Why Discounting is killing your Ecommerce business
I’m guilty of it. You’re guilty of it. We’re all guilty of it.
It’s the default response when we’re trying to attract new customers and grow our top line sales. To make our product more attractive to the market.
It’s easy to knock-off 10%, 15% or even 20% off the sales price. We can get so obsessed with discounting that it becomes standard practice in our business.
However, rarely do we step back and truly understand the costs of this run-of-the-mill approach to winning new business.
As an accountant and specialist in Ecommerce business models, I will comfortably tell you that discounting is the number 1 killer of profitability.
It’s a default tactic often deployed by amateur marketers to ‘acquire more customers’, or founders who are not confident in their product.
Don’t get me wrong – I am not against discounting as a tactic – but what I’ve found is that many founders are discounting their products without understanding the financial and long-term consequences to their business.
It’s a dangerous habit that is entrenched in most Ecommerce businesses.
In this blog, I will unpack how much discounting is really costing your Ecommerce business, and offer recommendations on how you can start to wean yourself off this deadly habit.
But first, a quick lesson on finance 101
There are 4 ways you can improve the profitability of your business.
They are as followed:
- Increase prices
- Sell more volume
- Decrease direct variable costs
- Decrease fixed operating costs
Now, the fun thing about these levers to improve your profit is that they are not created equal.
Increasing prices is the most effective way to maximise the profitability of your business.
This is because raising prices doesn’t impact the unit cost of sales. All the additional dollars you make in price increases go directly to your bottom line profit.
Now, the same thing happens in the reverse when you offer discounts. For every dollar that you discount, that is one dollar of profit coming off your bottom line.
Let’s use this Ecommerce business as an example.
This Ecommerce business does $1M in annual sales. It generates a 10% profit margin on the back of these sales, which is a pretty standard target profit margin. You wouldn’t want to be doing any less than that.
As you can see, willingly offering a 10% discount essentially erodes the company’s profitability.
At a 20% discount, it loses money.
Now there’s a very big assumption that is behind these financials. This example assumes that your sales volumes don’t increase as you lower the price.
I mean, if you discount your product, you should expect unit sales to increase as a result? Right?
Well, yes it should – but by how much?
How many extra unit sales do I need to make to cover the discount?
The common argument with the discount tactic is that a business can make up the loss in margins by increasing sales volume.
So the million dollar question is – how many extra sales do I need to make for every % discount?
The table below demonstrates the additional unit sales required for every % of discount that you provide you customers.
In this example we assume an Ecommerce business sells 1,000 units of product a month at a 40% gross profit margin.
Now, discounting the product by just 15% means the company needs to increase their sales volume by an additional 60% just to make the same gross profit dollars if they charged full price.
In other words, instead of selling 1,000 units at full price, the business needs to sell 1,600 units just to make the same gross profit dollars at a 15% discount.
And here’s the thing – if the business doesn’t sell that additional 600 units under the discounted rate, the business is worse off from a financial perspective.
So bottom line – if you’re not generating the additional volume in your discount campaign – you are losing money.
Use this calculator next time you run a discounting campaign to set a benchmark of the volume you need to sell in order to protect margins.
One final comment
I should also note that you should never discount below your gross profit margins.
You can’t make up losses with volume.
Buying something for $50 and selling it for $40 will never work.
It’s like the laws of economics – reality doesn’t work that way.