Issue 21 of The Psychology of Pricing
In the short term, discounted products may seem like a good idea. But as we have learned, maximizing short-term profits can come at the expense of long-term profits. While companies may generate temporary sales spikes, discounting may not be the best long-term solution. In this lesson, we are going deeper into the theory of why discounts should be avoided.
When faced with a choice between short- and long-term rewards, people reliably favor immediate rewards over higher total future rewards. The choice of the highest immediate reward is an effect called melioration. In a sense, melioration is a form of maximization. However, it does not necessarily account for the long-term effects of the choice. In fact, the process of melioration is often characterized by a failure to take into account the effect of future yield. (1)
Let’s assume two scenarios: a standard price and the promotion. The promotion creates a short-term increase in market share but also erodes the product’s long-term value. The value-erosion effect lasts longer than the promotion.
So what happens is that every time we conduct a promotion, we see a quick uptick in sales. At that moment, the reduction in the value of the product is not clear because we can only see the effect of the promotion. Let’s say we get a bump in market share of 10%. The brand’s value drops by 2%. So we see an overall increase of 8%.
But what happens next? In the next period, there is no discount, and now the reduction in brand value becomes apparent. And this reduction lasts a long time, for a few months, until people forget about it.
In other words, a short-term focus is a powerful temptation to implement promotions. But repeatedly relying on promotions decreases the value of a company’s brands over the long term.
Short-term spikes in sales doesn’t offset the negative effects of brand erosion. This is explained by a concept called melioration.
(1) Herrnstein, R. J., Loewenstein, G. F., Prelec, D., & Vaughan, W. J. (1993). Utility maximization and melioration: Internalities in individual choice. Journal of Behavioral Decision Making, 6(March), 149–185.