One of the biggest problems is discounts being given by employees and sales people indiscriminately. Very often they are given with little or no senior management involvement or authorisation. There needs to be better systems, training and communication.
If you have employees and sales people in your business, make sure you educate them about the profitability levels of different products. If employees and sales people are to have the ability to use discretion to give discounts there needs to be guidance. For example, you might decide that discretionary use of discounts is only appropriate when:
- they are used to up-sell or upgrade customers to a more profitable product,
- part of negotiations to get the customer to say “Yes” only after all other attempts have failed, and
- to win sales away from your competitors.
Discounts should not be given when they are not asked for or expected by the customer.
Significant improvements to profit can usually be achieved by tightening up your discount authorisation procedures.
A better way to profit from volume discounts
Discounts offered to incentivise customers to buy more are popular, and can be very effective. There are essentially two types of volume discounts:
- Flat rate discounts (sometimes referred to as full volume discounts) are where the discount is applied to the entire purchase, and
- Stepped discounts (sometimes referred to as incremental discounts) are where the discount only applies to the additional volume.
Consider this example for a product priced at £100:
If a customer buys 100 units they get a 10% discount under both types, reducing the price from £100 to £90.
If they buy 200 units, under the flat rate discount they receive 20% off the entire purchase bringing the price down to £80. And if they buy 300 units, the discounted price becomes just £70.
However, with a stepped discount, if the customer buys 200 units they pay £90 for the first 100 units and £80 for the second 100 units, which is an average price of £85. And if they change their mind and increase their purchase to 300 units, the 3rd lot of 100 is priced at £70 bringing the average price they pay for the 300 units down to £80.
Let’s consider the impact on sales and profits if a customer buys 300 units.
Under the flat rate discount the 300 units are all sold at a discount of 30% bringing the price down to £70 and total sales are therefore £21,000. With a stepped discount the average price is £80 and so total sales is £24,000. The £3,000 difference in total sales may seem small.
However, you should consider the impact on profit. Let’s assume that the variable costs are £60 per unit. If someone purchases 300 units the variable costs are £18,000 resulting in a total profit of £3,000. But if we use the stepped discount profit doubles to £6,000.
What looks like a small difference in the discount structure, in this instance, actually doubles profits. You should choose stepped discounts whenever possible. They encourage people to buy more and often work out cheaper.
Many businesses struggle and ultimately fail because their pricing is wrong. Price is the most powerful lever in the profit equation.
Most times, pursuing a high-price discrimination strategy is preferable to low-cost leadership. This is, in part, because most people in society are value sensitive, and not price sensitive.
We’ve looked at the potentially calamitous impact on profit of indiscriminate discounting and that you should either stop discounting or discount strategically.
In short, you should consider raising prices, rather than reducing. In the next chapter, we’ll explore the issue of raising prices.