Discounting – a profitless prosperity

In a low-inflation, overcapacity 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 seemed to believe until recently that it had 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 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.

Top advertising categories 2008 US $m

Top advertising categories 2008 US $m

Top advertising categories 2008 UK £m

Top advertising categories 2008 UK £m

Top advertising categories 2008 Brazil BRLm

Top advertising categories 2008 Brazil BRLm

Top advertising categories 2008 India $m

Top advertising categories 2008 India $m

Top advertising categories 2008 Russia $m

Top advertising categories 2008 Russia $m

Top advertising categories 2008 China CHYm

Top advertising categories 2008 China CHYm
Source: GroupM

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. Auto manufacturers face profitless prosperity and break-even economics at full capacity. Hence the decision by Dieter Zetsche at Daimler to dispose of Chrysler (what did Cerberus do on branding?), and the strategies of General Motors and Ford to cut capacity. Interestingly, Japanese and 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, although even they have problems now.

If you focus on price, you build commodities. If you focus on innovation and differentiation, you earn a price premium and create 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 2008 by 80%. Recent comments and actions by GM do indicate a slight difference in approach and a shift to more focus on product although, even having taken government money GM (and Chrysler) face Chapter 11 bankruptcy. Of the Big Three, only Ford, who resisted the siren calls of government aid, looks solvent. More competition from the Chinese and Indians, particularly Tata, will ram the point home. Even now, China’s Geely, a four-door, five-seat car, may be introduced into America, at under $10,000. Price promotion just does not work. The product is key.

BrandZ Top categories 2009
Year-on-year growth in total category value

Category Brand value growth
Mobile operators 28%
Soft drinks 24%
Coffee 18%
Fast food 16%
Beer 15%
Luxury 10%
Retail 7%
Spirits 5%
Technology 2%
Personal care 2%
Water 2%
Motor fuel -5%
Financial institutions -6%
Apparel -9%
Cars -22%
Insurance -48%
Source: Millward Brown Optimor

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.

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 find themselves in a weak position, in contrast to the health-based or wellbeing segments of the packaged goods industry, which 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.

Recent accounting changes in the US force companies to show 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 packaged goods company spends 17% of sales on trade promotion (price cuts basically) and only 8.7% 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-building advertising, particularly at a time when the trade is consolidating at such a rapid rate. Bribing customers for distribution is a recipe for ruin. Again, it is branding and product differentiation that must come to the fore.