Thursday, August 21, 2008

GM Discount Pricing

General Motors (GM) has recently re-newed their employee pricing discount after stating that they would not pursue this type of pricing policy again. Why? GM mentions that the market has weakened over the past few months. So in order to sell more vehicles, GM has decided to lower the price - which is an excellent application of the law of demand (as prices fall people tend to buy more).

Yes, but what is the effect of price discounting? One effect that is not often examined is the impact a lower priced product will have on the value of the firm's brand. GM spends an enormous amount of money on advertising in order to convey to its customers that GM products are the customer best choice in buying a car/truck or SUV. Given the weakening market, I wonder if GM is reducing its advertising - I am guessing that ad spending has not decreased substantially. But why not? If there are fewer buyers, then would not spending less on advertising make sense?

But GM is not slowing production, which would be the economic decision when demand is weak. Why not? Because GM has a very big problem - the huge liabilities they face from about a million people (employees, retirees and dependents) for health benefits. In order to fund those benefits, GM must generate huge sums of revenues. When demand is weak, those revenue streams start to dry up, and to prime the revenue pump, GM has decided to lower prices to increase sales revenue. Notice cutting advertising does not really work in GM's best interest, since they need to get the word out that they are selling products at lower prices in order again to increase their revenues.

GM's other problem (along with Ford and Chrysler) is that they are producing a number of vehicles that are not in high demand given curent gas prices. Much of GM's advertisement's during the Olympics are for the Volt which they tell us will not be available until 2010. My guess is that this will be a rather pricey vehicle, and the rate that car buyer will substitute will be much slower given the higher price of the vehicle. If GM is really interested in generating sales revenue, then they could produce a lowered price vehicle. I think GM is banking on the demand for the Volt being high enough that this will offset the need to sell the vehicle at a lower price, and they could be correct.

What do you think?

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