FALL 2007 VOL.49 NO.1

Jeffrey M. Stibel

Discounting Do’s and Don’ts

Please note that gray areas reflect artwork that has been intentionally removed. The substantive content of the article appears as originally published. REPRINT NUMBER 49106 INTELLIGENCE

PRICING Discounting Do’s and Don’ts Recent evidence shows that some discounts and sales can be detrimental. Jeffrey M. Stibel

Marketers cannot avoid discounted sales, and consumers have come to expect them. The average shopping mall, grocery store or online shop is littered with discounted prod- ucts: Tide detergent is 10% off; books are sold with free shipping; Nike sneakers are buy-one, get-one-free. Discounting is a com- mon marketing technique that effectively drives purchase behavior. Marketers often choose to forgo some revenues in favor of increasing overall sales. Most companies provide product discounts to effect purchase decisions, but some discounting and sales practices can have a negative effect. How should a discount be presented to consumers? Discounts are usually driven by sales events. Marketers pay particularly close attention to the amount discounted, time period, placement, packaging and than spending $8.50 per U.S. household, promotion of the sale. This creates a pro- yet the total amount is roughly the same. motional package that allows a marketer to When the president wants to demonstrate build a sales event. a large amount of spending (say, for educa- Underlying any discount is the de- tion), he references the total amount; when cision. How a product is priced is determined he wants to discount spending (for exam- by a number of factors, such as cost, value and ple, when discussing a budget overrun), he elasticity. How that should be presented notes the dollars spent per person. Trans- and represented to consumers is less under- parent, yet effective. stood. There are endless ways to present , Psychologists have broadly demon- and this decision will ultimately affect how a strated that framing effects can cause price appeals to consumers. highly intelligent people to make poor de- Researchers describe changes in pur- cisions. Framing effects create biases and chase behavior when the same information errors across all areas of decision making. is presented differently as “framing effects.” Doctors have made critical errors in medi- For example, most people believe that gov- cal diagnoses, shareholders have ernment spending of $1.5 billion is larger demonstrated irrational behavior in the stock , and judges have sent inno- Jeffrey M. Stibel is president and CEO of cent people to jail. Web.com Inc. of Atlanta and was previously Framing effects have had a profound general manager at United Online Inc. of effect on and purchase Woodland Hills, California, provider of NetZero, behavior. At United Online Inc., we priced Juno Online Services and Classmates Online. our NetZero Internet access at $9.95 per He serves on the boards of directors of Autoby- tel Inc., the Brown University Entrepreneurship month because we found that the price Program and the Gordon Institute’s Entrepre- point performed significantly better than neurial Leadership Program at Tufts University. more even increments, such as $9.00 or

8 MIT SLOAN MANAGEMENT REVIEW FALL 2007 SLOANREVIEW.MIT.EDU $10.00. On a more granular level, research discount into true value. This provides has shown that some products perform added complexity and can lead to informa- best at $.99 versus a $.95 price point. tion overload. For that reason, framing the In another example, at MediaWorks we discount in terms of real value can increase experimented with different pricing frames purchases. In one experiment, we showed for discounted products. We found that that framing a monthly service discount as consumers are more apt to purchase a additional months free versus dollars off product that is offered for free with a $4.95 increased purchases by over 100%. shipping charge than a product that costs For simpler purchase decisions, dollar $4.95 with free shipping. The total pur- and percentage discounts work very effec- chase price was the same, but the free tively. This is particularly true for products product increased sales. and services that have become commod- How should a product or service be dis- itized. Commodities are typically compared counted? While most promotional details by price alone, as all other features are are carefully analyzed, less thought typically identical. When price is the single driver of goes into how to present the economic value a decision, price discounts perform best. of a promotion. There are many ways to Take the Internet service provider wars. present the same discount, such as dollars off, Originally, Internet service varied across added value, or a percentage off. Though providers, and consumers were presented these marketing promotions can represent with the challenge of comparing price, reli- the same discount, the impact on purchase ability and feature sets. Once ISPs were decisions is often different. commoditized, consumers began to become In three recently published papers, I dis- more price sensitive, and discount providers cuss the importance of framing effects and were able to increase market share. Today, their impact on purchase decisions: “Cate- most of the ISPs are losing customers. How- gorization and Technology Innovation” ever, for a number of years, the leaders in the (2006), “Mental Models and Online Con- space were losing marketing share to dis- sumer Behavior” (2005), and “Increasing count providers, despite the fact that these Productivity through Framing Effects for companies were also offering steep dis- Interactive Consumer Choice” (2005). This counts. This was a direct result of discount research specifically tested how framing ef- framing effects. While AOL LLC primarily fects can cause promotions and discounts offered free months to its consumers, to fail. It compared consumer interest, NetZero and Juno Online provided pricing number of purchases and drop-off rates for discounts. As a result, AOL’s market share discounts that were presented in dollars ($5 continued to deteriorate, while NetZero and off), percentages (10% off) and value (buy- Juno maintained record growth. Framing one, get-one-free). Even though the actual discounts in terms of dollars off is beneficial discount was the same, performance and when price is the primary determinant. sales differed significantly depending on The recent research on pricing empha- how the offer was presented. Underlying sizes the need to consider framing effects this phenomenon are framing effects. when determining sales and discounts. For complex purchase decisions, we Consumer choice is driven by perceptions found that dollar discounts perform poorly that do not always correspond to reality. If relative to providing additional product consumers perceive something to be a value. Dollar discounts add complexities good value, they are more likely to make a that can reduce purchase behavior. Prod- purchase. If a discount does not fit with a ucts such as software or automobiles are consumer’s perception of the product of- major decisions that require forethought fering, it will not succeed. and a comparison between significant amounts of information. These products Reprint 49106. tend to perform worse with dollar discounts Copyright © Massachusetts Institute of Technology, because consumers must first convert the 2007. All rights reserved.

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