06.08.2021

Discounts: A Double-Edged Sword

CAO, Zike | 許佳龍 | 徐紅

For retailers seeking to stand out in the cutthroat world of e-commerce, discounts can offer a powerful advertising tool. Across the Web, businesses compete for customers’ attention by announcing the most exclusive deals and hottest “flash” sales. However, big discounts do not always translate into big profits. According to HKUST professors Kai-Lung Hui and Hong Xu and their colleague, slashing prices online may actually harm retailers.

Online “daily deal” platforms such as Groupon and LivingSocial connect bargain-hunting shoppers with local retailers keen to attract customers and increase their revenue. Most daily deals offer substantial (“deep”) discounts. Traditional business logic suggests that cutting prices should increase sales. “In general,” note the researchers, “discounts should appeal to consumers because they help them save money.”

However, online daily deals are an important exception. “Buyers cannot inspect the products before and usually do not consume the products immediately after purchasing the deals,” the researchers explain. Until the products arrive, buyers cannot be certain of their quality. Compounding this uncertainty, daily deals are usually offered by small or medium-sized local businesses, which are “less well known and less visible to consumers” than big brands.

“When consumers cannot assess product quality because of information asymmetry and when the merchants are not well known,” the authors tell us, “offering discounts may not help promote and sell the products.” In fact, they may do the opposite—harming rather than boosting retailers’ profitability. As low prices are often considered a signal of low quality, say the researchers, “excessive discounts may reduce sales immediately.”

To quantify the impact of discounts on demand, the researchers analysed more than nineteen thousand deals from Groupon. Their results were conclusive: “Deep discounts reduce sales.” The average discount offered on Groupon is 55%, but many retailers cut their prices even further––in some cases up to 80% or even 90%––in the hope of picking up more business. This strategy is likely to backfire. “If a merchant offers an additional 10% discount,” the authors estimate, “sales could decrease by 0.63%-4.60%.” 

How should retailers address this problem? “Perhaps recognizing the concern about product quality,” note professors Hui and Xu, “many online daily-deal platforms provide third party support information as a supplementary quality signal.” However, the researchers’ analysis led to another startling discovery. “The negative effect of discount on sales is exacerbated in the presence of third-party support,” they report. In such cases, positive reviews leave potential customers wondering why such popular products have been so heavily discounted.

Clearly, “deal of the day” discounts can be a double-edged sword for retailers. A one-size-fits-all approach will not work. Instead, the researchers explain, “the offering of discounts should be tied to consumers’ confidence in product quality.” The sellers of “credence” goods such as organic food and medical supplies, whose quality is difficult for customers to assess even after purchase, should be especially careful. They “should avoid offering deep discounts,” the researchers warn, “because such discounts arouse consumers’ suspicions.” These novel findings have crucial implications for small and independent retailers turning to the Internet to boost their sales—especially in the wake of the COVID-19 pandemic.

許佳龍

Associate Dean, School of Business and Management, Deputy Head, Elman Family Professor of Business, Chair Professor
Information Systems, Business Statistics & Operations Management

徐紅

Assistant Professor
Information Systems, Business Statistics & Operations Management