking at the data.

This is radically different from JCPenney's approach, which tried to flip a switch on its entire promise and somehow thought customers would react well, with little testing. From the Fortune article, about Johnson's plan to radically shift the department store's pricing strategy:

Johnson wasn’t going to wait around for an answer. When a director asked when he planned to test the notion, Johnson scoffed. Never mind that other retailers had tried such pricing only to see customers vanish. He had made his decision. After all, his hero, [Steve] Jobs, disdained tests and instead relied on his gut. At the same time, Johnson didn’t seem particularly interested in how Penney operated, according to Ullman. The outgoing CEO noted in a regular update to the board that the new CEO had not asked a single question about how the business was currently running.

Johnson's rushed timeline, aversion to testing, and the fact that getting rid of mechanisms like list prices broke the department store's core promise, made the disastrous outcome inescapable. In early 2012, JCPenney reported that in-store sales fell 19% from the previous quarter a year ago and online sales fell 37%, according to the Fortune article. This was a staggering defeat.

To be fair, JCPenney had to do something, given the looming disaster that its race-to-the-bottom pricing was having on the company's bottom line, especially in the face of Amazon. There was also plenty of pressure from Wall Street to act quickly, in addition to activist hedge funds and short sellers.

Even so, this doesn't beat the fact that companies are held to the promises they are founded on. Deviating from this promise out of the blue will never end well. Amazon, even with the removal of list prices, continues to improve upon its promise. JCPenney, conversely, didn't.