This Is Your Brain on Bargains: JC Penney and the Curse of Discounts

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A short history of the shopping deal (... now 25% shorter!)

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Reuters

Discounts wield a dark magic. They create dumb blindness in rational shoppers. At profit-obsessed corporations, they cut margins in half. And if you're the sort of chief exec who thinks he's smart enough to do without them, they can make your credibility disappear.

That's the lesson Ron Johnson is learning now, as the new CEO of JC Penney.

Here is a guy knows his way around a store. After reinventing Target, Johnson took over as retail guru at Apple, where he designed those iconic glassy cathedrals of hardware. But his newest battle pitches him against his own customers. Johnson's opening move at JC Penney was to replace the store's barrage of special discounts with a permanent "fair and square" structure, where prices start 40% lower and stay there.

Johnson might see himself as a visionary standing athwart a sea of bargain shoppers yelling, "Stop!" But in the meantime, stop is exactly what they've done.

In May, JC Penney announced store sales fell 20 percent from last year. For the last two weeks, the business press has published eulogies for Johnson and his strategy. Whether he ultimately succeeds is beyond our knowing. (I would tell you, don't bet against discounts, but then again, why bet against the Steve Jobs of retail?).

The deeper story is that JC Penney is part of a backlash against the most tried-and-true pricing strategy in the business: the ubiquitous discount. Is Johnson crazy for abandoning daily deals, or are we, the consumers, crazy for falling for them?

A SHORT HISTORY OF DISCOUNTS (NOW 25% 30% SHORTER!)

John Wanamaker invented the price tag and the modern American department store in Philadelphia in the 1870s. But he had a problem.

Every year, after Christmas, business would slow down, and he would have to lay off workers until the spring. So he tried something new. He would buy from wholesalers in bulk and charge buyers just a sliver above cost, for a limited time only, to keep traffic moving through the store. It was the nation's first blowout January sale. And it has a hit.

Around the same time, Frank W. Woolworth, in New York City, opened the first of more than a thousand "nickel-and-dime" stores. Woolworth had learned something similarly simple and powerful: If you put something carefully chosen and awfully cheap in front of customers, they will probably buy it.

Wanamaker and Woolworth are the godfathers of the American discount, Ellen Ruppel Shell describes in her book, Cheap. They taught their descendants that Americans were suckers for the mental cues in targeted bargains. More than 130 years later, their example has gifted us the retail holidays of: Black Friday, pre-Black Friday, post-Black Friday, December-month-long, Christmas, after-Christmas, New Year, clearance, and on they go.

HOMO DISCOUNTIS

Step back from this cascade of bargains, and it all seems ridiculous. Blame the customers.

"Consumers don't know what anything should cost," William Poundstone writes in Priceless: The Myth of Fair Value. "They walk the supermarket aisles in a half-conscious daze, judging prices from cues, helpful and otherwise." The rational customer is a myth. We're more likely to pay more attention to objects on our right. More likely to gravitate to the number 9. More likely to buy cheap indulgences at the check-out. What's wrong with us?

It's not that we're idiots so much as we're lazy. Choosing anything is hard work, and our brains don't like to work that hard. As a result, we are attracted to simple answers to our difficult questions. This is the foundation of most biases, and it's true for shopping. Which of these similar shirts gives me the best value? That's a ridiculously hard question. What shirt will I get the best deal on? That's easy: It's the one that says "25% OFF", probably. Discounts make shopping simple -- not just on our wallets, but also on our brains.

It's no wonder bargains can become addictions. They give us a sense of accomplishment. They make us feel smart and frugal. For experiential shoppers, they punctuate the shopping landscape like road signs. For time-oriented shoppers, they save time.

The metaphor that bargains = drug works in two ways. For consumers, they're addictive. For retailers, too much can lead to overdose and brand damage. In 2008, with clothing stores like American Eagle slashing prices in the teeth of the recession, Abercrombie & Fitch announced it was done with discounts for fear the constant promotions would destroy the brand. The stock plunged 80% in 11 months. Witness the (pricing) power of the bargain.

JC PENNEY vs. HISTORY

There are two kinds of shoppers, says Brett Gordon, a professor at Columbia Business School. There's the bargain-hunter and the clock-watcher. If the first walks into a store without a bargain, she leaves. But the second customer isn't looking for markdowns. She's looking at her watch. She just wants what she wants, and fast, coupons or no.

"With constant promotions, JC Penney has been attracting the first customer, who is cheap, and losing the second customer, who is actually willing to spend more," Gordon says. "They're stuck with the lemons addicted to coupons. And, like with any addiction, you can either cut them off or wean them off."

JC Penney chose to go cold turkey. Its new strategy features normal low prices, monthly specials, and once-a-year discounts. Even if it isn't paying off immediately, Gordon says it's the right way forward. Or, perhaps, the only way forward.

"It's very hard to get people to change behavior when it's been ingrained in the customer," he said. "The issue is: Can JC Penney weather the temporary decline before customers start coming around, or will they fail in the interim?" The company is flying into a perfect storm. Department stores are in decline for economic reasons (the recession), demographic reasons (incl.: younger people moving away from older suburbs), and technological reasons (Amazon.com is a department store in every room).

"A lot of people have said Ron Johnson has to succeed because he did amazing things for Apple stores. But this isn't apples to oranges," he said. "Literally, it's apples to pennies."

***

In January 2009, the stock of Abercrombie & Fitch hit rock bottom at $17, months after the company announced it was done with bargains. Then, with the economy, the stock started to climb. Past $30. Past $50. Past $70. The pricing strategy, whose failure was so obvious to business writers in 2008, had ostensibly preserved the company's brand among upper-middle-class buyers.

But profits are fickle. Three years later, the stock is back to $30.

Abercrombie's story might be a perfect example for JC Penney, or a horrible example, or something in between. Who knows? But victory depends not on the unstoppable genius of Ron Johnson, but on his customers' immovable dedication to discounts. Changing somebody's mind about a product isn't so hard. Changing our brains? That could take a few business quarters.

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Derek Thompson is a senior editor at The Atlantic, where he writes about economics, labor markets, and the entertainment business.

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