A pricing and discount strategy plays a massive role in the retail business. The prices retailers set for their products — and the discounts they offer — are often a major deciding factor for customers unsure about purchasing. While lower prices may increase the chance of a sale, it's a delicate balance. If retailers cut prices too far or for too long, it hurts profit margins. But if they never offer a discount, they may send customers directly into the arms of competitors.

According to a 2 Visions survey, consumers are twice as likely to change their shopping behavior based on available retail discounts. A discount may encourage a shopper to make a splurge purchase, even if they didn't plan on buying the item before they saw the sale price. And, with inflation increasing prices on everything from clothing to groceries, consumers are becoming more picky about how they spend their money. In short, they're looking for good deals.

The trick for retailers is to find the sweet spot that captures customers while still earning enough profit to keep the business humming. In this guide, learn how discounts impact consumer buying habits and effective discount strategies in retail that maintain profit and brand value.

The Role of Discounts in Retail Strategy

Retailers have long used pricing and discounts to influence consumer behavior and define the perceived value of their products. While there are various pricing strategies, they generally fall into one of three categories: Premium (Prestige) Pricing, Everyday Low Pricing (EDLP), and High-Low Pricing.

Premium (Prestige) Pricing

Premium (Prestige) Pricing aims to convey exclusivity, luxury, and superior quality. In this strategy, the price of goods is as high as the market can support. The goal is to build an audience of loyal buyers who believe the items are valuable and that there are no viable alternatives quite like them. Premium Pricing works for companies with limited competition or where quality makes them particularly unique. High-end fashion designers like Louis Vuitton, Chanel, or luxury auto companies like Ferrari use Premium (Prestige) Pricing.

Everyday Low Pricing (EDLP)

In an everyday low-pricing strategy, customers are sensitive to the cost of goods. There's lots of competition and substitute items consumers can choose from, so maintaining low prices is key to ongoing retail success. Otherwise, customers will simply buy from another brand. Examples of everyday low-pricing include retailers like Walmart or Costco, both known for selling household goods and groceries cheaply (or relatively cheaper vs. the competitive alternatives).

High-Low Pricing

High-Low Pricing involves setting higher regular prices with frequent deep promotions. This strategy allows retailers to vary profit margins on specific items while using discounts to attract bargain hunters. For instance, department stores like Macy's and many grocery stores utilize High-Low Pricing by offering frequent promotions to attract customers while maintaining higher regular prices.

Retailers use discounts differently in each pricing strategy:

• Premium (Prestige) Pricing: Discounts are rare and typically used to clear out end-of-season items without devaluing the brand.

• Everyday Low Pricing (EDLP): These retailers focus on consistent low prices with less reliance on promotions.

• High-Low Pricing: While regular prices are higher, frequent deep promotions create a sense of urgency and attract bargain hunters.

The Profit Margin Dilemma

The impact of discounts on profit margins is a bit of a double-edged sword. On the one hand, retailers may attract more customers. That means more sales. However, if a brand discounts goods too much, it erodes retail profits. In that case, the retailer must sell enough items to compensate for the discount. Otherwise, profits will fall, even if the overall company revenues increase.

A few mistakes can quickly diminish the effectiveness of a store's discount strategy:

• Offering discounts too frequently: If everything is constantly on sale or a retailer regularly provides discount coupons to clients, they'll expect lower prices every time they shop. If there are no current retail promotions, they won't buy. Instead, they'll wait a few days until the next discount comes out. This mistake is hard to come back from. If a retailer stops offering discounts, clients may lose trust in the business and shift to buying from a competitor. That further lowers profit margins, creating a vicious cycle of downward pricing pressure that often characterizes the CPG and Grocery retail business.

• Not understanding the brand's reputation: If customers buy from a brand because they believe it offers high-quality products, frequent discounts can cause reputational damage. Customers may begin to suspect the products aren't quite as high-value as they initially thought. Subsequently, customers may start to purchase fewer items from a brand in favor of other brands they believe offer better quality. When they do so, it lowers profit margins.

• Excessive discounting: Too much discounting can easily transform a retailer following a Premium (Prestige) or High-Low Pricing strategy into a discount brand. Once that happens, it will be tough to change their perception. Then, a retailer is stuck with lower profit margins and reduced earnings.

