Should I discount my prices and what difference will it make to my profit?
Most people love a deal – or like to receive a discount.
At the end of the day, a discount means we’re paying less than what we would normally expect to pay for whatever we’re buying.
Giving discounts is something widely used by retailers – both on the high street or online. Walk down any high street and you’ll soon see shop windows with 20% off…30% off…40% off signs. Flick on the TV on Boxing Day and it won’t be long before you see ads promoting money off at the Boxing Day Sales.
Retailers use discounts to make themselves more attractive. Stand out from the crowd. In doing so they get more customers ‘through the door’ and that means more sales. More sales means more profit.
That’s what retailers do but do discounts actually work?
The reality of it is that discounts are a price reduction.
Given that price is the single most important factor in determining the amount of profit a business makes that would suggest discounts will lead to LESS (not more) profit.
The question is should I discount my prices to make more profit?
Or will they mean you’ make less profit instead.
This article will answer that question by looking at the impact of discounts on profits, common situations when discounts could be used or should be avoided and highlight some possible alternatives to discounts.
WHY DISCOUNTS MIGHT BE GOOD
There are several situations where the use of discounts could really help a business.
1 Increase sales quickly
Offering discounts is a simple way to quickly get more customer interest in whatever you’re selling and increase sales. If you decide to offer discounts to boost sales, then they MUST be used for a short period of time. For instance, flash or seasonal sales.
If discounts are used more widely then you are effectively permanently reducing your price and gross profit margins.
2 Move excess/old stock or use spare capacity
Any business which holds stock to sell will have some products in the warehouse which is either old or slow moving. Or both. Discounts can be an effective way of selling off this stock and releasing the cash that the stock is currently tying up.
Similarly, manufacturing businesses might have periods of time when they have a lot of spare capacity. Offering discounts could be used to generate additional sales in those ‘quiet periods’ when their machinery may otherwise stand idle.
3 Attract new customers
If a business wants to win more ‘budget-conscious’ customers, then money off discounts is certainly one way to attract them.
THE 4 BIG DANGERS OF DISCOUNTING
Before using discounts business owners need to be aware of 4 big dangers which must be avoided. If not, the risk profits going down not up.
1 Repel the ideal prospective customer
If a business feels that they need to offer discounts, on a regular basis, then it shows that they don’t really believe in their product / service. They don’t have enough confidence to sell it at full price.
If you show a lack of confidence and the prospective customer picks up on it, then they’ll soon start questioning if your product / service / solution is as good as you say it is.
The use of discounts could have the opposite effect on your ideal customers – they’re repelled away instead of being attracted to you.
2 Focus becomes the price NOT your solution
As mentioned above discounts are essentially well publicized price reductions. By doing this your proposition to the customer is less about value (i.e. the value to the customer of your product / service) and more about the price.
That becomes a big problem If your ideal customers are looking for value and want a higher priced but good solution rather than an average solution which is cheaper. If a good solution is what they want then the offer of a cheaper price is unlikely to affect their buying decision….in a positive way.
The use of discounts may yet again repel, rather than attract, customers.
3 Sets a precedent – which might be hard to change
Discounts can create a dangerous expectation with your customers. If you’re always giving a discount then why pay full price when you can wait a bit and pay less when the next discount comes around.
At the end of the day, if you start off cheap, then customers will become to expect you’ll continue to be cheap.
Once that expectation sets in it’s very hard to raise your prices to what they should be without losing customers.
4 Reduces your profits
Reducing gross profit margins and the bottom-line profit is the BIGGEST danger to a business when it comes to offering discounts.
There is a widespread belief amongst business owners that a small discount (or price reduction) will lead to a much larger percentage increase in sales volumes with the net result being an increase in bottom-line profit.
This is a myth.
It rarely actually happens.
The reason for this is that business owners underestimate how much discounts reduce the profits of a business. As a result, they completely underestimate how much sales volumes have to rise by to offset the effect of the discount and increase profits.
