May 22nd, 2013

Shopping on Co-Pilot: The Power of the Deal in Bad Economic Times

By Neale Martin

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Ben Johnson’s past successes as head of Apple’s retail operations made him a prize catch for JCPenney when the retailer lured him away as their new CEO in November 2011. The market’s response to this hire was largely positive: the company’s share price gained 17.5% on the news. Johnson’s vision for the struggling department store chain was to replace its long-standing retail approach of ever-present sales, deals, and discounts with “everyday low pricing,” and to focus on an enhanced customer experience by creating “store-in-store boutiques” and shifting some of its floor space to high-end fashion brands.

This aggressive new strategy, to put it lightly, didn’t work.

Johnson was fired just 17 months after taking the helm. His vision for JCP not only failed to improve, or even stabilize, the company’s sales and profits—it made them significantly worse. While it is easy to point out the myriad ways that JCPenney is not Apple (and business talking heads had a field day exhaustively listing those differences), the biggest flaw in Johnson’s thinking was not understanding the psychological power of the deal during times of economic stress.

Our firm’s habit-based model of behavior posits that consumers are in one of three states when shopping—pilot mode (novel or high-involvement situations), co-pilot mode (heuristic or rule-based), or autopilot mode (habitual). While habits typically dominate shopping behavior, the past five years of tumultuous economic climate have disrupted these routine purchases, shifting consumers from autopilot shopping to co-pilot situations built upon a deal heuristic.

There is widespread evidence of this emerging trend since the financial crisis began in 2008. Private label products have surged, seizing up to 30% market share across many product lines. Even in food purchases, private label brands account for roughly 20% of sales, up from 15% before the economic doldrums began (and a report by Rabobank projects private-label food sales to grow as high as 30% by 2025).

But nowhere is this deal heuristic more visible than in clothes shopping. Americans are spending less on clothing as a percentage of income than at any time in history: last year, clothing purchases amounted to just 3% of annual spending, a sharp contrast from the 7% spent in 1970 and 13% in 1945. Retailers often mark up the “regular” price of clothes just to be able to mark them down dramatically for big sales—which occur virtually every week. The men’s clothing store Jos A Bank has built its entire marketing program on seemingly ludicrous sales events, marking down suits with $900 retail tags to $200 or offering customers to “buy one suit and get three free.” These extreme discounts haven’t hurt Jos A Bank’s performance; the retailer has enjoyed a healthy 9% profit margin and 8.5% annual growth rate since 2008.

Ben Johnson’s failure as a retail strategist was thinking that he could make a rational appeal to customers who are driven primarily by their unconscious mind’s inclination to make quick, effective decisions in a chaotic environment. This does not imply the unconscious mind is irrational or driven by simple emotions. It is not irrational to assume that full retail prices will be marked down eventually. It is not emotional to believe that if one retailer is not offering a deal, whatever one is looking for can probably be found on sale somewhere else.

In Habit: The 95% of Behavior Marketers Ignore, we discuss the role of category neurons in brand positioning. The reason that Apple is able to avoid offering margin-killing discounts and deals is because it is a uniquely positioned brand. The company has zealously isolated its brand identity from the rest of the PC, mobile, and tablet industries, creating a distinct category in the customer’s mind. JCPenney is a department store that largely sells the same brands and types of products as every other department store in its tier.

While we typically contend that the vast majority of behavior occurs in autopilot mode, there has been a profound shift toward co-pilot, deal-seeking behavior that doomed any hope that JCPenney’s strategy could succeed. Some companies are successfully leveraging this trend toward heuristics, carefully deploying coupons and targeted sales to ensure customers return to their stores. But many more retailers and brands are undermining their brand value, turning once loyal customers into unreliable deal-prone opportunists.

Mr. Johnson could have been successful with his “no deal” strategy had he adapted to the unconscious customer mind and worked methodically to change behavior over time, rather than directly trying to stop customer habits in their tracks. This long-term strategy could have slowly shaped customer expectations by utilizing attractive sales to lure customers back to JCPenney, and then reinforcing that decision with an enhanced boutique experience and improved product lines. While “slow” from an investor’s mindset, this approach could have evolved the JCP brand to something resembling the one in Mr. Johnson’s strategic vision in a few short years. But the “rational” approach won, and JCPenney lost.

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