Discount-heavy pricing strategies create long-term cycles of dependence that lead to promotion-addicted shoppers and lowered profit-margins—companies end up repeatedly undercutting themselves. Brands and retailers, therefore, are looking for ways to wean people off of these discounts and utilize everyday low-price strategies and or other pricing strategies that undercut competitors. Newer direct-to-consumer brands have broken free from these models by using a high-priced “straw man,” eliminating the need for discounts and opting for low- and full-price models.

Why We Wrote This

While there are many factors that contributed to retail’s existing challenges, companies are not paying enough attention to how their short-term actions are impacting their long-term success. One of the primary culprits is excessive discounting, which trains and attracts shoppers who always want products for less, cutting into margins that are already under pressure and building up a troublesome customer base. Companies across the space need to seriously understand the powers of discounting while implementing changes that mitigate its downsides. Taking action now will pay dividends in the years to come, while standing still or relying even more heavily on discounts will only spell more bad news. — Richie Siegel, Founder and Head Analyst, Loose Threads

Stores have spent years conditioning shoppers to wait for discounts, leading to a messy, sales-focused environment both off- and online. These discounts undermine the long-term value proposition of brands and retailers, since they erode brand value and its perceived quality. Brands and retailers need to shake off this dependence and streamline their discounting and pricing strategies to refresh their brands. They need to become as nimble as the new, direct-to-consumer companies that have created a more sustainable pricing and inventory strategy. Even though discounting is a trap, companies like Amazon and Best Buy prove that there is a viable path forward. — Janet Acosta, Strategy and Insight Lead, Loose Threads

Trailblazers

  • Amazon has used a multitude of strategies to create customer loyalty regardless of price.
  • Walmart relied on everyday low pricing from the beginning, structuring its stores, marketing, logistics, and business model around the practice.
  • Glossier is training a new generation of shoppers not to wait for discounts by creating demand for its products and interest in its community at all times.
  • Everlane sought to simplify the apparel-selling process and defined a large part of the new direct-to-consumer movement in the process.
  • Best Buy avoided the discounting trap and is beating expectations, even with Amazon as a looming threat.
  • MVMT successfully adapted the direct-to-consumer narrative to the watch business, diminishing the need for discounting and aligning itself with low-cost luxury-quality.

Stragglers  

  • Macy’s is attempting to reinvent itself with its North Star strategy, but its reliance on discount shoppers and muddled messaging is leading to confusion and a non-existant clear way forward.
  • Ann Taylor’s reliance on discounting has turned it into a bargain destination, instead of the luxury retailer it was meant to be.
  • JCPenney’s strategy to eliminate discounting was badly thought out and did not take the consumer’s point of view into account.

How we got here: Pricing habits are hard to break

Discounting was originally intended to quickly boost sales or sell off extra inventory. Mass-market brands and retailers, however, have grown so reliant on sales tactics that most shoppers are conditioned to expect discounts every time they shop. These consumer expectations accelerated in the era of online shopping, which has given consumers instant knowledge of the price differences between different online and offline retailers.

This creates an unfortunate cycle where brands and retailers feel forced to use discounting as necessary, evergreen marketing tactics, leading to decreased margins, diminished perceived value and consumers who refuse to purchase until items hit a certain discount threshold.

On the other hand, digitally-native, direct-to-consumer companies have built themselves up around excluding middlemen—namely wholesale—which often allows these companies to offer everyday low prices. Although they do not frequently offer discounts, they create consumer demand by proclaiming they have equally high quality as designer labels, but with a lower price. This eliminates the need for discounting while creating a unique value proposition that compels shoppers to open up their wallets. It also eliminates the impulse to wait for a sale: there are no discounts to wait for. These tactics take inspiration from Walmart and Costco, which pioneered the strategy.

However, a number of brands and retailers are still stuck in the discounting cycle. While many are trying to escape, quickly changing pricing strategies is difficult, as shoppers instantly react—and broadcast—the changes, which can adversely affect revenue and send the business into a panic.

