Discounting, Sales Psychology And Behavioral Economics
Not long ago, I spoke with an IT service provider (our client), who related an impactful discussion with a telco customer’s procurement director. The company offered a $5,300 discount as an incentive to begin the implementation of a customer relationship management (CRM) system for $53,000. Here is a summary of the dialogue:
Vendor: It’s a smart decision for you to move from managing your customer data with spreadsheets to an automated CRM system. To get started sooner, we are prepared to give you a 10% discount.
Buyer: Can you explain that please?
Vendor: Our understanding is that starting phase one ASAP is critical because your people are managing hundreds of customer relationships with a spreadsheet-based system, and your sales per customer need to improve relative to the industry.
Buyer: So, the 10% discount is solely on the $53,000 price tag?
Buyer: But this is just an initial deployment. You know the deployment plan is for 250 seats by end of year one, 1,200 in year two and full deployment of 2,500 seats by end of year three. By that time we will have invested over five million with you and others! And you are offering a $5,300 discount. That’s just a rounding error! The discount should be $500,000!
At this point, it was clear that the discount strategy had backfired. There are multiple reasons for this.
The Importance Of Perspective.
The 10% discount ($5,300) may have been attractive in context to the original cost of $53,000. However, the customer viewed the transaction against their total investment for the solution, which from their viewpoint rendered the discount as trivial — less than a fraction of one percent. Instead of being a positive, this was viewed almost as an insult. While predictable, the customer’s reaction was not rational because a savings of $5,300 is the same whether it is a savings applied to $10,000 or $10,000,000.
This reaction is an example of what behavioral economists, such as Dan Ariely, call predictably irrational. We have all experienced examples of this. For example, my cousin recently drove 20 miles to a supermarket because of a 50% off sale. He bought $100 worth of groceries for $50. The next day he bought a $1,500 grill from the local hardware store because it was “only” $75 more than the one at Home Depot, which was 10 miles away and “not worth the trip.”
Lack Of Rationale For The Discount.
The client’s indignation points to the vendor’s loss of credibility for failing to recognize the full context. If the customer has a business reason to make the purchase sooner, then the discount is not needed to motivate a decision. Again, the rationale offered made no sense in this context.
Procurement’s role is not only to fulfill strategic internal requirements, but to do so at the lowest cost possible. Therefore, it’s not surprising that procurement wanted to expand any discount discussion to the overall investment the customer would make.
Emphasis On Discount Rather Than Value.
The customer was making a significant investment to improve their business. This would have been a much better focus to get the deal done and cement a credible relationship.
Shifting The Perspective To Value
As a result, when debriefing our client, we decided to focus on the value-based leverage of their solution. We spoke with our client and asked three essential questions:
- Why is the telco making an investment?
- Why would they make the investment with you?
- How much are the answers to the first two questions worth to the client?
From these questions, our client realized they should win because their differentiation had a direct impact on the very reason the telco was implementing new CRM systems in the first place: Their sales per customer were currently lower than their competition’s. Our client had differentiation because they had implemented similar systems for them before, and there was proof they could implement the new solution six months sooner than others could. The value of the six months was between $8 and $15 million, at least 2.5 times more than the cost of the entire solution for three years.
We suggested that they call the person who had evaluated their solution in the first place, with whom they had a relationship, as well as the customer’s head of sales, to discuss the importance of implementing six months sooner. If the impact was anywhere close to the vendor’s estimates, no discount would be necessary, and getting the deal done sooner would be a matter of urgency for the customer.
Unfortunately, procurement had already received a discount and wanted it applied across a future rollout of the solution. We suggested that any discount promised for the future should be tied to a commitment from the customer. This would make the discount a “principled concession.” To make it easier, we suggested giving the customer some alternatives that we call multiple acceptable proposals (MAPs) for different levels of commitment. Ultimately this approach was successful because the customer felt they had control by having some choices, while the built-in concessions were principally related to each alternative deal construct.
This scenario presents many lessons, including the following:
- Don’t offer discounts as an “incentive” unless it is necessary as a principled concession to solve a problem, (e.g., you are at a price disadvantage and the competition delivers a comparable outcome). This was not true in this case.
- Ask the three questions listed above to discover whether you have value-based leverage. The answers will reveal whether any discounts or incentives are required and whether your opportunity is real.
- When you provide value to the customer rather than dictating terms, offer them choices that contain some different business outcomes. This will enable them to make a value-based decision by comparing credible alternatives. You will give the customers a feeling of control while staying principled in your discussions.
In the meantime, ask: Why? Why you? How much are you worth to them? And, of course, offer your customers options that are value-based so they can make informed decisions.
Note: this article originally appeared January 2020 on Forbes.com. You can view the original post here.