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Discounting – profitless prosperity

Consumer price inflation

In a low-inflation, over-capacity market with little or no pricing power, many manufacturers have turned to price promotion and discounting. The best example is the car and truck industry. General Motors still seems to believe it has a balance sheet advantage over its competitors, particularly in Detroit. Why else would it introduce heavily price-based competition such as five-year zero-coupon financing or discounts of $4,000 to $5,000 a unit? Probably, the most extreme case was Hyundai in South Korea offering negative interest rates on financing – a form of cash giveback. One dealer in America offered a buy one, get-one-free deal on sports utility vehicles (SUVs). Luckily, it was a failure.

If you give cars away it is only to be expected that consumers buy them. No surprise, then, that the American auto market stood at 16 or 17 million units before the credit crisis, or that housing markets and house prices showed similar buoyancy, when fixed-term money was being given away at such low interest rates, despite the shudders in the sub-prime markets.

The problem is that consumers grow used to such discounting and wait for new car or truck introductions and the discounting that goes with them. The auto manufacturers face profitless prosperity and break-even economics at full capacity. Hence the decision by Dieter Zetsche at DaimlerChrysler to dispose of Chrysler (what will Cerberus do on branding?), and the strategies of General Motors and Ford to cut capacity. Interestingly, the Japanese and South Korean manufacturers, and some German ones too, have tended to resist excessive discounting, offering lower levels of $1,000 or $2,000. Instead, they concentrate on design, new products and branding to build a price premium.

If you focus on price, you build commodities. If you focus on innovation and differentiation, you earn a price premium and build brands. This seems to be the approach of Alan Mulally at Ford, as he brings a laser-like focus on the Blue Oval and disposes of peripheral brands. Conclusive evidence of the inadvisability of discounting came when General Motors had to lower its earnings forecast for 2005 by 80%. Recent comments and actions by GM do indicate a slight difference in approach and a shift to more focus on product. More competition from the Chinese and Indians, particularly Tata, will ram the point home. China's Geely, a four-door, five-seat car, will be introduced into America in 2008 or 2009, at under $10,000. Price promotion just does not work. The product is key.

A similarly unfortunate trend is occurring in the food industry. Packaged goods companies continue to try to build share by discounting and price competition, particularly as distribution concentrates. They pay higher trade discounts and slotting allowances, and fund increased promotional activity, although the approach may change as the economics of the food industry shift, following Chinese and Indian expansion.

Just like the media owners, the food manufacturers are being squeezed by a second factor – obesity. Diabetes is a pandemic and a huge area of public concern. Increasingly, commodity-like food companies are not in a strong position.

Interestingly, the health-based or wellbeing segments of the packaged goods industry do not suffer from the same phenomenon. Here, companies are more focused on product innovation, research and development or science, along with branding to build stronger market shares. As a result, brands and margins are more robust and volumes greater.

US companies have recently been forced to disclose gross and net sales, at least temporarily. As a result, more data is available on the balance between advertising and promotional spending. According to Cannondale, our marketing and channel management consultancy in the US, the average consumer package company spends 17% of sales on trade promotion (price cuts basically) and only 9% on brand-building advertising. Many CEOs know what they spend on advertising, but not on trade promotion. Often the latter exceeds the former, even in heavy-spending above-the-line companies.

It may well be that manufacturers will seek to cut trade spending and boost brand spending, particularly at a time when the trade is consolidating at such a rapid rate. Bribing customers for distribution is a recipe for ruin.

Top global marketers* spending by category
by measured media bought in 2006 and 2005 $m

Category 2006 2005 %
change
%
total
Advertiser
count
Automotive 22,195 22,291 -0.4 22.7 16
Personal care 19,526 18,394 6.2 20.0 9
Entertainment
& media
9,538 10,038 -5.0 9.8 8
Food 7,793 7,638 2.0 8.0 7
Drugs 7,707 7,376 4.5 7.9 9
Electronics 4,023 3,800 5.9 4.1 8
Soft drinks 3,916 3,941 -0.6 4.0 3
Retail 3,576 3,355 6.6 3.7 7
Cleaners 3,571 3,323 7.5 3.7 4
Restaurants 3,553 3,375 5.3 3.6 4
Computers 3,247 3,223 0.7 3.3 5
Telephone 2,488 2,956 -15.8 2.5 4
Financial 2,433 2,622 -7.2 2.5 5
Beer, wine & liquor 2,050 2,261 -9.4 2.1 6
Candy 1,137 1,104 3.0 1.2 2
Toys 699 704 -0.6 0.7 2

Source: Advertising Age
* As defined by Advertising Age.