Retailers' Costly Discount Binge

Rampant price-cutting is short-sighted and teaches shoppers to avoid anything that isn't on sale. Better ways exist to boost business

By Amy Tsao

As the Christmas holiday approaches, retailers often start acting like used-car salesmen. This year is no different. Spooked by the unusually short shopping season and weak consumer demand, stores of all kinds are assaulting shoppers with two-for-one deals, early-bird specials, and online friends-and-family coupons. The splashy sales seemed to have lured consumers into spending a bit more over the critical Thanksgiving weekend, but retail spending still rose just 0.4% in November. And holiday sales have continued to be relatively weak through mid-December.

Ultimately, all the price-slashing may yet give retailers what they want: Halfway decent fourth-quarter revenues, despite the weak economy. But the long-term effects of too much discounting are certain to be ugly. Deals and gimmicks may increase during the holidays, but for all too many companies they're now a constant addiction. "Most retailers, and many consumer package-goods companies, have started to rely much too heavily on promotion throughout the year," says Bob Leone, professor of marketing at Ohio State University's Fisher College of Business.

To some degree, it's the Wal-Mart (WMT ) effect at work. Over the last decade, improved buying power and the use of more sophisticated computer systems allowed the giant retailer to undercut competitors and still expand profit margins, says Brian Stinson, retail analyst at Midwest Research. So-called category killers such as consumer-electronics retailer Best Buy (BBY ) and home-improvement giant Home Depot (HD ) have also added to the competitive pressure. By homing in on just one area of retail, these companies have done a good job of keeping costs and prices down.


  Less nimble competitors have had to depend on heavy promotions to keep up. As a result, consumers are increasingly conditioned to expect a deal on almost everything they buy. Discounting strategies are used so regularly "that it becomes almost the rule that you buy something [at a bargain price]," says Dominique Hanssens, professor of marketing at UCLA's Anderson School.

Most retailers know they can't afford to go head-to-head with the mega-discounters. They all know what happened to Kmart (KM ), Ames, and Bradlees when those chains tried. All of them were forced into bankruptcy reorganization -- or out of business entirely -- because they couldn't come close to Wal-Mart's "Everyday Low Prices."

Yet, from department stores to specialty chains, many retailers have adopted me-too strategies that have left them no choice but to compete on price. That's one reason why Brian Tunick, specialty retail analyst at JP Morgan, figures that a full 90% of specialty retailers will report that this holiday's sales were lower than last year's.


  Traditional department stores are probably in the hottest water, Stinson says. Over the last decade, chains such as Sears (S ), Macy's (which is owned by Federated Department Stores FD ), and Marshall Field (owned by Target TGT ) have struggled to win back market share mainly by lowering prices. But the dizzying array of sales and special offers have confused customers and conditioned them to shop for deals.

This strategy has also backfired financially: Department stores' sales have declined for years, and their stocks have taken a beating. Federated's stock is down 34% in the last five years, while Wal-Mart shares are up 157%.

Retailers can look no further than the auto industry to see the repercussions of constant and deep discounting. Car buyers "don't show up unless there's a sale," says Carl Steidtman, chief economist at Deloitte Research. After September 11, giants like General Motors (GM ) and Ford Motor (F ) offered 0% interest rates on car loans and other enticing rebates to spur buying. Over the short term, sales spiked, but consumers eventually became sated. These days, carmakers are still promoting like mad, yet their sales are tumbling.


  What has been happening to carmakers can happen to just about any product, says Hanssens. In a recent study, Hanssens tracked the economic impact of a cheese promotion that lasted one week. The immediate result was an increase of $95,000 in revenues of the promoted brand. But the retailer actually saw a $130,000 loss in overall cheese revenues because gains in the discounted brand were more than offset by consumers not buying regularly priced cheeses. By week six, cheese revenues had settled back to pre-promotion levels -- and stayed there for the remaining 20 weeks of the study.

Happily, a better way way exists. To sell more at full-price, retailers must differentiate themselves from rivals and convince shoppers of the added value they can offer. One key to that is brand-building, something many retailers have all but abandoned. The reason: A store can typically move three times the normal volume of a product in a week when it's on sale, Leone figures. Advertising and marketing are much slower to take effect and harder to measure -- but they're critical to ensuring long-term survival.

Of course, it's easiest for higher-end retailers to exercise price discipline because their affluent customers tend to be more willing to pay full price. Leather-goods specialist Coach (COH ) and stereo-equipment maker Bose are examples. So is teen clothier Abercrombie & Fitch (ANF ), which puts merchandise on sale -- but does so only infrequently because it has invested heavily in developing a strong brand.


  However, even a lower-end retailer can wean itself from the price-slashing habit. For instance, home decorating goods retailer Pier 1 Imports (PIR ) has been burned in the past by overpromoting, but these days it's on a real tear. That's partly because of a boost from the housing boom and nesting craze that started after September 11. But Pier 1 has helped its own cause with a TV ad campaign that highlights the variety and uniqueness of its products. Analysts expect it to report earnings per share in the holiday quarter of 33 cents, up 27% from last year.

Loyalty programs -- where a store's best customers get access to special deals -- are another good idea. These programs tend to boost sales because they require customers to spend a certain minimum amount before being able to take advantage of discounts. Women's clothing chain Chico's FAS (CHS ) started its Passport Club in 1991. Once a member buys $500 worth of clothes, she gets 5% off on every purchase.

The program seems to be working: Members spend an average of $125 each time they visit, vs. just $79 per visit for nonmembers, Chico's says. That may be one reason its profits are still strong: Its earnings per share are expected to jump 33% in this year's holiday quarter, to 16 cents.


  Could such strategies work for big retailers? Brand-building has certainly paid off for the shabby-chic discounter Target (TGT ), which has carved out a niche while avoiding Wal-Mart-style commodity prices. Target attracts youthful shoppers with trendy clothing and designer housewares. Lower-end department store Kohl's (KSS ) is growing quickly by solidifying its reputation as a one-stop shop for the busy mom. Kohl's stocks brand names like Nike and Dockers, and maintains a strong lineup of soft goods like sheets and towels.

The record is less clear when it comes to higher-end, service-oriented department stores, such as Nordstrom (JWN ) and Saks (SKS ). Their fortunes fluctuate dramatically with the ups and downs of the economy. But they still fare better in good times and bad than most rivals that compete mainly on price.

Add it all up, and it's pretty clear that price-slashing is a risky, short-sighted strategy. Building a solid rep with consumers takes longer, but it pays off in the end.

Tsao writes for BusinessWeek Online in New York

Edited by Thane Peterson

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