Small businesses need to know the destructive power of discounting. A discount comes straight off the bottom line i.e your profit. So making a decision to discount should not be taken lightly. You will expect to increase sales, but the increase in the volume of sales required surprises many.
Here’s the sums. In this example if you have a product or service with:
- $100 sales price
- $60 cost of sales (cost to provide the product
or service excluding your costs of doing business)
- $10 wages and overheads
Your net profit (margin) is $30 (or 30%)
Sales are okay at 10 per week ($300 total net profit per week), but then cash starts to get tight so you consider discounting to generate more cash. To make the same total net profit after a modest 20% discount will require a doubling of sales to 20 per week. Yes, you have to sell twice the current volume. This assumes that the cost of sales stays the same (quite likely) and that wages and overheads also remain the same (doubling sales may require some extra advertising, more commission to sales people, extra hours for staff and overheads).
So unless you are prepared to accept less total net profit our sales will need to double (and no increase in costs). Is that realistic? How easy is it to sell twice what you normally sell? Makes you think doesn’t it. Sure there might be times when you need to increase sales e.g. end of product life, but also beware that by discounting you are setting a new price benchmark for your product or service.
Here’s another way to think about the problem. If your goal is to increase cash from the current $300 per week, could you sell seven (three less than currently) for 20% more ($120) than the current price? If you can sell 30% less but at a 20% higher price you can make get 16% more profit! And by selling 30% less you might be able to reduce your cost of goods or wages and overheads which would mean even more profit. Wouldn’t that be great?! Or you could use the likely lower cost of goods, wages and overheads to increase the value of what you provide e.g. calling the customer to ensure they are happy, free delivery, easier returns policy, loyalty rebate for repeat business.
I wanted to keep this blog focussed on the impact of discounting on margin so will write separately about enhancing (maintaining) net profit by up selling and cross selling.
If this has made you think and you want to try this for yourself, calculate now is a useful website that keeps thing very simple but illustrates the danger of discounting.
Go 2 Market principle: make sure you understand your margin. Carefully consider the financial result of lowering (versus holding or raising) prices. There’s a lot of temptation to discount but there are alternatives.