Large discounts hurt sales Monday, 3 December 2018
Many small- to medium-sized companies try to attract new customers on daily deal websites such as Groupon.com. They often offer very large discounts, but that’s not a great idea. Dr Zike Cao of Rotterdam School of Management, Erasmus University (RSM), discovered that when a discount becomes too large, potential customers walk away. Bringing in positive reviews from Facebook or Yelp doesn’t help either. In fact, it makes things worse.
Daily deal platforms are a popular promotion tool for small- and medium-sized local businesses. More than 60 per cent of online visitors to the top 40 websites in North America enroll in at least one daily deal programme. Research shows that these platforms can be a very effective tool for attracting new customers. Local businesses, such as restaurants, beauty salons and gyms, often try to get new customers through these platforms by offering large discounts. “In the data we collected, the mean percentage for discounts is over 50 per cent, and it is very common to see discounts of 70 or 80 per cent,” said Dr Cao, who is an assistant professor in RSM’s Department of Technology & Operations Management.
Dr Cao wondered if large discounts indeed help in getting more customers. He and his colleagues Dr Kai-Lung Hui and Dr Hong Xu from Hong Kong University of Science and Technology analysed 19,978 deals from Groupon and conducted an experiment. Cao: “Surprisingly, we found that large discounts don’t improve sales, but instead reduce sales. This negative effect is more prominent among credence goods, such as medical treatments and car repairs, because it’s difficult for consumers to know the true value of these services. We also see this negative effect on deals with low sales and when the deal is offered in areas with higher levels of income and education.”
Cao and his colleagues say that this negative effect of large discounts occurs because people become concerned about the quality of the offered product or service. “Most deals on daily deal platforms are for services, which you obviously can’t return to get your money back if you are dissatisfied,” Cao said, adding that most deals are offered by small local companies that people don’t know very well. “The consumer reasons that if the product or service is good, it doesn’t need a large discount.”
Cao also investigated if displaying positive reviews from people on websites like Facebook and Yelp counter the negative effect of large discounts and stimulate sales. Again, the assistant professor found a surprising effect. Cao: “Positive reviews combined with large discounts, actually make things worse. They reduce sales. We think people become suspicious if a product or service with many positive reviews is still offered with a large discount.”
If businesses want to use daily deal platforms to attract new customers, Cao recommends to give reasonable discounts, but not very large ones. "It’s also a good idea to use a flexible discount rate, whereby all customers get higher discounts when more sales are made. So, people who purchased the deal early, get some of their money back later, if certain sales thresholds are reached. And finally, don’t display third party reviews if you offer a large discount.”
Read the article here: Zike Cao, Kai-Lung Hui, Hong Xu (2018) When Discounts Hurt Sales: The Case of Daily-Deal Markets.Information Systems Research 29(3):567-591.
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