Discounting Prices: What You Need to Know

Many people think they have to drop prices to win new business. However, discounting is not usually a good long-term strategy.

In the digital world, it is common to see the main product bundled with a number of add-ons and bonuses to build up the value and make the price look like a bargain. In a product launch, this price is then further discounted for a short time to give the impression of scarcity, and encourage quick sales. This is based on the law of scarcity from Robert Cialdini and Robert Martin’s ‘The Principles of Persuasion’.

There are times when discounting is an effective strategy to:

• Reduce dated or excess inventory,
• Drive quick sales and raise cash in hard times,
• Create demand in a product launch, and
• Attract new customers.

However, there are risks associated with discounting.

For example, you often see clearance and end of season sales advertised, with large discounts being offered. The danger in this is that it can become an expectation, and customers wait until the sale comes around before they buy.

The ‘Guaranteed Cheapest’ strategy is also popular. The problem with that strategy, is that as soon as a competitor reduces their price to be cheaper than you, you lose that advantage.

Other businesses discount as a normal way of life.

For example, I needed some built-in cabinets for my office, so after doing some research, I selected a vendor. The salesman came, measured up and gave me a price. And then before I said anything, he offered me a 10% discount. This was totally unnecessary as I would have paid full price. So, this salesperson cost the owner of this business hundreds of dollars in revenue, because he gave a discount that was not needed. And as he offered me a discount without asking, I assume he does this with most, if not every sale. How much is this costing the business year after year?

Many businesses that discount have no understanding about how this affects their results and how much more volume they need to sell to counteract the discounts they offer.

I would caution to make sure you know your numbers, and to make sure this does not become an ongoing expectation for your customers.

How Much More Volume Do You Need to Sell When You Discount?

Now this might be a bit boring, but it is important to understand.

Your gross margin is calculated by dividing the gross profit (selling price less cost price) by the selling price. So if you sell something for $100 and it costs you $70.00, your gross profit is thirty dollars. Divide the gross profit (thirty dollars) by the selling price ($100) to calculate your gross profit margin of 30%.

If you now give a 10% discount, your selling price becomes $90. The cost is still $70. so now you are only making $20 on each sale, and you have to sell half as many again (that is increase your volume by 50%) to make the same amount of money as before.

Margins vary for different businesses. So here is a table that will help you see what the effect of discounting would be on your business.

Select your present margin across the top of the table.

As you go down that column, you will see how much your volume needs to increase to achieve the same amount of profit, when you discount by the percentage in the left column.

The Effects of Increasing Your Margins

The follow-on question is this. How much could my volume decline to make the same amount of profit if I increased my prices?

Here is a table that highlights this.

Once again, select your present margin across the top of the table.

As you go down that column, you will see how much your volume can decrease and still achieve the same amount of profit, when you increase your price by the percentage in the left column.

For example, if your gross margin is 30% and you increase your price by 10%, your volume can decrease by 25% before you get back to your starting profit. Sometimes it is as simple as asking a higher price.

I once consulted with a client in a hardware store, where we determined that the difference between financial viability and failure was as little as a dollar more on a can of paint. What would this do to the volume of sales? Absolutely nothing!

So, how much could he increase price before volume would be affected? That is the judgement call that has to be made, or more appropriately tested to find out.

(You can read more about margins and other ratios for running your business in the ‘Analysing Your Finances’ section of the Self Employed Business Manifesto.)

Perception of Value

People do not buy on price. They buy on perception of value.

Dan Kennedy in his ‘Magnetic Marketing’ course, teaches that one of the most important skills a small business owner can learn, is to create ‘widgets’.

He is referring to the things you can do to add value to a product or service, and change the way it is perceived in the marketplace.

A good place to start is to ask the question: “What is it that everyone dislikes about dealing with any business in my industry?”

An example I frequently go back to is the trades. And not much has changed over the years, because just the other evening I was speaking at a seminar, where a lady said that she had been at home all day waiting for a tradesman who never turned up.

Then someone else chimed in and said, “You know the thing I hate is that they always leave the mess behind.”

Now not all trades people are like that, but those who are, have established a reputation that tarnishes everyone else.

So, a great ‘widget’ for a trade business is to guarantee you will turn up when you say you will, and you will clean up your mess: or the customer doesn’t pay.

If a trades person offered you that guarantee, would you be prepared to pay a higher price?

Of course, the benefit needs to be spelled out in all your marketing messages, including the scripts your sales team use in answering the phone.

Guarantees are an excellent tool to help you increase the perceived value in the customer’s mind. In many cases, it’s simply a matter of articulating what you would do anyway.

So, if you would refund a client’s money if they were unhappy, or you would take a certain action to ensure your customer is delighted, then stating this as a guarantee will allow you to potentially increase price and increase volume.

‘Bundling’ is another way to increase perception of value. Do you have products or services that can be bundled together to increase the average sale to the customer?

When people have no way to make an intelligent decision, price is the only way they can differentiate.

Unleash your imagination to reinvent the way your customers perceive you along with your products and services, and price will be much less of a consideration.

Members of the Self Employed Business Academy have access to a ‘Discount Calculator’ so you can readily calculate how much extra volume you need to see when you offer a discount. Read about the benefits of membership here and then click on the button in the header for instant access.