1) Excessive discounting created a vicious cycle of shoppers who expect sales and refuse to pay full price, leading to thinning profits and overused promotions.

Similar to Facebook notifications and email pings, buying on discount is a psychologically-satisfying process that creates a shopping addiction. Studies have found that shoppers who focus on sales end up spending a significantly higher amount of money than those that don’t. And for a large portion of shoppers with severe discount habits, it takes a discount of at least 50% before they’ll agree to buy certain items.

However, overzealous discount strategies can pose a problem to brands as they establish client trust at a lower price, which consumers will grow to expect. When this occurs, brands then start defaulting to these lower prices and must spend time, money and human capital to constantly promote and manage the discounts. This creates a race-to-the-bottom where prices continue to drop, as well as an environment where companies hurt their the value of their brand by constantly undercutting themselves.

Brands that rely on department stores to sell their items also face discounting-addiction, since entering contracts with these entities often subjects them to sales they do not control. The brands must match the lowest price at which their items are selling and ensure price parity across all channels. Retailers have attempted to combat this limitation with exclusives and private labels, bringing original products to stores that aren’t as beholden to outside prices. Target, for example, has exemplified this with its renewed focus on private labels, as has Bloomingdales’ promotion of brand exclusives, dubbed 100% Bloomingdales.

Straggler: Macy’s

Race-to-the-bottom pricing tactics have led to slimmer profit margins for Macy’s, which has seen a decline of same store sales for 11 consecutive quarters. Despite the reality that 50% of its sales come from the top 10% of its customers and the other 90% of its customers count on discounts and promotions, the company has been unable to articulate a clear way forward. Business communications from the brand have focused on a wide range of developments—a new off-price offering called Backstage, leaner and higher-quality merchandise, catering to its discount shoppers, and a new loyalty program—all while working with brands that want to limit discounting and regain their lost value.

However, consumers’ love for off-price stores is dragging Macy’s down; two-thirds of Macy’s shoppers also frequent stores like Nordstrom Rack, TJ Maxx and Ross. Macy’s can’t afford to get rid of discounts, as billions of dollars of revenue come from discount-hungry shoppers each year. This has led to a muddled business strategy that Macy’s has dubbed “North Star.” The strategy’s five pillars appeal to a mix of the high-end and low-end, but no coherent blueprint shines through.Even Macy’s homepage serves as a microcosm for the company’s problematic discounting strategy: a cursory look in mid-January 2018 showcased an “Ultimate Pop-Up” sale, with items 40-70% off. Only after scrolling to the bottom of the page, did the “Macy’s edit” appear, featuring a curated list of full-price fashion.

It’s unclear if Macy’s unfocused strategy will help the company come out of its funk, but its popular brand name, relatively high foot traffic and cash flow give it an edge and an opportunity to drive the right kind of change.

Straggler: Ann Taylor

As its margins have decreased in the last few quarters, Ascena Retail Group, Ann Taylor’s parent company, has recently gone through a long period of low revenue and plummeting stock prices. The retailer responded with the decision to close 250 retail locations by July 2019 and to look for rent concessions in 400 stores. One of the problems they cite is consumers’ unwillingness to buy items at full price—a result of constant sales and reliance on discount-based customers the brand can’t shake for fear of losing too much revene. Even though Ann Taylor and LOFT are meant to be Ascena’s luxury portfolio brands with items anchored at high prices, constant discounting results in negative comp performance and decreased average selling price— down by 5-7% in the latest quarter.

In response, Ann Taylor is attempting to focus on “value without promotion,” according to Ascena CEO Gary P. Muto’s comments in the company’s Q1 2018 conference call. The company is also attempting to cut out sales through an advanced demand planning pilot with Accenture to support full-ticket selling by increasing the effectiveness of inventory allocation. Although these efforts are a step in the right direction, they are only incremental and won’t drive real change for the brand, especially if it keeps undercutting itself through sales.

