The purpose of our literature review is to provide us, in part, greater understanding into the behavior of product pricing and sale volumes, and also to highlight the impact of price cuts on brand equity.
While finding prior studies regarding the above mentioned topics, we were confronted by an issue fairly commonly observed in secondary data collection. There were very few research papers on the impact of price cuts on sale volumes. Thus, we went about the topic in a round about fashion, the conclusions we believe will provide a fairly adequate picture of the actual scenario.
During our search for literature the most common discussion we came across was the impact of sales promotions on sales. Since they are price cuts, but only temporary ones, they are worthy of being mentioned. Companies consider sales promotions to boost their sales in the short term, but the true impact of these promotions is more often than not neglected by the management.
According to Nick Wreden (2006), “an effective pricing strategy must be driven by the right corporate strategy. Poor pricing often results from a misdirected over-emphasis on sales or market-share growth.” He goes on in his publication to explain his reasoning by highlighting how bad pricing strategies are more of a disaster than a benefit to corporations considering them for the purpose of boosting their sale volumes. He them explains why competitive pricing is not a good idea as “a low-price strategy is difficult to maintain over time. It also attracts price-conscious buyers, who are notoriously disloyal.” This raises an interesting point. The fact that the kinds of consumers that price cuts attract are more interested in low prices than the brand they are purchasing. What guarantee does this provide that all the benefit created by a price cut will not be completely undone in case a price war starts? (Case in point, the bar soap market we are considering is highly competitive).
This brings us to the interesting classification of consumers by David Meer (1995) who classified consumer groups into four categories, namely System Beaters, Brand Loyals, and Deal Shoppers and the uninvolved. According to the research he conducted regarding different product categories, “First, categories that are used directly on the body, like soap, cosmetics, and shampoo, fall into the Brand Loyal quadrant.”, Which means that the soap market mainly consists of brand loyals. Comparing this with the research conducted by Wreden, Op Cite, we can conclude that Price reduction would not be a good idea, provided that it attracts the kind of consumers that are not the kind of consumers a bar soap producer would want to attract.
Meer then also highlights some insightful points which highlight further disadvantages of price discounting:
“By 'training' customers to buy on price, the chances are higher that they will defect to a lower price elsewhere. It also blinds them to the value that you offer. Finally, and most important, discounting may win a sale, but can have a disastrous effect on your bottom line. Lowering prices by just 10% means you have to sell 33% more to achieve the same profitability. A 20% discount means selling twice as much. (Seasonal, volume and other profit-based reasons to discount represent acceptable business strategy.)”
The most striking part of what he has stated is that discounting blinds consumers to the value that a brand has to offer. He suggests it would be more sensible for firms to find the maximum price people would be willing to pay for a brand and then decide how to price their products.
If discounting truly blinds consumers to the brands actual value, this leads us to the relationship between price and quality. Even though most studies have found only a modest relationship between price and quality, consumers have a strong tendency to associate price and quality and perceive quality to be higher than it actually is if the price is (Lichtenstein, D.R. & Burton, S. (1989)), and they tend to attribute quality based on price (Agarwal, S. & Teas, R.K. (2002)).
This seems to imply that price reductions may in fact have a disastrous impact on brand equity if price is reduced in order to increase sales volumes. Lichtenstein et al. (1993) pointed out that price is regarded as indirect scale standards of product quality by the customer. It is a concept that price is positive correlation with product quality, i.e. higher the price is, better the quality is. 1
Chen, T, Sun, B & Singh, V (2006) in their research paper provide a more integrated view of the picture. They take the task of investigating the impact of price cuts on consumer decisions, provided that the price cut is being done by a renowned brand. This seems especially relevant to our discussion as the brand we are considering in price reduction is also a famous brand.
Since we are considering a one time permanent price cut, According to Lucas (1976), a publicly announced permanent price cut can lead consumers to strategically shift their preference to adapt to the new pricing regime. In other words, consumer preference structure can shift in response to announced changes of policies.
Chen et al (2006) asserts that when consumers are faced with a price cut of a premium brand, they realize that “that it is permanently cheaper to consume premium brands.” The paper then goes on to incorporate the idea that in the long run consumers are more
1From the study of Boyle, J.P., “correlations between price and quality have a tendency to vary depending on the product category, but usually, the correlations are low overall and often negative (unless otherwise noted, cited studies were conducted with US consumers). One of the earliest studies (Oxenfeldt, 1950) found the correlation between price and quality for 35 products to be a low 0.25. Sproles (1977) and Riesz (1978), who examined 135 and 685 products, respectively, found almost the same correlation, 0.26. Riesz found more than 20% of the products had a negative correlation between price and quality. Other studies have reported correlations ranging from 0.01 (Gerstner, 1985, for non-durables) to 0.29 (Morris and Bronson, 1969). Similar studies conducted in other countries have reported similar results (e.g., Faulds and Lonial, 2001), and most studies have reported negative correlations for at some products at minimm. In almost every case, the conclusion drawn by the researchers was that price is not a good predictor of overall product quality.” for further reading, source is cited in references.
Most concerned with quality than price. This leads them to the conclusion that the price cut may actually do Marlboro good as: “First, the price of Marlboro is permanently lower, which directly increases the utility of purchasing Marlboro. Second, consumers who went through the experimentation phase reduced their quality uncertainty of Marlboro, which increases their purchase probabilities and brand loyalty for Marlboro. Third, consumers emphasize more on quality. As a result, market share of Marlboro increases”
It's important to note that according to this research paper, when there is a publicly announced are brought into affect, consumers are made to shift from habit persistent stage to experimental stage where they are willing to try out new brands. This paper concludes that “Before the permanent price cut, Marlboro was vulnerable to the discounted brands. A drastic and publicly announced price cut was necessary to break consumer inertia. Marlboro's policy was effective in increasing its market share” Thus, its likely that if product quality is maintained (Lichtenstein et al. (1993)), it is likely that consumers will be willing to try out the brand which's price has been reduced. If the price matches their expectations, they are likely to stick to the brand and become brand loyals, as opposed the idea that Wreden et al 2006 proposed.
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