November 03, 2019

Price Deflation

The transactional brand has no qualms with discounting.

A few years ago, a Private Equity firm asked me to speak with the Chief Marketing Officer at a business they were looking to acquire. During the call, the CMO said something that just stopped me in my tracks. Here's the paraphrased quote from the CMO:
  • "I don't care what we're selling. I can craft an offer, any offer, that will cause any customer to buy anything. Period."
That's the definition of a Transactional CMO!

I'll bet I've analyzed a dozen brands in 2019 that introduced new items at prices more expensive than the brand average. In other words, if the average item sold for $25, the brand introduced new items that cost $29.

This causes a unique dynamic among existing customers. Your existing customer sees a $29 item and says "that's too expensive". Instead, the customer buys the $25 item. Your merchandising / inventory / product team then measures results, and notices that customers "don't like" new $29 items. Now there's an inventory problem. What's the best way of getting out of an inventory problem? Discounting items.

Here's where the marketing team gets involved. They apply 25% off your entire order (how generous), meaning that $25 items are now $18.75 and $29 items are now $21.75. The customer finds both price points appealing, and buys something.

Of course, gross margins are normally around 60% ... so let's say that the customer places an AOV of $75. Cost of Goods = $30.
  • Gross Margin at Full Price = $75 - $30 = $45.00.
  • Gross Margin at 25% Off = $56.25 - $30 = $26.25.
So now you have to generate 71% more business just to equalize gross margin dollars. Good luck!!

A lot of the price deflation I'm seeing in 2019 starts with a merchant trying to generate gross margin dollars by introducing new items that are more expensive. This creates a customer response problem, which becomes an inventory problem, which becomes a marketing discounting problem, which becomes a gross margin problem which is addressed by introducing more new items at more expensive price points which ... yeesh!

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