However, not offering discounts at all isn't a great solution, either — particularly when the economy is going through tough times and people have less to spend on the items they buy. If their competition provides substitute products of the same quality at a discount, retailers will quickly lose market share by following a no-discount policy. That also lowers profit margins and overall earnings, making it challenging to meet sales and profit goals.

Customer Psychology and Discount Sensitivity

Psychological Price Endings

Psychological price endings involve pricing items just below a round number (e.g., $9.99 instead of $10). This tactic takes advantage of the way customers perceive prices, making them feel they are getting a better deal. Research shows that customers are more likely to purchase an item priced at $9.99 than $10, as they tend to focus on the leftmost digits, perceiving the price as significantly lower. This technique is particularly effective in driving impulse buys and can work well in conjunction with other discount strategies.

We've examined this from a retailer's perspective. But what does customer behavior in retail look like for discounts, and how does it factor into customer loyalty, brand reputation, and the decision to buy (or not to buy)?

Scarcity and Urgency

Finding a great deal makes customers happy. This is especially true with High-Low Pricing retailers, where frequent promotions create a sense of urgency and excitement among customers.

For instance, take an expensive status item like a Hermès purse. They run into the thousands of dollars, so scoring one with a 50% discount might feel like finding a diamond in the rough for a Hermès fan. And since Hermès seldom (if ever) offers discounts, a one-time savings isn't likely to lower its perceived value among customers.

On the other extreme are retailers known to offer frequent discounts, like Kohl's. The department store provides sale coupons nearly every week, and when you visit a local branch, you're likely to encounter racks of clothing and other items with sale and clearance prices. Few items are offered with no discount at all, so customers regularly expect to pay lower prices on everything they buy. While Kohl's has a legion of followers who enjoy its low pricing and regular savings, customers looking for high-quality items might shop elsewhere, perceiving Kohl's as a discount brand with less valuable goods.

Reference Price

The initial price of an item and its subsequent price adjustments impact how a customer interprets the discount.

For instance, consider two discount strategy examples. The retailer sets the initial price for Product A at $200, where it stays for six months. It then shifts the price to $150 for a "limited time."

On the other hand, Product B starts at $200, but it drops to $150 the next week, then $125, then $100. According to an HBR study, consumers would likely value Product A's discount more than Product B's since the price doesn't change often. They might hold out for even further discounts on Product B before purchasing.

Perceived Value

In Premium (Prestige) Pricing, customers generally want to feel a company values their business and gives them exclusivity. Frequent discounts can harm this perception, while occasional, well-placed offers can enhance the brand's value.

“When you take a sip of Cabernet, what are you tasting? The grape? The tannins? The oak barrel? Or the price? Believe it or not, the most dominant flavor may be the dollars.” - Levitt, Dubner: Freakonomics

Strategic Discounting Techniques

If you think discounts can help you build your brand and attract new customers, there are ways to implement them without devaluing your brand reputation. Here are a few best practices for retail discounts.

Start by Determining Your Goal

First, why do you want to offer a discount? Is there a build-up of inventory you want to get rid of? Are you losing market share to a competitor? Is your store new, and do you want to start building a loyal customer base? Or are you trying to achieve sales growth through discounts?

All of those goals can lead to different retail discount strategies. If sitting inventory is a problem, offering a discount solely for those products can help get them off your shelves to make room for new items. If you're trying to meet a revenue goal, offering a flat discount on popular items among your customer base can deliver results.

However, if you have a market share problem, a single discount probably won't shift loyalty back to your brand. It might lead to a discount war with competitors, further diminishing profitability in retail. Instead, you'll want to find a way to lure customers back without sacrificing earnings.

A new store might benefit from a one-time discount to increase customer awareness about your brand. However, you'll likely want to work on building a customer base through advertising and other mechanisms rather than solely through discounts. Otherwise, it won't be easy to sustain profitable growth in retail.

Define the Items You Want to Discount

Most retailers offer an array of products. You won't walk into the store and find only one item for sale. Instead, there will be a variety of products meant for customers with differing needs. Products may have contrasting inventory levels, seasonality, demand, and sales rates. Those factors should all fit into your discount strategy.

Some products are more likely to be a better fit for discounting than others. For instance, say you have 3,000 sweaters left in stock in mid-January. The spring clothing line is coming soon. Selling those sweaters at a clearance discount can eliminate the extra inventory while bringing in revenues. However, you might not want to offer a discount on your newest spring clothing items in mid-February since it's the beginning of the season.

