Retailers have long known where to put the bargain bin—in the back of the store, where customers have to work a little bit to find it. That way, they might be tempted on their journey through the aisles to buy something at full price, increasing the store’s bottom line.
When it comes to the online environment, however, retailers have fallen all over themselves to do the opposite—putting discounted items front and centre on their homepages in an effort to woo shoppers.
“The e-commerce world is a brutally competitive environment,” says Harvard Business School marketing professor Thales Teixeira. “One of the biggest levers retailers have at their disposal to bring in customers is a price.” More discounts, however, means reduced margins for sellers.
“IN THE RUSH TO PROVIDE DISCOUNTS, STORES ARE SUBSIDIZING HIGH-VALUE CUSTOMERS”
“The use of this lever of discounts has been so high in many aspects, it is causing e-commerce companies to become unprofitable,” says Teixeira, the Lumry Family Associate Professor of Business Administration. “We don’t think that’s necessarily the right approach.”
In a new working paper (pdf), Teixeira and HBS Assistant Professor Donald Ngwe propose that online stores take a page from their brick-and-mortar counterparts, and update their websites to create the virtual equivalent of the back-of-store bargain bin. They argue those changes would not only improve retailers’ bottom lines but, somewhat counterintuitively, could benefit customers as well.
“We are taking the know-how and best practices from the offline environment and seeing how to adapt it to an online environment,” says Ngwe.
Their study gauges the effect of so-called search frictions that make it harder to find discounted items or require additional clicks by consumers to find bargains. “We want to see how well these extra clicks stand-in for this physical friction of walking to the back of the store, and just how willing customers would be to go deeper into a website to find a better price.”
In previous work, Ngwe has shown that outlet stores function much like the proverbial bargain bin, requiring extra effort for customers to travel to those stores to find discounted prices. That has the effect of stratifying consumers by their sensitivity to price, with bargain hunters willing to literally go the extra mile, and less sensitive customers going to the local mall.
By making discounted products so visible online, however, online stores are essentially depriving themselves of revenue that they could capture by customers willing to pay higher prices.
“People are lazy, and, on average, the first thing you present to them has a disproportionately high likelihood of being accepted,” Ngwe says. “In the rush to provide discounts, stores are subsidizing high-value customers.” It would almost be as if a high-end retailer such as Louis Vuitton or Gucci told people to go their outlet store first, Ngwe says.
Huge gain in sales
In a series of experiments involving a real online fashion and apparel retailer, Teixeira and Ngwe reverse the standard method by adding a number of different frictions to the website, including eliminating the link to the outlet catalog on the store’s landing page, removing the ability for customers to search by discount, and taking away markers that automatically calculate discounts for buyers.
Testing these interventions for more than 100,000 online shoppers, they saw dramatic results. Not only did the site not lose customers, it also experienced huge gains in sales, with products’ average selling price increasing by as much as 38 per cent and gross margins increasing by an average of 35 per cent. In some cases, margins more than doubled.
Even the researchers were surprised to see such a stark impact for such simple (and low-cost) changes to the website.
“We were able to achieve huge increases in the gross margins for retailers without changing the product assortment, without changing prices, and with minimal investment,” says Teixeira. “All of that went directly to the bottom line of the retailer.”
Fearing that this phenomenon may only affect repeat customers who already know about discounts on the site, they ran the experiment twice—once for customers who had cookies for the store in their browser, showing they’d shopped there before, and one for customers without them. They found little difference in the buying behaviour of the two groups.
“Both new and existing customers behave in ways that are beneficial to the seller,” Ngwe says, “perhaps because customers are so familiar with the way clothing works and know there will be a subset of products that are discounted.”
A benefit for buyers, too
Of course, if stores are making more money on higher sales, that means customers are necessarily losing money. But Teixeira and Ngwe contend that adding these frictions could actually benefit buyers, as well. On the most basic level, if retailers are losing money because they are competing in price wars, they are more likely to go out of business, decreasing the variety of stores consumers have to choose from.
“WE WERE ABLE TO ACHIEVE HUGE INCREASES IN THE GROSS MARGINS FOR RETAILERS WITHOUT CHANGING THE PRODUCT ASSORTMENT, WITHOUT CHANGING PRICES, AND WITH MINIMAL INVESTMENT”
Less intuitively, however, they argue that making discount items less prominent presents a wider range of products to customers, allowing them to find items that better fit their needs. In the experiment, when they tweaked the website, the overall sales conversion rate for buyers actually went up by as much as 23 per cent, meaning that customers weren’t just buying higher-priced items, rather, they were buying more items overall.
When Teixeira and Ngwe drilled down into the past history of customers, they found that those who were more sensitive to price continued to spend the extra time to find bargains on the website, showing little difference in the cost of the items they purchased. However, customers who valued other attributes—such as higher quality or the latest fashions—spent extra money on higher-priced items they presumably liked better, rather than reflexively buying the discount items presented to them first.
“If you make the bargain bin the centrepiece of the store, they get focused on the bargain bin, and there are only a handful of products they can choose from there,” Teixeira says. “When you say you can choose from anything in the store and the bargain bin, then people saw more of an assortment, including more items that appealed to them.”
Of course, the devil is in the details. Each retailer has to find the proper balance between adding frictions that make discounts a little harder to find without frustrating the customer and sending them off to a competitor. But the study shows that retailers have more flexibility than they might realize in making bargain items less prominent—and that doing so might benefit stores and customers alike.