When Discounting Your Products Could Cost You Money
Many businesses discount their products and services to boost sales. But do they also make more profit?
There is only one thing better than a good deal - a great deal. At least, that's what conventional wisdom says. However, when store owners look at their product profitability after a weekend of heavy discounting, they often find that their profits are way down. What may be a bargain for shoppers may ultimately not be such a great deal for small business retailers.
Owners of small physical stores or e-commerce websites often fear losing customers if they do not offer substantial Black Friday, Memorial Day, or Labor Day discounts like the big box retailers.
But what concrete evidence would support such fear?
In my experience, many small business owners seem to copy what others do. If other small businesses, not even direct competitors, heavily discount their products for a specific holiday, many follow suit and do the same. The buzz seems to be too irresistible not to participate.
Should that sound like you, here are a few pointers for consideration.
When Discounting Could Make Sense
In simple terms, you are in business to make money and not to give it away. Therefore, as a rule of thumb, discounting can be a valuable tool if - and only if - your business earns more money by implementing such a strategy than without it. You may be surprised how rarely this simple requirement is met.
To illustrate my point, let's take free shipping as an example: Many sites offer free shipping if a customer exceeds a minimum purchase amount. Whether free shipping makes financial sense for your business depends on three things: (a) the amount your customers typically spend with you; (b) your product margins; (c) the shipping cost. If your minimum purchase amount is significantly higher than what your customers typically spend with you, then the additional margin could more than offset the shipping cost. To make this work, you need to set the minimum not too high to deter shoppers but not too low to lose money. It takes some serious number crunching to figure out what the right optimum is.
One area where discounting could make the most sense is a clearance sale. The discount should entice shoppers to buy a specific discontinued product to clear valuable shelf space for faster-moving items. Here is the problem, though. Don't feel tempted to bring this item back any time soon. Customers will notice and possibly may recognize an emerging pattern.
Another area where discounting could make some sense is to entice new customers to shop at your store. However, the success of this strategy depends very much on whether a one-time new-customer-discount in the form of free shipping or a price reduction will motivate them enough to shop with you. As an alternative to discounting your products, you could include a small gift as a thank-you for first-time shoppers.
When Discounting Your Products Could Cost You Money
Here are three don'ts that you should avoid if you use discounts in your business.
Don't create a time pattern with your discounts. Customers are very smart and learn fast. They quickly find out that your store always has a special discount on Valentine's Day, Memorial Day, Labor Day, and, of course, Black Friday/Cyber Monday. Many of these savvy customers just delay or pull forward their purchases by a few weeks to make them coincide with any of these holidays to take advantage of your discounts. What may appear like a spike in your revenue can also just be a shift of purchases your customers would have made anyhow, albeit over an extended period. The financial result for you as a merchant often only becomes visible later: a significantly reduced profit with roughly the same amount of revenue.
Don't allow discount stacking. Some big-box retailers are a real feast for astute bargain shoppers. These stores frequently discount a specific product while offering another store-wide discount at the same time. As if these discounts weren't enough to lure you to shop with them, they sometimes top it off with another minimum purchase discount. I have never understood why discount stacking is a viable business strategy for these big retailers. So far, I could only come up with two explanations: (1) not many customers take advantage of them, or (2) their non-discounted product prices must be so high that they need these discounts to bring them down to a more normal level. Either way, a small business like yours usually doesn't have the margins or brand strength to afford such a strategy.
Don't offer store-wide discounts. Unless your products have the same absolute margins or contribute equally to your profitability, a store-wide discount can create havoc to your profitability. Let's assume that you offer a 20% discount on all your products in your store or on your website. A problem arises if the prices of your products vary. Some cheaper items are priced at $10; others are more expensive and cost $100. A 20% discount on a $10 product is $2, while on a $100 item, it is $20. You would have to sell ten times as many $10-items to reach the same discount amount as if you sold just a single $100-product. What if your $100-product becomes a hit and you sell 50 of those. The total discount given during the sales event would be $1,000 (50 x $20) - what a nasty blow to your profitability.
Do Customers Expect Discounts?
It depends. In my experience, since big retailers, large chains, and certain online stores continuously bombard us with discount offers, everybody has learned to expect them. Some stores even send out coupon-codes daily. If you want to buy something, I am sure that you find it on sale somewhere.
However, small businesses are a different matter.
If you offer precisely the same products as the big guys, you may have a problem sooner or later as you will be increasingly undercut on price, especially online.
The good news is that small businesses have usually carved out a niche for themselves, offering unique products and services to a narrow range of customers. These customers do not buy from you, because you are the cheapest. They know that you are not. These customers buy from you because of your service, your cause, or the quality of your products. Would they buy more from you if you offered them a discount? Hard to know for sure, but probably not. You may get a little sugar rush, but from my experience, I doubt it would be anything lasting because many of these customers do not buy from small businesses based on price in the first place.
Where Does It Leave Us Now?
Discounting is for me half art and half numbers.
If you do not know your finances and cannot pinpoint which products or services are the most profitable, then extensive discounting can destroy your company.
However, if you are good at analyzing your sales, you may recognize patterns in your customers' behavior. And that can be the starting point of a very targeted and narrow discounting strategy.
Thanks for reading Digitally Explained! Subscribe for free to receive new posts and support my work.