As small business owners, managers, and marketers one of the issues we must confront each holiday season is whether or not to give price discounts as part of your planned marketing programs. The uncertainty can seem enormous. How much should the discount be? When should you run it? In what situations should it apply? Will I profit? Here are some considerations when making those decisions.
Ways to Think About Profit
Whenever you give a discount you should do so because you think that the additional sales and word of mouth/attention it generates for your company, both today and in the future, will bring you more profit than if you do not. Contrary to what the accountants may have you believe, it is not a cut and dried decision. There can be a great deal of uncertainty because no one can tell the future or look back at what would have happened had you not had a discount.
When evaluating profitability of any price cut, the relevant comparison is: how much did you make as a result of the price cut versus how much you would have made without the discount. When looking at the short-term effect, factor in the increase in unit sales that resulted from the discount. When evaluating long-term profit, factor in the increase in future sales due to word of mouth and repeat purchases by new customers. Additionally, if your product has a limited shelf life, consider the risk of unsold inventory if you do not run the discount.
Pros and Cons of Discount Pricing
To most, the downside of offering a discount is obvious: you make less money per unit sold. This may lead you to think you will make a lower profit with discount pricing. It CAN happen, but not necessarily. The advantages can be great. Here are the pros to consider before running a price promotion:
The pros related to giving a discount:
- A discounted price will increase the number of items you sell.
- Promotions increase the attention you receive from potential customers. More people will hear about your product, resulting in more current and future sales.
- Online coupon codes increase the number of Websites that mention your company. This increases the number of people who come across you while surfing online.
- If your competitors are discounting and you are not (during the holiday season, for example), you may lose customers you may normally sell to at full price.
How to Compute Your Discount’s Short-Term Breakeven Point
When figuring the short-term breakeven point for a discount, you must answer the question “How many more items do I have to sell to make up for the price decrease?” The formula that answers this question is:
% increase to breakeven = 100 x (decrease in profit at the discount price) / (profit at the discount price)
For example, say an item costs you $55 and you normally sell it for $100. If you discount it at 25% off, at a price of $75, how many more would you have to sell in order to break even?
Profit at regular price: $100 – $55 = $45
Profit at the discount price: $75 – $55 = $20
Decrease in profit at discount price: $45 – $20 = $25
100 x $25/$20 = 125%
Under this scenario, to make a short-term profit your discount would have to bring in 125% more volume compared to your sales without the discount. In other words, if you normally sell 100 widgets you must sell more than 225 as a result of the discount to make a short-term profit.
What About Long-Term Profit?
The calculations above capture the directly measurable, quantifiable numbers. But what about other, less direct, benefits? Those should play into your decision as well. You may be in a situation, for example, where doing “business as usual” with respect to pricing will result in a decrease in sales. Or you may be overstocked on an item that is only sellable for the next six months, and is worthless afterward. These situations, while extremely relevant to any pricing decision, are not captured in short-term considerations.
Whatever your final decision, know that management is an iterative process. Make a decision and evaluate at certain intervals, adjusting if needed.
About the Author:
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