Let’s start with defining what a discount is.
Every customer is unique. The value that they place on your products and services is based on a wide range of factors that affect their decision. That can include things like quality, availability, size/colour/style, credit terms, delivery options and even whose money they are actually spending (theirs or someone else’s), as well as many other unique issues that may be relevant at that point. There are often dozens of elements to a decision which are consciously, and sometimes subconsciously assessed.
So setting a price to fit every customer is hard. If you set a single price and have no flexibility, then you may have to aim low to catch most of the potential customers, but may still be too high for some and be giving away loads of profit for customers that would have paid more.
So discounting helps to allow businesses to set prices higher, but have a way of adjusting prices to suit the circumstances or each individual customer. A sensible tool to get the best price possible for each unique situation. The problem is that many businesses and front line sales people simply confuse other discounting situations, and many use it as a lazy selling tool to get to a quick decision. So let’s explore some of the issues…
1.Discounting as a ‘Marketing tool’
You know the ones. “End of season sale, 40% off everything”. “Half price sofa sale”.
But this isn’t a real discount. The published prices have been inflated to allow the discount to be offered. If they want to offer a 50% discount, they simply double the target price to allow for it.
This is not a tool to flex pricing to each customer’s unique price point, just a marketing tool to encourage people to buy on the pretext of a ‘bargain price’. Bizarrely many buyers understand this and still allow themselves to feel that nice warm feeling of getting a great deal! It is a technique to make people think they are getting a better deal than they really are, and there is nothing wrong with this, providing your headline prices are increased to allow for these discounts. As one independent carpet store puts it… “We can’t knock 50% off, because we didn’t add it on to start with”.
2.Generic discounting to increase sales volume
This is the situation where a business thinks “if I am a bit cheaper, customers will buy more”. In effect it is half of the classic supply and demand equation. It’s just the assessment of ‘price sensitivity’. 5p on a tin of beans might reduce sales a lot, but £10,000 on a Rolls Royce would probably have no impact at all. It’s just the belief that lower prices should see higher sales volumes and vice versa.
This may well be true, but it is only half of the equation. The important bit is not whether demand will go up by offering discounts, but whether any increase in volumes would be enough to compensate for the lower profitability.
Let’s talk real numbers…
If the price of a product or service is £100 and the cost price is £70, then the gross profit will be £30 per item. This means if you sell 1,000 you will earn £30,000 profit.
If you think you can drive more sales with a discount, then the numbers will change. A 10% reduction means your sale price will now be £90. Your cost price is still the same at £70 so your gross profit is now only £20 per item instead of £30. So to make the same £30,000 overall gross profit you now need to sell 1,500 items. A 50% increase in the volume of sales to achieve the same result, but with all the extra costs of handling the higher volume.
So will your discounted price create enough extra sales to compensate for the discounts given?
So don’t drop prices and ‘hope’ you’ll make more money. Do the numbers and make an informed decision. In our experience you should be doing exactly the opposite (using the same example, a 10% price increase could mean that you could lose 25% of your sales and still make more money!)
3. To close the sale
This is when a specific amount of discount is applied in a one to one selling opportunity to get the customer to make a purchase. The customer may be a little hesitant or perhaps have other options, and a discount will close the deal.
However, as we said at the start, price is just one of a number of conscious and subconscious decisions being made by a buyer. So discounting to close a sale is ok only if you have explored all the other factors in the decision first. The real challenge is that sales people are often in too much of a hurry to close the sale, a situation made worse in difficult economic times. If you don’t explore all the other issues with the buyer, this puts the focus almost entirely on price. All buyers ultimately make a ‘value for money’ decision, weighing up all the features and benefits of the product/service and relationship with the seller, but they can’t do that if you don’t provide the information. Price is one factor, but not the only one
There are many other techniques to flex price in the right circumstances. Such as discounts for prompt payment, retrospective discounts for high annual spending, and even variable discounts to manage seasonal stocks etc. All require understanding and financial analysis to work properly. In our experience discounting is a shortcut to a sale, and applied with limited understanding of the financial impact on profitability, and low levels of training and discipline on when they should be used.
In the vast majority of businesses, getting pricing (and to do this, discounting) right, has a bigger impact on profitability than any other strategy you could use. Make better pricing the focus of your 2021 growth strategy.
THINK. PLAN. ACT
(Produced by Peter Hill, Author of ‘Pricing for Profit’)