Does Promotional Pricing Grow Future Business?

Do big discount strategies really prompt new customers to buy more items, more often? Or does promotional pricing actually undermine attempts to increase future spending among existing customers? A recent large-scale study of a U.S. catalog retailer investigated how discount promotion strategies ultimately affect the bottom-line business.

Writing in the winter 2004 issue of Marketing Science, the two marketing professors who conducted it concluded that heavy price reductions do in fact draw new customers and that these new customers spend more in the long run. However, the same discounts do not spur current customers to increase their purchasing. In fact, after receiving deep discounts, current customers buy fewer and less expensive items in subsequent purchases. The article, “Long-Run Effects of Promotion Depth on New Versus Established Customers: Three Field Studies,” was co-authored by Eric Anderson, visiting professor of marketing at Northwestern University’s Kellogg School of Management, and Duncan Simester, associate professor of management science at the MIT Sloan School of Management.

Anderson and Simester tested the long-term effects of price promotions on a U.S. catalog retailer of books and software over a three-year period (1999–2001), measuring the impact on company revenue, units purchased and the average dollar amount of each sale. They conducted three sets of tests — one with approximately 56,000 existing customers and two others with about 300,000 and 245,000 customer prospects respectively (the prospects were identified from rented mailing lists). A randomly assigned segment within each group was sent a control version of the catalog, which displayed a mix of regularly priced items as well as items with shallow discounts. The rest of each group received a promotional version of the catalog, in which many of the items were far more deeply discounted — on average 60% lower than regular prices (as compared to 30% lower in the control catalog). The promotional catalogs were otherwise identical to the control. Over the remainder of the test period, customers did not get the control or test catalog, but received identical standard edition catalogs.

The authors’ research demonstrates that price promotions raised short-term demand for items in the catalog overall. Among current customers, the promotional catalog earned 35% more revenue than the control, which lacked the deep discounts. Among each group of prospects, the differential was even higher.

However, the long-term effects differed, depending upon customer type. Among current customers who purchased from the promotional catalog, demand dropped off during subsequent mailings of the standard edition catalog, as compared to the control group. The current customers who had bought at deep discount tended to purchase fewer units from the standard catalog over the subsequent two years, and the average unit price of what they bought dropped about 11%. In contrast, among prospective customer who initially purchased from the promotional catalog, sales from subsequent mailings of the standard edition catalog grew. They actually purchased 21% more subsequently than did those prospects who had initially received the control catalog.

Anderson and Simester say two key factors contributed to the subsequent drop-off in purchasing among current customers who initially received the promotional catalog. The large initial discounts may have led customers to take advantage of low prices to stock up, and as a result they bought less later on. In addition, the authors discovered that the current customers who purchased from the promotional (deep-discount) catalog had historically made fewer, less recent and less expensive purchases than had the current customers who purchased from the control catalog. This would suggest that the promotional catalog induced the more value-oriented segment of current customers to buy, a group that by definition would make fewer and less expensive repeat purchases in the future.

Among prospective customers, the authors believe that seeing initially deep discounts in the first catalog primed the pump for future purchases. “New customers, however, don’t really have price expectations until they see the catalog itself,” says Simester. “Offering initial deep discounts to new customers both prompts them to buy right away and entices them to purchase from it in the future — and this in an industry where half the battle is getting them to open the catalog at all.

“The implications are relevant for retailers in general,” says Simester. “They need to distinguish between new and established customers when evaluating the impact of promotions and ensure that they consider the long-term impact of their promotions, not just the immediate outcome.”

For more information on the study, contact the authors at eric-anderson@kellogg.northwestern.edu and simester@mit.edu.