The Price Promotion Trap

Price promotions are a common marketing strategy to generate a burst of increased sales of a product to penetrate the market. Price promotions involve temporarily reducing the price of a product to in an attempt to increase the sales volume over the standard sales rate during promotion period. Price promotions are great for many reasons, some of which include massive increases in sales volume, increased usage and interaction with the brand for the market and quickly selling off large amounts of stock. These benefits however come with a sacrifice, and it’s worth considering them before engaging in price promotion to gain incremental sales over the promotion period.

Before talking about the two major issues regarding price promotions, it’s useful to break sales down into two categories. The first category is baseline sales. Baseline sales are the ‘normal’ sales expected over a given period, which is determined by going through past sales figures and making estimations based on analysis. Baseline sales are essentially the sales that would be expected in the absence of a promotion. The second category of sales is incremental sales, which are the extra sales made above the baseline amount when the price promotion is in place. The importance of understanding these categories will become clear.

Now that we’ve broken down sales into two categories, let’s start exploring the issues with price promotions. The first problem is inherent in the strategy itself – by reducing the retail price of your product, there is a significant amount of profit contribution forgone for each unit when engaging in a price promotion. Take for example a made up brand of pasta sauce, “Maggio”. Let’s assume that the baseline sales for Maggio without a promotion for a given week are 5,000 units. When the price promotion strategy is in place and retail price is reduced, 7,000 units are sold. The incremental sales are the extra 2,000 units sold above the expected amount of baseline sales.

Maggio pasta sauce costs $3.00 a jar to produce and normally retails for $5.00, returning a margin of $2.00. Maggio then decided to reduce the price to $4.00 as part of a price promotion to stimulate sales, but that halved the margin to $1.00 a jar. Despite the increase of 2,000 incremental sales, the overall profit has actually decreased from regular baseline profit of $10,000 to $7,000 over the promotional period. That means that despite increasing the sales volume by a full 40%, both the baseline and incremental sales combined returned a lower profit than would have been achieved without any price reduction. This is a major reason why price promotions are not always a good strategy as typically companies do not make profit from the price promotion despite the temporary increase in sales volume.

The second issue with engaging in price promotions is that they can create price sensitivity in the market if they occur too often. This is especially true for non-essential goods, where consumers will only make a purchase when the products are going cheap. Particularly in FMCG product categories, consumers will simply purchase products on the weeks that they are on a reduced price and hoard them for use further down the track. I call this the ‘Costco effect’. This cannibalises the non-promotion sales of a product, and drives down profit margins further and further. Essentially, as a marketer you can fall into this trap of reinforcing purchases only when the prices are low through poorly planned price promotions. This is a huge price to pay for generating only temporary bursts of sales volume.

I don’t mean to be all doom and gloom, but I feel it’s important to consider these implications before you jump into a price promotion. You need to be realistic about what this kind of strategy can deliver – just because you are selling heaps and heaps of product, it doesn’t necessarily mean your profit will be going up also. It’s worth taking time to plan and devise measures and metrics to get an accurate assessment of a promotion’s success. I’d argue that if a marketing strategy can’t be measured, it’s not worth doing.

JB

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