Have you ever been driving to work in the morning and heard one of your competitors advertising discounted pricing on the radio? Or have you been driving past your competitor’s premises and seen a huge sale advertised? Or even worse, has one of your clients come to you telling you they can get a similar product from your competitor at a drastically reduced rate? It is very very difficult to resist the urge to race into your business and immediately cut prices to stay competitive.
The single most overused marketing strategy to bring customers through the door is discounting. While this can be an effective strategy, for most businesses it generates a price war that they cannot afford to sustain.
We are in tight economic times, and reports are that retailers are not enjoying the traditional peak in Christmas sales. We have already seen major New Zealand retailers discounting heavily far earlier than in previous years to try and stimulate demand. The slowdown in the retail sector then flows through to all those in the supply chain, and eventually, everyone is affected. The automatic response where the volume of sales drops off is to drop the price of the stock to attract customers.
There is nothing wrong with discounting strategies if that’s what fits your business. If you are using it as a strategy to bring in cash flow by clearing obsolete or unwanted stock it may well be a good strategy. The important thing is to be careful – if you don’t understand the effect that discounting can have then you can cause a disaster in your business and its profitability. Discounting creates a leverage impact on profits, which means that by discounting you are essentially giving some or all of your profits away. The key is to understand the impact and just how far you can go.
Consider the following examples:
- a business with a 30% gross profit margin that offers a 25% discount (certainly nothing unusual about that in today’s market) requires a 500% increase in sales volume just to maintain its same position – and in almost all cases that’s just not going to happen. The result generally is the business trading below its breakeven point and generating losses. And you can only do that for a limited amount of time.
- a business that trades with a 20% gross profit margin and offers a 10% discount needs a 100% increase in sales to maintain its position. Again this will not happen. In effect, the business has just given away half of its profit and generally for little effect.
How about a different strategy? If we look at things another way and think about increasing the price rather than discounting. Using the above example of a 20% gross profit margin, but we increase the price by 10%, sales can afford to drop by 33% before we are any worse off.
The key is that you need to understand the costs within your business and perform a break-even analysis before making any rash decisions. You are far better off thinking carefully, analyzing the numbers, and making your calls based on fact rather than gut feeling.
Discounting can be an effective strategy, but make sure you are not simply chasing sales at any cost. For information on how this may affect your business, please contact us.
The material and contents provided in this publication are informative only. It is not intended to be advice and you should not act specifically based on this information alone. If expert assistance is required, please contact us.
