Small Business Taxes & ManagementTM--Copyright 2015, A/N Group, Inc.
Does discounting work? Generally, yes. There's a psychological reason why consumers look for a discount. The thrill of the hunt, the feel of a win. There could be other explanations, but there's no question that most shoppers feel good about getting a discount. But do discounts always make sense to the seller? And how much?
Before deciding to give discounts, you need to look at your business. The first item is your gross profit margin. (Gross margin is usually defined as your gross revenue less your cost of goods sold or cost of operations.) If it's only 15% you won't be in business long if you constantly give 20% discounts. But you've also got to consider your other operating costs (selling, general and administrative, etc.) and your fixed costs such as rent, depreciation, etc. (Selling, G & A, and similar costs may be fixed in the short run.) You may not have to cover some of these costs in the short run, but you must certainly do so in the long run.
If your fixed costs are a significant portion of your total costs, providing discounts if they substantially boost volume can add to the bottom line. You've got to work through the numbers. Talk to your accountant for assistance.
You've also got to know your customer. Is he or she sensitive to price? If you're selling to upper income customers, price may not be a factor. Business customers, particularly smaller ones, with high margins can also be relatively price insensitive. If that's the case, you can skip this article. You don't have to offer discounts. In fact, you may be able to selectively raise prices.
How do you test for price sensitivity? You may know from your dealings with customers (e.g., they never argue over price). If not selective sales are the best answer for most small businesses. And with computers to track results and e-mail to direct sales offers, many businesses should be able to do that relatively easily. Don't assume something will work. You may be surprised.
Here you want to know where your product or service stands. Is your product, service, delivery speed, etc. the same as the competition? Are you perceived that way? If that's the case a small discount should improve volume. If your product is better than the competition, you may stand above the competition and only discount occasionally, if at all. If you're not up to the competition, discounting may not help that much. You'll pick up customers by discounting, but the price may be steep. You might be better off spending money to improve your product. That's not to say extreme discounting doesn't work. There are a number of examples where it does, but many are larger operations and provide a substandard product that could give you a permanent negative image.
More than a few retailers use the approach with success. The list price may be the suggested list from the manufacturer, but few retailers sell regularly at that amount. Stores using this approach discount most, if not all items, and run sales with additional incentives. There are limitations here. Some customers will be continually lured by the sales, but a number will tire of the method. It may not be conducive to building a loyal following.
There's nothing wrong with a discount, but excessive ones can create a negative perception. Generally, discounts should be limited to 15% to 20% unless there are special circumstances. Liquidating an item, end of season or outdated inventory, flash sales, special deals from a distributor or manufacturer, etc. Regular heavy discounting will impact the value of your product or service.
The rule above may not apply to one-time sales. For example, buy a refrigerator and dishwasher and get a free stove. Two rooms of furniture for the price of one. Carpet one room, the second is free. Often the first one is "fully" priced so giving away the second item isn't as costly as you may think. Does it work? For many consumers, yes. But it's generally not a good strategy for items you sell on a steady, repeat basis. Notice the examples above. Most customers aren't shopping for furniture on a regular basis. And they're buying the deal--not looking at the individual price, or your product.
Usually an internet phenomena, but you can use it by direct calling regular customers. It's a one-day or even a 5-hour sale. No rain checks. When it's over, it's over--not every color in every size. This is a good approach to get people to commit quickly. This makes sense to generate cash during a slow period, to get rid of inventory, etc. Again, some businesses have used this on a regular basis, even creating a business model around it, but to retain profitability it's best used on an occasional basis.
Constant General Sales
Some businesses run sales almost constantly with some variations. For example, specific items on sale for two days, another group for three days, then 20% off on every sale over $50, then free shipping. And then a repeat of the cycle. This works, but you run the risk that customers will start anticipating the sales. "I need those sneakers, but they'll be a deal next week and I can wait that long". You could end up selling very little at full price. One company had salesmen's quotas and was so obsessed with making quarterly numbers that customers had to be stupid or desperate to buy before the last week of the quarter when huge discounts were available.
Everyone likes getting a deal his neighbor isn't. You can do this with a loyalty program, or just target regular customers based on sales data. This one can build loyalty.
In some cases you may be asked if you can do better on the price. That's often the case when quoting a price on a major item or a project, when there's one-on-one contact with a salesman, etc. This one often requires special handling. Even if you have a policy of giving in, you shouldn't do so without showing reluctance. For example, "that's our price to our best customers" or "it's already a good deal". This is when a good salesman earns his keep. The next step could be "I can cut 10% off the price if you make the order 1,200 instead of 1,000" or "I can give you a credit for $500 on your next order" or "I'll upgrade you to deluxe model for the same price". In all three cases you're probably giving away less than the customer thinks he's getting.
Free with Order
Giving away something with a high perceived value but that costs you little can often be very cost effective. Don't give away junk, or something that's known to have little value. Doing so could make the approach backfire. Free shipping is another example, but it may be overdone now.
Customer Targeted Discounting
This one is used on a number of internet sites. A customer looks at an item on Tuesday, you e-mail him on Thursday an ad where the item is featured at a sale price. You've dramatically increased the chances of making a sale. The downside is that after a few rounds the customer could spot the technique and look at the item but hold off for a couple of days waiting for a better deal.
This is one time when you discounting could backfire. A customer may be buying with the idea they're getting something not everyone can afford. In some cases any discount could backfire; in some you may be able to offer a discount, but on a limited basis.
Whatever approach you take, think through the situation first. Get outside advice on strategic moves.
Copyright 2015 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject. Copyright is not claimed on material from U.S. Government sources.--ISSN 1089-1536
--Last Update 08/28/15