You might think that offering discounts is a great strategy and you may feel you have seen some success with it, but there is a clear and present danger to discounting as a way to build sales. Read on and let us show you what we mean and what you can do instead that will actually bring you in more money.
Why it is easy to fall into the discounting arena
When your sales are falling, or you are experiencing an economic downturn it is all too easy to think that discounting will help increase your dwindling business income. Likewise, there is an ever increasing pressure of sales events, like Black Friday and Cyber Monday making you think that there is some magic correlation between increasing income and discounting products – after all if they are all doing it, maybe it does work?
In reality, you’re likely to be more profitable by holding your price and accepting the reduction in sales volume than discounting a product.
Sounds scary. Holding your price, but accepting the reduction in sales volume.
The idea that we should not immediately react to slower sales, with a gimmick to increase sales, even if at a lower rate of profitability feels like madness. But what is madness is the over zealous reactions to downturns that we mentally struggle with.
Here is why holding your price and accepting the reduction in sales volume works over discounting
Let’s look at an example to show the difference in your gross profit if you discount your selling price by 10% compared to holding the price at £100 and accepting a 10% reduction in sales volume.
If sales are currently at 10,000 per annum at £100 per unit, your sales will be £1,000,000. With costs of £60 per unit, your gross profit is £400,000.
Your gross profit is the important figure here, because this is the amount of cash that remains in your business for you to save, invest, or spend elsewhere.
Dropping the selling price by 10% might mean sales remain constant at 10,000 per annum with a selling price of £90 per unit, so you’ll achieve £900,000 in sales. Costs remain at £60 per unit, so your gross profit will be £300,000. This means a drop in the cash available to your business by £100,000 for the year.
If, however, you were to accept the 10% drop in sales but hold your price at £100 per unit, your sales revenue will still be £900,000, but you’ll only have to pay for 9,000 units, so your gross profit will be £360,000. A difference of £40,000 from a normal year.
In other words, holding your price and accepting the drop in sales results in a reduction in gross profit of £40,000 compared to a £100,000 reduction if you offered a 10% discount.
Here is another way to look at the effects of discounting
If you look at it another way, you can work out the increase in sales needed to maintain your original £400,000 gross profit if you offer a 10% discount. To calculate the increase in sales required, first calculate the gross profit for each unit: £90 selling price – £60 cost per unit = £30 gross profit per unit. This gives us a gross profit percentage of 33.33% (£30 gross profit / £90 selling price * 100).
To calculate the required increase in sales, multiply the previous sales volume figure by the gross profit percentage. To maintain your £400,000 gross profit, you’ll have to sell 13,333 units (10,000 units * 133%). That’s 3,333 extra units a year you need to sell during a downturn, either in your sales, or economically – that simple isn’t going to happen.
Discounting is just not the answer – it’s a race to the bottom! Look for other alternatives to respond to a drop in sales – starting with what you can do to delight your customers so they keep coming back!
”When you realise how much you’re worth, you’ll stop giving people discounts.” – Karen Salmansohn
How to spot problems in your cashflow before discounting becomes an option
Somewhere before you reach that moment of, ‘I think I need to have a sale’, there is a way to spot downturns coming and this is in your cashflow. Using your cashflow as a forecasting tool allows you to look at your historic data and project it forward in time. This helps you spot the patterns, trends, gaps and opportunities, revealing the true ‘story’ behind your business accounts. For example, forecasting may reveal a predicted seasonal slump in the next quarter, or a slowing in sales of a particular product or service category, allowing you to plan ahead and proactively take action to minimise any negative impact.
This means you will be less likely to be scared when you have to tell yourself to ‘hold your price and accept the reduction in sales volume’ to avoid a discounting scenario.
If you’re experiencing a drop in sales, get in touch so we can work with you to identify the reasons for this and explore alternatives to offering a discount.
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Photo by Benedikt Geyer on Unsplash