Wednesday, May 23, 2001

Don’t Give Away The Store

"Why are my prices so low? Because I’m insaaane!."
--Crazy Eddie, 20th Century electronics retailer and patron saint of dot-com e-tailers

As a marketer, the worst mistake you can make is to discount or give away your product. While it may be tempting to boost your top-line growth with sales and freebies, the disciplined marketer knows not to give away the store. You may be able to boost short-term sales, but you will cripple your industry’s ability to earn any long-term profits.

To understand why this is the case, we have to start with a deceptively simple question: “How does a marketer make money?”

As every capitalist knows, you make money when you buy low and sell high. Or, more formally, the profit equation states that you make money by capturing the value created by the difference between the consumer’s willingness to pay and the supplier’s opportunity cost. Increase that difference, and you add value; decrease it, and you destroy value.

It’s easy to understand the supply side of making money: reduce your cost of goods sold whenever you can, whether through mass production economies of scale and scope (what Henry Ford did by building the Model T), or by exerting buyer power over your suppliers (what Sam Walton did when he build Wal-Mart into the giant it is today). This is the job of operations, manufacturing, and purchasing.

For most people, even most marketers, however, it’s hard to understand the demand side of the profit equation. You see, your job as a marketer isn’t to create value by persuading people to buy your products, it’s to create value by persuading them to pay a higher price—and be happier as a result.

As a buyer, I’m looking for bargains: chances to buy products for less than I’m willing to pay. It’s all relative. If I’m willing to pay $7.50, $10 for a movie ticket seems outrageously expensive. If I’m willing to pay $50,000, I may do somersaults of joy when I bargain the BMW salesman down to $45,000.

The goal of the marketer is to increase the consumer’s willingness to pay. Period. It’s a consumer’s willingness to pay, not features or accessories that lets us charge higher prices—and earn higher margins.

Steve Jobs is famous for asking John Sculley if he wanted to change the world, or spend the rest of his life selling sugar water. He got it wrong. Steve Jobs saved Apple Computer by persuading millions to spend 30% more when buying a computer—just so that they could get it in blue instead of gray! What’s more, those iMac buyers were eternally grateful for the opportunity to spend their money. Now that’s marketing genius.

Now let’s return to our original subject, and look at the effect that discounts and freebies have on consumers.

Many people think of these as essential marketing tactics. In actuality, they’re self-applied hangman’s nooses. Sure, they may help you boost product sales, but they have exactly the wrong effect on the consumer. Giveaways and discounts reduce consumer willingness to pay, and that reduction trashes both margins and customer satisfaction.

Once upon a time, consumers happily paid $19.95 per month for Internet access. Think about it—for about the cost of your average newspaper subscription, you got access to an entire world of knowledge, entertainment, and services. Try to picture that transaction—sounds like quite a bargain, doesn’t it?

Then came the free ISP tidal wave. All of a sudden, you Internet was meant to be free. Companies like NetZero vacuumed up customers, while paid ISPs lost market share even after slashing prices. The free ISPs turned a cozy, reasonably profitable market into a devastated landscape of red ink.

Today, as the free ISPs float belly-up in the dot-com deadpool, the market has yet to recover. The number of Internet-connected homes has actually declined—many consumers are now unwilling to pay for Internet access, just as they’re unwilling to pay for email, maps, or stock quotes.

Worst of all, consumers are actually less happy, even though they’re paying less money. The free ISP giveaway forever altered consumer’s willingness to pay for Internet access, and destroyed the market for pure ISPs.

So when you’re tempted to lower your prices or hold a sale, make sure you have the discipline to resist their siren song. The disciplined marketer knows that her job is to make the product more valued in the mind of the consumer, not to lower the price.

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