The Danger of Discounting

Higher Margins - By: Brad Sugars
Business Coaching Article | Ten Principles of Leadership

We live in a price-focused world. Everyone is out to get the best deal.

The bigger retail organizations spent big dollars on promoting their sales through the media and it would seem to the ordinary businessman that this is the way to conduct business. "We'll make it up on the volume" you hear them say.

Don't be fooled by this. Not one bit.

The fact of the matter is that most businesses on average return about 10 percent on sales before tax.

This means that after deducting the cost of the goods or services sold and all expenses incurred in running the business, there is 10 percent of the original sale price left as your profit.

So if you discount say by 10 percent then the 10 percent you are giving away is the same 10 percent you would have made in profit. So typically, a 10 percent discount will leave you with no profit.

The table below illustrates the impact of discounting.

Present Gross Margin
20% 25% 30% 25%
Discount Increase in sales required to maintain gross margin
5% 34% 25.5% 20% 17%
10% 100% 67% 40% 50%
15 316.5% 152.5% 100% 75%
20% 400% 200% 133%

For example if your present gross margin is 30 percent and you give a 10 percent discount, you need to increase your turnover by 50 percent to make the same amount of profit.

There are some good and legitimate reasons to discount, such as obsolete or seasonal stock or specific cash flow requirements. There should be specific cut-off points for these strategies.

The big chains look at things slightly differently. Often they will work out how much of a particular product they will sell at full price and how much they will sell at a discounted price for the lifetime for that particular product.

So factored into the profit for a particular product is the fact that there will be some discounting. Most small retailers will discount because their competitors are and not really consider what it might be costing them.

One of the main reasons small businesses discount is to acquire customers. It invariably is far more profitable to work out some clever marketing strategies than to discount for this reason.

In reality, experience shows that most customers attracted to a business through discounting, rarely if ever come back again.

As any ActionCOACH client will attest, the payoff in marketing is to acquire the lifetime value of that customer not a single purchase.

Discounting in business should be dealt with very carefully. Because it is so prevalent, small business owners get trapped into thinking that it is a legitimate and profitable strategy.

Clearly it is tricky area and should be thoroughly considered before use.