Straggler: JCPenney

JCPenney attracts customers who expect sales and clearances they can top off with additional coupons and other money-saving tricks. So in 2011, when JCPenney famously tried to eliminate its reliance on discounting and introducing everyday low pricing, it lost 25% of sales within a year. Shoppers could no longer find a compelling reason to go to JCPenney, and the store suffered as a result.

Going directly from discounting to an everyday low pricing strategy is difficult and requires a well-thought-out approach. When JCPenney dropped sales and instead began to sell items at a lower price, the psychological rush that discounts gave customers was gone; they were accustomed to shopping under 60% off signs flashing around the store—the minimum percent off that JCPenney had calculated would lead customers to buy. Without the discounts, customers’ initial reaction was to buy less, even when the new prices were actually lower than those that customers would have received with discounting.

Shoppers felt fair-and-square pricing was another retailing gimmick. Though the store said that prices were “fair,” they were not low enough to satisfy value shoppers, many of whom wanted a steal, not a “fair” price. While a unique private label strategy may have found some traction, JCPenney largely continued selling items from other brands. Additionally, the company was announcing too many initiatives at once, from a price change, to a store redesign, to offering new and unique labels. It failed to rethink its identity, reinvent itself sustainably, test its new initiatives and come up with a more comprehensive plan for this strategy to work. Additionally, since JCPenney was selling the same items that can be found at other retailers, it was imperative that it think through the needs and expectations of its consumer base, rather than just push a new strategy onto consumers.

Actionable Opportunities and Questions

Brands and Retailers

  • What is the minimum amount of discounting needed for your products to achieve high sell-through? How can you increase this threshold so you avoid the peril of the discounting cycle?
  • How do you plan inventory levels to account for full-price and markdown sales? Is there opportunity to adjust for higher sell-throughs and fewer markdowns, thus eliciting a greater sense of exclusivity?
  • How can you create a pricing strategy that increases revenue while protecting margin? Would you need to raise prices to build a more full-price business?
  • If you need to use discounting to clear out old inventory, how can you do it in a way that doesn’t erode the psychological shopping process for customers?
  • How are your current price points connoting quality or lack thereof? How would changing your pricing alter these perceptions?
  • How does your markdown strategy translate globally in a e-commerce savvy era? Do sale cadences differ across markets? How do you account for these differences to maintain brand image?

Investors

  • If discounting is one of the main forces that brings consumers to a brand or retailer, how is the team accounting for this? Do they understand the nuance and complexity of pricing or do they have a more brash view?  
  • Has the team thought through its inventory and sell-through strategy? Is there an over reliance on discounting that might imperil the brand over the long term?
  • If the company sells other brands, how is it differentiating itself from other retailers that sell these same brands? Is the company only thinking in terms of pricing or is it finding other ways to cut through the noise?
  • If the brand wants to eliminate its reliance on discounting, how is it planning on doing so? How has the brand thought through how this will affect customer psychology? What are they planning to do to mitigate these effects?
  • What are the demographics of the current full-price vs. markdown customer? How can the company market to a more full-price customer?

Real Estate Developers

  • Since foot traffic is correlated to conversion, what services can you provide to increase foot traffic in your properties? When retailers see falling foot-traffic they are more likely to use discounting, which further erodes their financial stability.
  • How can you bring more full-priced shoppers into your properties? What other amenities can you use to attract them? How are some of your existing amenities attracting discount shoppers? How could you tweak them accordingly?
  • What sort of services do you have for VIPs, who tend to be more full-priced shoppers?

2) New direct-to-consumer companies successfully changed price perception by creating a regular-priced “straw man,” while others ignored discounting all together

The age of online consumerism, direct-to-consumer companies brought a new way of looking at pricing, which most famously looks to cut out the wholesale middlemen in order to reduce prices. But another, less explored tactic involves anchoring a brand’s prices to emulate those of department stores or luxury brands. This kind of comparison is meant to recreate the practice of everyday low pricing; it changes the price perception of a brand’s products by creating a regular-priced “straw man” that may not entirely exist or that is created artificially by the brand itself. The brand can then claim that the straw man sells similar products, but at an unnecessarily high price. The brand’s consumers then regard its prices as low and its quality as high, giving it the ability to sell at full-price without relying on sales.

