Often the first thing companies do during a downturn in the economy is reduce prices on their products and services. Call it an economy-inspired sales promotion. 

But is this a sound strategy? Do consumers always want the cheapest price? Can a price reduction actually hurt rather than help? 

While it may be necessary in some cases to reduce prices, discounting has its risks. The biggest risk is that it can create a negative long-term perception of a product and a down-channel effect, ultimately leading to market-share erosion. Discounting can turn a Rolex into a Timex; a Barneys into a Macys; a Mercedes into a Chrysler. Just look at what happened to AOL when they discounted their services: they dropped their prices in some cases to zero, yet saw significant brand and market share erosion.

And discounting can also be dangerous to low-cost providers not focused on brand. Value-minded consumers have long-term memories and it is hard to retain market-share when the economy recovers and you try to raise your prices or eliminate promotions. 

In some cases, it may make sense to buck the trend entirely and increase prices.
In fact, many companies–including Abercrombie and Fitch, Web.com, Hershey, Blue Nile, and Vodafone–are taking this counterintuitive approach. To be sure, many are blaming the cost of commodities and these increases will put a strain on short-term growth. But over the long-run this could build brand value. Abercrombie and Fitch recently announced they were raising prices, in part to help realign their clothes with high-quality-and their sales rose 5% as a result.

Don’t get me wrong; there’s no doubt that discounting and sales promotions are a vital sales technique when done correctly. It inspires excitement and creates a call to action. However, when offered at the wrong times–for no other reason than to boost sales–it can cut the other way and create brand deterioration.

Here’s why: 

Consumers give you their hard-earned money in return for something that meets or exceeds their perceived value. It doesn’t matter if they’re buying a hot dog, a handbag, or staying at a five-star hotel; consumers want to see value and quality in return for their money. 

And studies have shown that in many cases, the more people pay, the more value they ascribe to their purchase. Money plays a funny role in the purchase process: it anchors perceived value. If you discount prices during adverse times, consumers may begin to question the original value. 

Starbucks, which just posted its first-ever earnings loss, has begun to offer lower-priced options on its menu, such as the recently announced $1 cup of coffee, with free refills. This strategy may boost sales in the short-term but I suspect it will hurt the Starbucks image in the long-term (and so does CEO Howard Schultz, who once said, “Our marketing will emphasise quality and service, not price.”)

When you discount, you undo the “placebo effect” of higher prices. And this leads to a decaying belief in the value of the product offered. So it may be short-term thinking to devalue a consumer’s perceived value of a product simply to move more merchandise during shifts in the economy. 

There are ways around this, of course. Consider the auto industry, typically the first to discount their way out of economic woes. Chrysler recently did something to preserve their price while offering a discount for something that does not affect their brand: gas. Chrysler cleverly took discounting to the next level by offering up a $2.99 gas guarantee for three years on all new car purchases within its fleet. The idea was to subsidize the fuel that goes into the new car, not the MSRP of the car itself. They followed a hugely successful promotion from GM in 2001, which discounted the financing instead of the price of the car itself. To be sure, the auto industry has far more problems than brand deterioration, but this approach is nonetheless smart marketing during tough times. 

So if you’re considering discounting prices during this recession, consider the long-term consequences and the potential for inadvertently re-positioning your brand. And if you must, it may be better to focus on something ancillary–such as gas or financing in the auto industry–rather than what your brand truly represents. Because once that veil is pierced, it may be incredibly difficult to go back and reestablish the value proposition to your consumers. 

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