“20% Off!” “Buy One, Get One Free!”, “Black Friday Sale!” “… Going Out of Business!”
Your discount promotions are gutting your business – and you might not even know it.
We see promotions all the time where companies discount their products and services, but those businesses never share what that actually means financially behind the scenes – and why it leads to many businesses to layoff staff or close up shop entirely.
Promotions can begin a business’ death spiral, delay consumer purchases, and put you out of business before you even realize it.
Let’s take a look at both consumer behavior of discounting as well as the cold hard truth of the financials behind discounting. And lastly, let’s go over a few key strategies that can get the same perceived benefits of discounting – without actually discounting.
The Financial Toll of Discounting Your Products
Ready to dive into the nerdy numbers of business and see what discounts do to your company financials? 🤓
Pull out your trusty Profit and Loss Statement (P&L), look at your actual numbers and follow along with a few easy examples.
Let’s say you have $4mm in Gross Revenue.
And your Cost of Goods Sold (CoGS, what those sales costs you) is $1mm (25%).
Your Gross Profit is $4mm – $1mm = $3mm (75%).
Let’s say your business expenses are $2.5mm (62.5%).
That leaves you with a Net Profit of $500k (12.5%). Not bad.
The Impact of Discounting 10%
Now let’s say you decide to run a limited promotion, perhaps a mere 10% off sale….
You now have $3.6mm in Gross Revenue.
Your CoGS is the same at $1mm (25% -> 27.7%)
But… your Gross Profit takes a hit (75% -> 72.2%)
And since your expenses are also the same at $2.5mm… (62.5% -> 69.4%)
This brings your Net Profit down from $400k to $100k! (12.5% -> 2.7%) 😱
Yeah, you just lost 75% of your profit.
That’s scarily barely profitable!
The Impact of a 15% Discount…
Using the same example numbers above, a discount of 15% get us:
$3.4mm in Gross Revenue
-$1mm CoGS (same)
-$2.5mm in Expenses (same)
= -$100k (NEGATIVE One Hundred Thousand) in Gross Profit 😱😱😱
THIS is how many businesses start their death spiral out of business. You can NOT discount your way to profitability!
You can not discount your way to profitability!
What if Discounting Increases Your Quantity of Sales?
Okay, so let’s say you want to argue that discounting your products will increase your quantity of sales…
Maybe. But remember, with increased sales volume, your Cost of Goods Sold (CoGS) increases, too.
So let’s say that your 15% discount promotion increases your sales volume and your gross sales stays the same as without discounts at $4mm…
Your CoGS, however, increases – because of sales volume – to $1.2mm. (See, we keep the same CoGS percentage of 29.4% from our previous calculation with a 15% discount.)
Gross Profit rebounds to $2.8mm with the same percentage of 71% from our previous calculation, too.
But Expenses stay the same. So our Net Profit ends up at $300k – or only 8.1%.
Still profitable, but less profitable than had you not discounted in the first place!
Mega Discount! Double Your Sales! (…?)
Let’s say you ratchet your discount up to 40% off and that leads to a huge increase of sales (almost DOUBLE) so you’re now grossing $4.5mm. Your CoGS also almost doubles to $1.8mm (42%!!!). Your Gross Profit is down to $2.6mm. And your Net Profit is a mere $125k… or 2.8%.
“We’re losing money on every sale! Make up for it with volume!”– Worst Advice Ever
Take a look at what happened to Wahoo at the end of 2022. Among other problems, they ran some pretty steep promos during the holiday season to move inventory.
“…the promotional activities to manage its elevated inventory levels, including Cyber Week discounts, continue to drag on its profitability. Therefore, we expect the company will report negative EBITDA in 2022. In addition, we do not expect Wahoo will be able to significantly improve its profitability and cash flow…”Wahoo Fitness Deb Ratings Lowered on Potential Default
And now what happens when your customers see you running promotions and discounts? What does that do to their behavior?
Let’s look into the behavioral psychology of your buyer who knows you run promotions and sales…
The Psychological Impact of Discounting
Psychologically, to your customers, when they see you discount your product, a few questions come up for them.
You’ve asked yourself these questions before as a consumer.
Have you waited to buy something because you knew Black Friday was around the corner or a Super Bowl promo was likely coming up?
Have you ever been frustrated when you found out someone paid less for the same airline ticket that you bought, or got a better deal on the same car than you did?
Your customers have these exact same thoughts.
When your customers see a promotion for something they were considering buying – or recently bought – they ask “If they [your company] can sell this to me at this discount, why were they overcharging me before?”