The newest direct-to-consumer companies are free of discounting altogether and are instead focused on selling items at lower cost and rolling out products one at a time, all the while selling at full-price.

Trailblazer: Everlane

Everlane, which was founded in 2011, was one of the first companies to use the no-middleman approach with its focus on radical transparency—showing the price it cost to make each item and the company’s markup on each product. Founder Michael Preysman stated that his original intent was to fix a system that was broken—namely, the exorbitant amount of money retailers were spending on showrooms, marketing, advertising and logistics, which led to high markups in the first place. Everlane initially saw high demand and crowdsourced support for its brand, with revenue figures reportedly doubling from 2015 to 2016 ($50 to $100 million).

Noting the success of Everlane and others, an explosion of copycat brands arose that use similar marketing and tactics for products in all types of verticals—from apparel to shoes, glasses to makeup.

Trailblazer: MVMT Watches

Another example of a company that followed the eliminating-the-middleman formula was MVMT, a 2013-founded watch company that presents itself as a high-quality watch worth $400-$500 that sells for only $95. By comparing itself to this straw man, the company can claim superior quality for a lower price, and can forgo competing with other $100-$150 fashion watches.

With its Instagram influencer campaigns, “lowest price” claim, and perceived superior quality, the brand markets itself as the preeminent high-quality watch for millennials. It can charge more than other fashion watches but less than luxury, attracting luxury shoppers who want to save money and mass shoppers who want luxury for less. All of this ups the perceived quality and value of the brand and diminishes the need for discounting, as the brand is already claiming lowest possible pricing while creating an attractive, valuable product.

Trailblazer: Glossier

A new crop of direct-to-consumer brands no longer rely on stating that they cut out the middleman. Instead, they use their unique products, branding and communities to stand out. Glossier, for instance, takes a fresh approach,  focusing on slowly releasing and selling full-price products, training a new generation to not wait for discounts. It relies on creating pent-up demand for a product so that it can sell out quickly. The company releases products through a multipronged strategy that includes its widely read “Into the Gloss” blog, brand ambassadors, influencers and owned social media channels. The orchestration of this dedicated fan-base mixed with paid promotions creates buzz about the products before they’re released.

The company controls its SKU count and product release cycle, focusing on creating a brand and product people love—one product at a time—in order to keep them at full price. And the company hardly ever discounts—its Black Friday sale offered a rare—and mere—20% site-wide reduction.

Actionable Opportunities and Questions

Brands and Retailers

  • If you are a brand that is thinking about moving into wholesale, how can you manage pricing expectations after introducing your first third-party channel? How much control are you willing to cede to a retailer before it starts to harm your pricing strategy?
  • Is everyday low pricing part of your core brand DNA? If not, is it worthwhile to pivot or will you lose high-margin sales?
  • If you’re an older retailer, how can you learn from direct-to-consumer brands when it comes to your pricing strategy? How can you attract more full-price shoppers?
  • How would you go about creating a believable “straw man” to which you can compare your products? Would it be sensible to add a markdown strategy on top of it?
  • How can you adjust your inventory strategy to replenish quicker and better forecast demand, similar to what direct-to-consumer brands are doing?

Investors

  • How are the inventory requirements impacting the cash flow for the brands you are looking at? How could this change as the brand scales?
  • Is the “straw man” that the direct-to-consumer company going after still a differentiator for the category you are looking at? Is it a strong enough value proposition alone to get consumers to flock to it or will the brand need something with more weight?
  • Is it still important for the brand to talk about its lower prices in its marketing strategy compared to simply pricing with lower-prices in mind? How overtly should brands communicate these lower prices?
  • What are the profitability and margin scenarios for long-term growth in a “straw man” vs. discount structure? What are the per unit revenue drivers vs. the volume drivers, and is there a way to keep both?

