With total sales shrinking this summer, Quaker Oats's new CEO, Robert Morrison, was desperate for some good news. He told analysts about Quaker's fast-growing bagged-cereal business, where sales volume was up 9%. Bad idea. Quaker was boosting volume by slashing prices and squeezing margins. Sales were up, but profits were down. Worse still, Quaker was signaling that its brand is just another cereal. Little wonder once-loyal customers are migrating to more deeply discounted store brands.
General Motors recently offered a new, indirect discount: a free security system called OnStar, worth $1,500. This comes on top of other rebates which total $2,000 on some models. But OnStar was supposed to be a strong reason for consumers to pay more for GM luxury cars. Now it's just another freebie. "People used to be proud to own a Corvette or Cadillac. Now they just wait for the price wars," sighs an Arlington, Va., car salesman.
These stories aren't unusual. Through discounting, foolhardy executives at many major companies are undoing one of the great marketing achievements of this century: the creation of brands. Rampant price cutting is turning product and service brands back into commodity businesses. Commodities are usually interchangeable goods, like soybeans or steel, whose sellers compete mostly on price.
Commodity companies generally have razor-thin profit margins and vicious price competition. And industries that rely on discounts train consumers to think of their products as commodities. Think of airlines, which have coached consumers to wait for price wars and super-savers.
Why do businesses resort to reckless discounts? They offer a variety of rationales: We're just trying to meet our quarterly numbers; we're trying to build brand loyalty; we're chopping prices to match our competitor's. None of these excuses hold up. Discounting shrinks profit margins, which squeezes quarterly returns. Brand loyalty is based on the idea that a product or service is uniquely better and different, not cheaper. Discounting thus erases the key difference with the competitor's products.
Consider the saga of the Lacoste polo shirt. Rene Lacoste, a 1930s French
tennis champion, created the legendary shirt. His distinctive crocodile
emblem soon developed real cachet, fetching high prices and earning fat
margins. In 1970 Lacoste sold its U.S. rights to Minneapolis-based General
Mills. Sticking to the high-price, high-margin strategy General Mills had
by 1980 turned Lacoste shirts into a $400 million business.
But then the company began discounting. Sales fell, triggering another round of price cuts and the use of inferior, synthetic materials to maintain margins. When annual sales dived to $50 million by 1985, General Mills sold the crocodile to a sportswear marketer at a deep discount. The brand continued to flounder. Lacoste, with its partner firm, Devanlay S.A., bought back the license in 1992 and reintroduced the classic polo shirt. Its strategy is to charge more than three times the price of its competition, precisely to restore the brand's prestige. Today the crocodile's sales are on the rise.
If your competitors try to start a price war, unilateral disarmament may be the best response. Only 15% to 35% of consumers (depending on what they're buying) consider price the chief criterion for selecting a product, according to a recent study by the Copernicus consulting firm. That means more than 60% of consumers don't consider price at all in choosing a product. Nearly 80% cannot correctly recall the price they paid for a product in the last seven days.
When they do think about prices, two factors drive their thinking: the amount of disposable income they have and how much they care about the product category. Some people are emotionally involved with great brands like BMW, Sony and American Express. Some small part of their identity depends on buying the brand they consider the best. In other product categories, like toilet paper or toothpicks, the same people will buy on price. Others will think a toilet-paper brand is very important but a credit-card brand isn't. In short, each type of product has its share of "high involvement" buyers, who care about quality and brand, and "low involvement buyers," who care mostly about price.
In every product category, high-involvement buyers outnumber low-involvement ones by more than 2 to 1. Businesses that focus on the needs of high-involvement buyers can consistently charge higher prices (and earn higher margins) than their discounted rivals.
The retail gasoline industry provides a striking example. If ever there were a commodity product, this is it. Yet after months of research, Mobil identified the needs of high-involvement buyers: fast and friendly service, brightly lit stations and clean rest rooms. Mobil decided to put the service back in service station and charge a bit more for fuel. Result: While 1997 sales fell 2% for the industry as a whole, Mobil enjoyed a 3% increase--a big boost in a highly competitive business. Mobil's retail gasoline sales revenue remained steady in 1998, as total industry sales revenue, hammered by discounting, declined another 3%.
While there are some reasons to lower prices (such as sweeping technological change that lowers production costs across the industry), marketers should learn the lessons of Lacoste and Mobil. Especially in the Internet age, when price-based shopping is easier than ever, companies need to give customers a definite reason to buy their products. Once a company has identified what sets its product or service apart, it must clearly communicate this vision to customers through an integrated marketing, advertising and sales plan.
The lesson is as bold as it is simple: Know your customers and price accordingly. When you discount, you're telling high-involvement buyers that they're wrong to care so much about your brand. So sell your products for what they're worth, and let your competitors keep on discounting. Let them sell commodities, while you build a brand.