October 01, 2006

$10 Off A $25 Purchase At Lowes

A few weeks ago, I received a promotion from Lowes, offering me $10 off my next purchase of $25 or more. The card they sent me expires October 7. You may assume that I will make a trip to Lowes before the week is over.

In their most recent quarterly filing, Lowes gross margin, year-to-date, is about thirty-four percent. This means that, for every dollar of merchandise sold at Lowes, sixty-six cents are paid to the vendors they purchased the merchandise from, leaving thirty-four cents of profit. Of course, Lowes must pay employee salaries and overhead and numerous other fixed costs.

Fixed costs do not come into play when considering a $10 off $25 purchase incentive. Assume that I visit Lowes tomorrow, and spend $30. I proudly present my incentive, resulting in a purchase amount of $20.

On my $30 purchase, Lowes earns about $10 of gross margin. This is why they can give me a $10 incentive. If I spend $40, Lowes earns about $12 gross margin, gives me $10, yielding $2 profit.

From a bean-counter's standpoint, the promotion makes sense, because Lowes is likely to earn profit on the transaction, or bring in customers who typically shop Home Depot or another competitor, thereby stealing a tiny amount of market share.

So the financials seem to make sense. From a strategic standpoint, do you think this is a good idea? What type of customer is Lowes training to purchase from its brand? Since I usually shop at Home Depot, or my neighborhood hardware store, I will purchase merchandise at Lowes only because of this incentive.

During my tenure at Eddie Bauer, our business performed progressively worse each year. As it became difficult to move inventory, we had in-store sales, and frequent catalog/online promotions. On the surface, these sales and promotions all appeared to work.

But direct marketers thoroughly understand the concept of "building a housefile". At Eddie Bauer, we slowly "built a housefile" of customers who liked to purchase merchandise either on sale, or with a promotion (free shipping, twenty percent off). Even if we did a good job of providing great merchandise, we eventually had a million or more loyal customers who purchased merchandise if there were something in it for them. Building a housefile of full price customers, after building a housefile of sale/promotional customers, is a very difficult proposition.

There is also the ugly circular logic that occurs when a business heads down the promotional path. If promotions and sales truly fail to deliver incremental, profitable customers, then gross margins erode, applying pressure on the profit and loss statement. Eventually, the brand must reduce expenses, or apply pressure to vendors to lower cost of goods. If the latter is challenging, then the brand must look internally to lower expenses. The process of lowering expenses seldom proves fruitful to the employees working at that company.

Promotions frequently provide a short-term lift to a business, especially a business that is not quite hitting its sales objectives. However, a "different" kind of customer is recruited to purchase from the brand. Occasionally, unintended consequences occur when recruiting customers to prop-up short-term financial results.

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