Real Estate Developers

  • How can you get more younger brands into your stores—brands that tend to have more full-price businesses and thus more full-price shoppers?
  • How can you structure programs that will let them test and learn so they understand the importance offline retail?
  • How can you take the foot traffic these younger brands bring in and funnel it to other tenants in your properties?
  • How can you give direct-to-consumer brands concessions if they bring in more younger and full-price shoppers into your properties?
  • Alternatively, how do you capitalize on traditional luxury customers who are most willing to pay full-price? Are they willing to convert to new brands?

3) Large brands changed customers’—and their own—expectations around discounting to become full-price businesses

Everyday low pricing and Walmart

Everyday low pricing eliminates the need for discounting and presents itself as pricing that is low and fair at all times. Walmart has used this strategy to become the biggest retailer in the world, boasting 486 billion in revenue for 2017. Walmart uses scale and volume to provide its shoppers with everyday low prices—experts estimate that this saves customers an average of 15% on their typical shopping carts. Even though it makes thin margins on its sales, it sells enough volume to remain highly profitable. Psychologically, this tactic simplifies decision-making since customers can see the price and make the decision to purchase, or to walk away. This gives retailers space to create advertising messages for the products and brands themselves, instead of focusing on discounting.

Walmart takes any measures it can to lower prices: finding the cheapest overseas factories, paying employees low wages and taking a no-frills approach to its store environment. Sales are so high that they constitute 80% of restaurant businesses’ sales. However, this builds a reputation of lower quality and skeptical labor practices, which has lowered Walmart’s brand equity and caused the company to receive backlash. Walmart has seen its fair share of boycotts because of investigations into international factory conditions. Additionally, when Walmart bought Bonobos, Bonobos’ brand equity decreased; people felt like Walmart’s influence was going to cheapen the fabrics and quality processes used to create Bonobos’ clothes.

Trailblazer: Amazon

Initial pricing model

Amazon’s entire business model was created around accepting thin margins and optimizing for lower prices, cheaper and faster shipping and more variety than the rest. After years of fulfilling these promises, the brand built extremely high brand equity based on low prices and fast delivery, and boasts consumer trust in spades.

The retailer’s initial pricing technique was to anchor its prices relative to competitors, always coming in cheaper without worrying about its margins and sometimes even losing money on sales. Books emerged as one of the first products Amazon managed this way—the company initially sold bestsellers at 40% below list price and other books at 10% off, offering shipping for only $3.95.

The addition of Amazon Prime

All of this trained shoppers to think of Amazon’s pricing as cheap. The company’s aggressive pricing plan also prioritized cash flow over margin, which was used to reinvest in the company. It took this further in 2005 when it launched Amazon Prime in a bid to get its customers to buy more products and make Amazon a larger part of their lives: it gave Prime shoppers free two-day shipping in exchange for a $79-per-year membership. The company found that customers using Prime spent three times more on the site than those without a membership.

Analysts estimated that the company lost $11 per user in the first few years of Amazon Prime, but as the service started achieving scale, the cost of fast shipping has significantly decreased as Amazon has built out hundreds of fulfillment centers as it slowly takes over more of the process from third-party carriers. This, along with the revenue it was generating from Amazon Web Services (launched shortly after in 2006), helped the company grow sustainably. Now, Amazon also bundles other services into Prime including TV, movies and music streaming, unlimited photo storage, one free pre-released book each month, and more recently, cheaper prices on select products—all in a bid to keep customers shopping with the same retailer.

Focusing on dynamic pricing

Although dynamic pricing software has gained prominence in the last few years, Amazon tested variable pricing on its site as early as 2000 when customers trading notes on DVD prices online noticed that some people had paid more than others. A company spokesperson said that these tests were meant to find the optimal price for revenue and sales volume, but the company ultimately apologized and gave shoppers back the difference, promising that customers in any future test would get a refund if they paid more than the lowest price used. Since then, Amazon has evolved and it now uses dynamic pricing software, which changes prices multiple times per day for millions of its products. This helps Amazon find true price elasticity, while also putting low prices on popular products to drive a low cost perception.

