The Math of Multiple Discounts

Recent research by Akshay Rao and Haipeng Chen confirms that people have a hard time processing a sequence of percentage discounts. For example, if you have a $100 item at 20% off, and then take another 20% off, what is the price? In most cases, it’s 20% off $80, or $64, not $60. The researchers tested their hypothesis on a group of marketing students (who should know better, right), who selected multiple discounts over favorable single discounts. They also tested their results in the real world, comparing sales of items at 40% off or, 20% off, then an additional 25%. The latter test yielded greater sales, although the actual discount amounts are the same.

This is a good illustration of framing, and of innumeracy. It suggests that we should unbundle discounts.

It’s also important to note that even pricing people sometimes experience this problem, and good communication is critical to make sure that discounts derive from the appropriate starting price. Savvy purchasing managers may negotiate that all discounts derive from list price. Not only will this get them a better price, accounts payable will then refuse to pay an invoice with discounts derived from prior discounts instead of list price.