[Pricing Nugget #018] Coupon Value: When Less Sells More

Imagine you are a pricing manager, and you plan your next promotion. Your boss tells you that you have an unlimited promotional budget.

"Wow," you think, "let us create real sales momentum and offer serious discounts."

Your promotional tool is coupons. Usually, you use $5 coupons. But now, you go "all-in," and you increase your coupon value to $25.

The campaign launches... you watch the numbers... you are ready to celebrate... but...

...revenue drops.

Ooops - what has happened? You will find out today...

Customers can redeem these coupons for various products of a specific brand or product line (technical term: "vertically differentiated products") and not just for a particular product.

Product line coupons are redeemable, for example, for any Apple notebook, any Lindt chocolate gift box, or any of the different buffet menus in your favorite Korean restaurant.

In the past, your coupon value was $5, which customers could use for any product in your product line. The average price for your products is about $50. Now you raise your coupon value to $20, expecting your customers to spend more and buy more expensive products.

You launch the campaign, and to your surprise, you find that customers actually choose less expensive products when the coupon value is higher.

Researchers found that coupons trigger two mechanisms. 

First, a coupon increases the available budget so that customers can and might spend more. This "budget-increase mechanism" is straightforward.

Second, a coupon makes customers calculate a percentage discount, and customers would buy the option with the higher relative discount. This "savings-comparison mechanism" is a bit trickier.

Let us dive a bit deeper into the latter.

Given that the coupon has the same face value, customers choose the cheaper of the two options as the percentage-wise discount is higher (i.e., the denominator is smaller).

The researchers argue that the "savings comparison" mechanism only activates if two conditions are met:

1. The difference in savings percentages is substantial, and
2. Customers have the mental energy available to do cognitively demanding calculations.

"Savings-comparison mechanism": Let us look at an example.

You offer two products: Product A for $40 and product B for $60. The coupon face value is $5, so that the percentage savings are $5/$40 = 12.5% for product A and $5 / $60 = 8.3%. Hence, the relative percentage savings difference is 4.2% points. This difference might be too small to trigger a "savings comparison," and only the "budget increase" effect applies: the customer buys the more expensive product B.

Now you raise the coupon face value to $25. The percentage savings become $25/$40 = 62.5% for product A and $25/60 = 41.7% for product B. The difference in savings increases to 20.8%. In this case, the "savings comparison" mechanism might kick in, and your customer chooses product A as this comes with a larger percentage discount. This finding means, with a higher face value, customers redeem the coupon for a cheaper product. Vice versa, in this constellation, a moderate face value would make your customers turn to the more expensive product.

What can you do about it?

The study discovered specific conditions when a savings comparison mechanism gets activated, and the function of spending level on coupon face value assumes an inverted U-shape.

In this situation, a moderate coupon face value is more effective than a high coupon face value to sell a higher-priced product option:

• Products are relatively expensive.
• Customers do not experience overload (i.e., the number of items is sufficiently small to conduct the savings calculations).
• Customers have a higher tendency to compare prices and options.
• Customers have weak preexisting preferences for a product.

The bottom line

Think carefully about offering a moderate or high coupon face value to stimulate sales: customers might buy a less expensive product when the discount is higher in certain situations.