Discounting prices is necessary to hang on to existing customers and win new ones – isn’t it?
NO! Discounting is the very last thing you should do.
Firstly, big price drops rarely lead to any significant increase in sales. Many high street and online retailers promote “50% off” sales, but these are marketing techniques, where headline prices are inflated in order to present an apparent discount. Consumers aren’t stupid, and they no longer believe the honesty of these deals.
Secondly, even if lower prices might increase sales volumes, that is only half the equation.
A 30% margin business decides to drop prices by 10% to increase sales. The key question is not whether sales volumes will increase, but whether they will increase enough to cover the discount being given to everyone.
- Business sold 100 items at £10 each = £1,000. Profit £300 or 30%.
- Decides to sell for £9 each, to boost sales. Profit now £2 per item.
- Volume increases by 40%. Great result? – No!
- 140 items now sold at £2 profit = £280. £20 less than before!
- Needed to sell 150 items @ £2 profit to make same £300. 50% more just to stand still
The outcome varies at different margins as does the price sensitivity of products. But most businesses simply do not ask this question or work out the dynamics. If you think blanket price reductions will increase sales, they might. If you think they will increase profit, they don’t.
But what about one single customer where you will lose a sale unless you discount. Surely selling 100 items at £9 is better than 0 items at £10? Let’s consider a few issues…
Gross profit is just the start. There are transaction costs of invoicing and debt collecting. Items are picked, packed and shipped, and people cost are part of every step. Many may find that the overheads involved in any transaction might reduce an overall gross profit of 30% to a net profit of 5%.
Example:
(Using same numbers as opposite)
100 items generated £300 gross profit. (30%)
Share of overheads approx. £250. Net profit £50 or 5%
Discounting by 10% reduces gross profit to £200.
Transaction costs remain £250, so now a net loss of £50 on this sale
You might argue that the overheads would be the same with or without this sale, so you are £200 better off by making this sale, than not making it. Perhaps on a one off decision, but these are not one offs. Make this a common or even systemic issue and the impact can be catastrophic.
So why is price the big issue?
Because we make it the big issue. If the sales process does not cover all of the other critical elements of the transaction, such as urgency, quality, reputation, design input, delivery, credit terms, refund policies and a host of other conscious or subconscious elements of the buying process, then the only issue to argue over is price.
But we are in a recession, surely that’s different?
Yes. It is even more critical that business focus on margins and profits than at any other point in an economic cycle. You don’t want to be doing the same work for less money, and you certainly don’t want to be doing more work for less money!
Even in recession, there is a big part of every market that wants quality and service above price. In fact, for some customers these issues become more important.
For example, there is stacks of research which shows that the speed of returning a quote for a potential sale has a significantly greater impact on the buying decision than price does.