Dangers of Discounting
February 19, 2008
The urge to discount should be continually resisted.
Don’t destroy your business in the mistaken belief that higher turnover equals more profits. That slash and burn approach to pricing has led many businesses to a sad ending.
Before you ever lower a price, get out your calculator and do the sums. You may be stunned to find out how much extra work will be required to make the same profit.
A simplistic example may help illustrate the point.
1. Assume I do ten $10,000 jobs where I make a 30% margin and it results in $30,000 net profit from all ten jobs.
2. If the practice of giving a 10% discount on each job became entrenched (or my discounts over the next ten jobs averaged $1,000), the result would be:
* a net profit of $20,000 for the next ten jobs; or
* doing 15 jobs to again have a net profit of $30,000.
| Jobs | Revenue | Cost | Net Profit |
| 10 | $ 10,000 | $7,000 | $ 30,000 |
| 10 | $ 9,000 | $7,000 | $ 20,000 |
| 15 | $ 9,000 | $7,000 | $ 30,000 |
What a stark truth! If I regularly give a 10% discount, I have to do 50% more work to make the same amount of money.
Of course, this is all based on a margin of 30%. Discounts pose an even greater threat if you are trading on slimmer margins.
Not only will you have to work harder to maintain profits, but your costs may significantly increase due to the extra work. Not only will staff and equipment costs rise, but numerous less obvious costs may also have an impact. Take the time to work through those hidden costs to see just how much the extra work is really costing and examine just how thin your margins really are.
No company can sustain extended periods of discounting. Well established companies may give the appearance of heavily discounting, but don’t be fooled by their marketing. If the discounts are genuine they can only offer them because of large buying power, switch selling or they have the rare good fortune to be selling high margin products.
You can be sure that any successful trader long ago learned how to make money and is not in the business of giving it away through uncontrolled discounts.
If a discount is to be offered, use it for a special purpose like clearing old stock. Or, if you are a service provider, link the discount to the job’s margin and not the overall fee revenue. Just imagine how magnified a “little” discount can be if it applies to the whole revenue.
In summary, uncontrolled discounts are commercial poison. Don’t routinely discount unless you ready to enjoy early retirement.
| Photo by CarbonNYC |