“I never pay retail!” might be the proud catch-cry of the modern consumer, but it can also be the death knell for small businesses.
According to accountant and business advisor, John Harrington, Principal of Harrington Financial Solutions, discounting can be destructive, unless it is part of a carefully planned pricing strategy.
“Discounting erodes your gross profit margin so it actually costs your business money. It works best where one or two items or services are discounted to attract new customers to your business, and while they are there they buy full price items. It is much less effective where you are virtually giving product away in the hope that the customer will like it so much that they come back next time and pay full price for it,” said Harrington.
Harrington warns against discounting as a knee-jerk reaction to cost cutting by the competition. “It makes no sense to rack up losses by dropping your prices just because your competition down the road offers cheaper product. It is much better to work to improve the performance of your own business and differentiate it on the basis of value for money, quality and excellent customer service. These are the things that will bring customers back and build loyalty.”
“In fact, there’s plenty of evidence to suggest that discounting can breed customer disloyalty – if all you’re offering is a cheap price, there is nothing to hold them to you if someone offers a cheaper one.”
“The numbers really tell the story. Let’s say your gross profit margin is 20%. If you offer a 10% discount, you will have to double your sales to achieve the same profit. With a gross margin of 35%, if you offer a 10% discount you will need to boost your business by 40%. If you drop your prices by 12%, you’ll have to more than double your sales. And if you give away 20%, you’ll need to increase your turnover by 133% to match your original profit,” said Harrington. “Not many businesses are achieving that level of turnover growth.”
Summary:
1. Consider discounting in the context of your overall pricing strategy, for example to gain initial exposure or to attract new customers.
2. Never panic-discount to match competitors – after all, if they think their products and services aren’t worth as much as yours, who are you to argue!
3. Work on improving the performance of your own business. Your accountant or business advisor can help you here with meaningful benchmarks and practical solutions.
4. Actively differentiate your business from your competitors on factors that breed customer loyalty – quality, value for money, great customer service.
John Harrington is a Principal at Harrington Financial Solutions, North Sydney.