The Discount Matrix (see below) illustrates this with some numbers.
THE DISCOUNT MATRIX
GROSS PROFIT % | DISCOUNT % | |||
5 | 10 | 15 | 20 | |
70 | 8% | 17% | 27% | 40% |
50 | 11% | 25% | 43% | 67% |
30 | 20% | 50% | 100% | 300% |
Example 1 :
A business with a high gross profit margin of 70% and decides to offer a discount of 20%.
Sales volumes have to rise by at least 40% for profits to increase.
If sales volumes rise by less than 40% then profits will be lower than what would have been if the discount hadn’t been offered. Ouch.
Example 2 :
A business with a modest gross profit margin of 30% and decides to offer a discount of 15%.
Sales volumes have to rise by at least 100% (ie double) for profits to increase.
If sales volumes don’t double then profits be lower than what would have been if the discount hadn’t been offered. Ouch.
The Discount Matrix shows the lower the gross profit % is the much higher the sales volume rise must be to increase profits.
It means, discounts, for those businesses is a high risk tactic if the goal is to increase profits.
ALTERNATIVE STRATEGIES TO DISCOUNTS
The good news is that there are a couple of alternative strategies which businesses can use if they want to avoid using discounts.
1 Focus on value
The truth of it is that most buyers look for value. For a few that means paying less. For the majority that means they want value for money. Invariably they’re interested in the value and benefits that a service / product gives them compared to the price they’re paying.
In trying to give more value to customers every business has a choice.
- Increase the value & avoid discounting the price
- Discount the price & keep the value unchanged
It all means that one of the best alternative strategies to discounting is therefore to focus on value and be Krystal clear on your value proposition.
Having a compelling value proposition, dramatically increases the likelihood of customers buying from you and at your standard price. That’s because when they compare the benefits to the cost they feel that they’re getting a ‘good deal’.
To have a compelling value proposition you need to :-
- Give a lot of value (this might be mean having to create more of it)
- Communicate the value very clearly to your customers
- Ensure your price is fair when compared to the value the customer is getting
- Ensure your price means you make a healthy profit
2 Stand your ground
Over the years I’ve seen numerous instances of a prospective customer asking for a discount at the very last minute. The business owner, having been ‘ambushed’ agrees to the discount because they don’t want to miss out on the sale.
All these ‘last minute’ discounts are bad news as they reduce profits and erode the long-term financial health of a business.
You need to stand your ground and don’t give in. There are a number of strategies that can be used to help you do this….
- Prepare for possible objections a customer might have by creating great answers which you can confidently use. Confident answers are re-assuring to customers.
- Willing to reduce the price BUT only if your product / service is downgraded. This could be done by removing something from the product / service OR reducing the quality in some way. Either way it reduces your costs and maintains your gross profit.
- Willing to reduce the price BUT only if you get something in exchange. So, for instance, the customer gives you something which has a value to you.
That could mean the customer….
- Pays in full in advance so you have the cash sooner
- Guarantees to buy a minimum amount from you in the future
- Commits to being a customer of yours for a certain length of time
FINAL THOUGHT
Used in the right situations (eg selling old slow moving stock and turning it into cash) discounts can be a good tactic. Even so, they should only be used for short periods of time.
Otherwise, discounts really should be avoided.
As highlighted above they create several dangerous pitfalls that are hard for businesses to avoid. They can easily result in businesses attracting fewer (rather than more) customers and reducing (rather than increasing) sales and profits.
So before using discounts it’s important that you have clarity.
- Clarity on the main purpose of what the discount is and what the resulting benefit
- Clarity that discounting is the best tactic to achieve that result compared to other alternatives.
- Clarity on your financial numbers so that you know how much sales must rise for profits to rise – having a good accountant will help you here.
- Clarity on how you will monitor performance throughout the discount so that you know if the discount offer is having the desired effect.
If you’d like to discuss any of the above or would like a chat to see how we can help drop us an email to wecare@krystal-clear.co.uk or call one of the team on 0161 410 0020.