The conclusion is that figuring out what items are ripe for discounting involves a careful analysis of sales patterns, consumer demands, revenue, profit and inventory goals. Once you narrow down what items you'd like to discount, you can determine how much of a discount you're willing to offer.

Don't Forget Profit Margins

No matter what items you decide to discount, it's imperative to remember profit margins. Cutting prices below their profit margins means you'll sell at a loss, which isn't an effective long-term sales strategy. Earnings will plummet unless you compensate for the loss by selling other products or attracting new customers.

Explore Different Discount Techniques

There are dozens of ways to provide savings to your customers through discounts. Here are a few techniques to consider:

Flash Sales

A flash sale is a limited-time offer for savings on specific items or product categories. Usually, it lasts 24 hours or less, providing deep discounts on products you select.

Personalized Offers

One way to strengthen customer relationships is to offer tailored discounts. A personalized discount provides savings to the customer based on their past browsing or buying history or their unique interests. For instance, if you know your customer has a cat and you sell pet goods, you might offer a personalized discount for the cat food they typically buy.

Tiered Discounts

Tiered discounts are popular among SaaS companies and retailers that offer bulk goods. In a tiered discount system, the retailer lowers the price based on the number of products the customer buys. Tiered discounts are also helpful for upselling customers to a higher-priced product category with extra features.

Maintaining Brand Value While Discounting

As we touched on earlier, too much discounting can devalue your brand in the eyes of your customers. So, you want to walk a fine line between incentivizing customers to buy from you and avoiding overly frequent discounts. There are a few ways to do so.

Offer Seasonal Discounts

Some retailers follow a seasonal model, where products vary depending on the time of year. An excellent example of this is clothing stores. During the spring and summer, clothing retailers offer warm-weather clothing; in the fall and winter, they switch to styles suited for cooler temperatures.

Most clothing retailers offer end-of-season sales and clearances, where they heavily discount unsold items to make room for new items. This strategy doesn't diminish brand value since other retailers follow it, and it allows customers to take advantage of lower prices.

Have an Annual Blowout Sale

In this strategy, retailers dramatically lower prices on a single day or weekend. Consumers then use the sale to stock up on desired items at great prices. Usually, there's a lot of built-up anticipation, so shoppers may spend a little extra so they don't miss out on the low prices. One example of a company that does this well is Amazon, with its Prime Day, which usually occurs sometime in July.

Implement a Loyalty Card System

Loyalty cards allow shoppers to accumulate points. Once they reach a certain number of points, they can redeem them for a discount or free item. This type of discount program encourages buyers to stick around for the long term since they must spend enough money with the retailer to earn a discount.

Communicate Value Through Advertising

Discounts are just one part of a comprehensive marketing strategy to attract customers. Try using other methods, like social media posts or advertisements, to convey the value of your brand. As people become more familiar with your store, they'll associate it with your messaging, helping you build a loyal customer base.

Case Studies of Successful Retail Discount Strategies

Let's look at a few retail case studies of brands with creative and successful discount strategies.

Sephora (High-Low Pricing): Sephora utilizes High-Low Pricing by maintaining regular prices with frequent promotions through its Beauty Insider program, allowing customers to earn discounts and rewards.

REI (Premium Pricing): REI maintains higher regular prices with occasional end-of-season sales. Clients associate REI with high-quality items, and they are willing to pay extra even without frequent discounts.

Adobe (High-Low Pricing): Adobe's strategy involves high regular prices with occasional deep discounts, such as 30-40% off their Creative Cloud plan during specific times of the year. This High-Low Pricing attracts new users without diminishing its premium brand value.

There is no one-size-fits-all discount strategy solution for all retailers. Instead, brands must consider their objectives, audience, brand reputation, and desirable profit margins to develop a sustainable discount strategy that best aligns with their business model. After careful analysis, retailers can decide on an approach that balances the desire to win over new customers while preserving revenue and operating profit goals.

Is it time to refine your brand's discount strategy? Perhaps you want professional assistance to help you build a long-term Pricing Analytics & Strategy capability that drives profitable growth. If so, reach out to Revology Analytics. Our team can help you customize a pricing and discount strategy that maximizes profits while growing your customer base