And secondly, the next time they want to buy from you, they wonder “Why should I buy now, if I know there will be a discount coming up?”
Back to Black Friday… “Over 70% of consumers indicate that they believe the best deals of the year are found during the holiday shopping season.” If you’re shopping with a brand that you know doesn’t play that game, however, you buy for other reasons that are not discount related.
Take REI, for example, and their #OptOutside movement:
“Since 2015, we’ve closed our doors on Black Friday, choosing time outside over the busiest in-store shopping day of the year.”REI’s OptOutside
REI customers know not to wait to buy and not to expect a discount. They buy when they want the product they need and for other motivating reasons that we cover further on under strategies below.
Lastly, if you have a premium priced product (and you certainly should), discounting it hurts the perceived value and makes justifying your regular pricing far more difficult. More on luxury marketing in a moment.
People tend to take your discounted price into account and “anchor” that as the actual value of your product or service in the future. Customers now value your product at the discounted price and most people will take that price into account when making future purchase decisions.
They expect you to be selling at the sale price forever forward. They determine the price they expect to pay in the later on based on your present day promotion.
Increasing Sales without Discounting
The reason you likely planned to run a promotion and discount your products and services was that you wanted to increase sales. You can get the same bump in sales, however, without discounting.
You can get the same increase in sales without discounting!
Increased Value in Promotions
You can always add in more value to your offering or promotion – value that is greater to your customer than the cost to you.
This is especially prevalent in luxury brand marketing. For example, the addition of an exclusive free gift with purchase for a limited time only or while supplies last.
Your luxury buyer isn’t looking for a deal so much as they’re looking for status. How can you help them show their status?
Adding in a limited time free personalization or customization can increase the value of what you’re selling without discounting.
Offer exclusive access to a private members only community just for your customers and clients. This could be as simple as a private Facebook group, a Slack team, or a Discord channel.
You can offer perks or points, like induction to a VIP Buyer club or a Silver, Gold, Platinum level.
Back to REI above. They have a co-op that us members – not customers – buy into. That is also a loyalty program. With points. Add a credit card that gets you points. And additional exclusive members perks.
Zappos famously created a VIP Buyer program that provided a few perks like free shipping. Getting in was as simple as making a purchase – or asking for membership. But the exclusivity and perks kept buyers coming back and buying more.
And while we’re talking about Luxury Marketing, rewind back in this article to the comment about “anchor pricing”. Luxury buyers looking for status and exclusivity often see more value in a higher price point. Simply adding in a higher priced package or offer can help you both to sell more of the package you do want to sell AND, as a bonus, you’ll start getting a few much more profitable higher end sales, too.
One of our Mastermind members used this to his advantage when selling coaching programs.
Initially given the choice between a $10k/year and a $30k/year coaching program, many of his buyers would purchase the $10k program. Simply by adding in a $75k/year coaching program, he saw an increased number of buyers for the (now mid-tier) $30k/year program. AND as expected, he acquired a select few new high end clients in the $75k/year program – high end buyers who never would have bought the $30k/year program!
Scarcity and Urgency in Promotions
Fake scarcity is dumb, insincere, and possibly even fraudulent. Real scarcity, however, is a very effective motivator.
We’ve all felt FoMO (Fear of Missing Out) before.
Because we’ve missed out. And that sucks.
When it’s holiday time and the latest hot holiday gift is out of stock and you didn’t get it before everyone else did. When the airline price you were considering is now gone. When the concert tickets you wanted were all sold within minutes of going on sale. When that hot stock you were thinking about hockey sticked before you could buy it. And on and on.
What is actually limited in your business?
Do you take phone consultations? Your calendar only has so much space.
Does your team service your clients? There’s only so much availability for new clients.
Do you sell physical products? There are only so many in inventory.
Does your product use a limited quantity or difficult to source ingredient? There’s only so many you can make.
One of our Mastermind members handles physical system installs for businesses. Before putting proper systems in place, they were responding to requests same or next day, not getting signed contracts, footing the bill for goods, and having a hard time collecting payment months later. With proper systems in place to handle new business, however, and real proper scarcity on their calendar, they began booking business 2+ months out, collecting deposits up front before buying hardware, getting signed contracts, and getting paid. All without discounting.
One of our other Mastermind members has an online supplement business and creates a limited run of special hand crafted products from time to time. These are premium priced and very limited quantity due to their ingredients. These sell out every single time they are released. Because of scarcity. All without discounting.
Where is the real scarcity in your business? Have you highlighted that to your customers?
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Are you ready to connect with like minded Business Owners, Founders, and Entrepreneurs who’ve “been there, done that” ?