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 or make our product more attractive to the market. Trying to grow top line sales? Just knock 10, 15 or even 20 per cent off the sales price. It’s easy!
We can get so obsessed with discounting that it becomes standard practice in business.
But it’s important to take a step back and truly understand what this run-of-the-mill approach to winning business is actually costing you.
In this article:
Why discounting kills your profits
As an accountant and specialist in ecommerce business models, I can comfortably tell you that discounting is the number one killer of profitability.
It’s a default tactic often deployed by marketers who are looking to “acquire more customers”, or by founders who are not confident in their product.
Don’t get me wrong – I’m 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 businesses, but particularly eCommerce.
There are four ways you can improve the profitability of your business:
- Increase prices
- Sell more volume
- Decrease direct variable costs
- Decrease fixed operating costs
Of the four, the most effective way to maximise the profitability of your business is to increase prices.
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.
What happens when you discount
For every percentage that you discount, the reverse happens: all the additional dollars you make come directly off your bottom line profit.
Let’s look at an example:
Let’s say an ecommerce business does $1M in annual sales. It generates a 10 per cent profit margin on the back of these sales. This is a pretty standard profit margin – you wouldn’t want to be doing any less than that.
When you add a 10 per cent discount to your product, this essentially erodes the company’s profitability. At a 20 per cent discount, it loses money.
Now I know what you’re thinking. The above example assumes that your sales volumes don’t increase as you lower the price.
The common argument with the discount tactic is that a business can make up the loss in margins by increasing sales volume.
Well, yes, in theory it should. But the question is, by how much?
How many extra unit sales do you need to cover the discount?
Let’s take an ecommerce business that sells 1000 units of product a month at a 40 per cent gross profit margin.
Now, discounting the product by just 15 per cent means the company needs to increase their sales volume by an additional 60 per cent just to make the same gross profit dollars if they charged full price.
In other words, instead of selling 1000 units at full price, the business needs to sell 1,600 units just to make the same gross profit dollars at a 15 per cent 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.
The bottom line is that if you’re not generating the additional volume in your discount campaign, you’re losing money.
Next time you run a discounting campaign, use this calculator to set a benchmark of the volume you need to sell in order to protect your margins. Just make sure you select “Make A Copy” first.
Or try one of these four alternatives to discounting instead.
One final thought: if you discount below your gross profit margins, you can’t expect to build a profitable business.
You can’t make up losses with volume. Buying something for $50 and selling it for $40 will never work.
It’s just the laws of economics – reality doesn’t work that way.