This dynamic pricing technology captures all of the upside of discounting but doesn’t drag consumers into an expectation of constant discounting since pricing changes are mostly invisible to the shopper. The technology optimizes price for highest sell-through and revenue, while also ensuring that certain popular products remain cheaper than the rest. And with the addition of cheaper pricing for Prime, Amazon is creating a pricing ecosystem that is attractive both for customers and itself.

Trailblazer: Best Buy

Best Buy, on the other hand, successfully used a strategy which undercut its competitors—notably Amazon—instead of itself. Best Buy is one of the rare companies that has turned itself around from the threat of becoming the next Circuit City—an impressive feat since electronics are commodities and are available at many other stores. Best Buy’s stock price rose more than 50% in the past year and revenue figures went up 3% in 2017, which was higher than expected according to its Q3 2018 earnings call.

Instead of relying on discount customers and constant sales, the company found a real competitor to go after—other companies. Rather than lower the value of its products by continuously holding sales and clearances to sell through, the company introduced a pricing strategy that undercut or matched the prices of competitors. With this price match guarantee, customers had the freedom to ask the retailer for lower prices if they found the item at a lower price from another retailer.

As part of the Best Buy 2020 strategy, price matching was instrumental in raising profits—it removed any pricing anxiety around shopping at the store. With the pressure to contort itself into a heavy discounter that was still high quality out of the way, the company not only ensured that customers would make their final purchases in-store, but also gave customers more of a reason to stay in the store, allowing more chances for its other, prudent in-store initiatives—including a smart home section and better-trained store associates—to meet success.

Actionable Opportunities and Questions

Brands and Retailers

  • How can you find creative ways other than discounting to put context around your pricing so that consumers understand the value they are getting from your products?
  • How can you explore and invest in dynamic pricing software that helps you better price your items with market forces? How willing are you to let software—not humans—control this process? What could be uncovered and what could go wrong?
  • Do your competitors rely on heavy discounting enough to make price-matching worthwhile? What would you be able to offer to flip the customers once they enter your stores and develop long-term loyalty?
  • With free or discounted shipping becoming table stakes in today’s retail environment, how can you find ways to ensure shipping costs don’t discourage online checkout? How does free shipping impact pricing perception for products?
  • What are the resources required to roll out price-matching strategies?

Investors

  • Beyond discounting tactics, how is the brand conveying value and driving sell-through?
  • How can your portfolio companies evade the race-to-the-bottom game around discounting and dynamic pricing? What strategic moves can they make to play a different game?
  • How can the brands you are looking at defend themselves against Amazon’s dynamic pricing? How big of a threat is it? How is the team thinking through similar situations?
  • How can pricing against competitors help or hurt the brand? When does it it actually make it harder for the brand to stand out in the market?
  • How important is price in the brand’s vertical category? How is price pressure affecting the category?
  • How good is the company about testing pricing? What are its strategies for landing at a certain price? How is it thinking about price elasticity? What technology is it using to get there?

Real Estate

  • What sort of aesthetic improvements can you make across your properties to connote a higher priced image? How will this drive more full-price customers to your properties, who will attract better tenants and so forth?
  • What sort of subsidies and incentives can you offer your tenants to remodel their own stores? How will this drive success for you and for them?
  • What value-added services can you provide to shoppers that will up their chances of buying from full-price businesses? How do your experimental offerings, such as dining and entertainment, contribute to this likelihood?

Going Forward

The current state of discounting is at best an annoyance and at worst wreaking havoc for brands and retailers that feel forced to use the tactic to compel consumers to purchase. Continuing on this path is unsustainable—the discount needed to persuade the average consumer to complete a purchase continues to increase. Brands like Amazon, Best Buy and new direct-to-consumer companies have figured out how to eliminate this reliance from their discount strategies. Other brands and retailers should follow suit if they want to avoid catering to discount-only shoppers or being forced to continue decreasing their prices until they bottom out.