Why do factory outlets exist? The answer might seem obvious to most shoppers: these are places where businesses dump factory seconds or stale goods at rock-bottom prices. Read: bargains, bargains, bargains. And indeed, this may have been the case when stores first appeared in the 1930s, usually located in rural areas close to the factory and selling damaged or irregular clothing, often to the employees themselves. .
Even though most clothing manufacturers have long since moved overseas, factory outlets have continued to exist, although they do not have a “point of sale” to speak of. And far from just selling discontinued merchandise, some companies are even designing specific product lines to sell there. So what’s going on?
“We take it for granted that factory outlets exist, but if you think about it, it’s kind of weird”
“We take it for granted that outlets exist, but if you think about it, it’s kind of weird,” says Donald K.Ngwe, Assistant Professor in the Marketing Unit of Harvard Business School. “Why don’t companies just sell this merchandise closer to their customers? Why do some companies have a lot of outlet stores and some don’t? What’s the difference between having these outlets and only have a sales display in the back?”
As a doctoral student in economics at Columbia, Ngwe was fascinated by the incredible range of products that retailers offer consumers and wondered how this practice had developed. He began to suspect that he had more to say about consumers than companies. “Companies need to know something about how we behave that drives them to adopt these retail strategies,” he says. “I see retail as a way to study consumer behavior outside of the lab.”
Ngwe’s research was aided by the fact that companies are collecting more customer data than ever before, recording not only demographic information but also details about every product purchase they make. “There’s so much attention paid to retail analytics that it’s like drinking from a fire hose,” he says. “Companies have more data than they know what to do with.”
Do outlets cannibalize?
A leading manufacturer of products in the fashion apparel and accessories category has agreed to provide Ngwe with consumer data in exchange for detailed customer analysis. Behind the company’s interest was concern over whether its factory outlets were cannibalizing customers at its main retail outlets, Ngwe says.
“In the business press, it’s fashionable to talk about how going down the market to the factory outlets hurts the brand,” he says. “Every time a company makes a foray into retail outlets, it’s going to win in the short term but hurt brand image in the long term.”
To see if this was the case, Ngwe separated customers by a variety of characteristics, revealing that, in fact, those buying from retail stores and outlets were virtually identical in terms of demographics, including income and postal codes. They differed, however, on two important variables: their willingness to travel and the degree to which they cared about ‘quality’, which in fashion often means how novel the design of a particular item is.
Ngwe found an almost perfect inverse correlation between the two attributes. In other words, the more a customer was willing to pay a premium price for the latest trends, the less willing they were to drive a long distance to get to an outlet, and vice versa. “The people who were the most willing to travel were the ones who cared the least about quality,” says Ngwe. Importantly, consumer behavior affected not only older items, but also new items produced in older, less fashionable designs that companies continued to produce for their outlets even after stopped making them for their main stores.
“Companies were actually making more old products because if they were making more new products for outlets, it would cause cannibalization,” says Ngwe. “You don’t want to expand the market to have more low-value consumers at the expense of your higher-value consumers.”
By selling lower quality models at lower prices at outlets, companies could avoid the cannibalization of the latest models in their main retail stores. Indeed, the travel distance between retail stores and outlets serves as a buffer to separate the two different types of consumers and maximize overall profit.
“By going to an outlet, you reveal something about yourself to the seller,” says Ngwe. “By the fact that you went there by car, the [retailer is] will offer you a good of lesser quality. This does not mean, however, that companies are “cheating” consumers. In truth, says Ngwe, consumers ultimately win by having more choice.
“From a consumer perspective, the fact that there are products for different preferences is an improvement over a more limited sales strategy,” he says, which allows consumers to buy cheaper items, or even less trendy, at a lower cost simply by driving a few hours.
Ngwe also used the same data to examine other companies’ pricing strategies, including the ubiquity of listing items as “on sale” that are almost never offered at the actual price on the label. “A company will offer a $300 blouse at 30% off, but you couldn’t buy the $300 blouse even if you wanted to,” he says.
Rather than mislead consumers, says Ngwe, such pricing actually communicates information about the quality of the item, which makes customers much more likely to buy a $300 shirt that’s sold for $200 than a shirt that’s sold for $200. regularly listed at $200. (That’s what former JC Penney CEO Ron Johnson discovered to his chagrin when he suppressed sales and offered everyday low-priced merchandise, causing sales to plummet. He was ousted in 2013.)
In fact, according to Ngwe, there was an exponential increase in sales as the “initial” price differed from the “sale” price, with no stabilization within the price range examined. “It implies that these original prices are credible, indicating something tangible about the characteristics of the product to the buyer. There is content in this price, whether it is genuine or not.”
At HBS, Ngwe plans to continue studying pricing, studying what they say about both companies’ selling strategy and their customers’ buying preferences. His latest research focuses on grocery stores, a much more complicated and competitive environment than clothing.
“I want to see what happens, for example, when Whole Foods comes to town – does that make it better for consumers by offering more variety, or do they lose out because other grocery stores then raise their prices?
Ngwe’s research helps lift the veil on the sometimes mysterious world of how companies rate their products and, in doing so, reveals not only what they say about companies, but also what they say about us.