In our previous 2 articles we looked at:
Pricing vs. Charging: What’s the Difference?
The 5 Gotchas of Discounting
Discounting certainly has its place. But make sure you are clear just why you are doing it. Here are some examples of how discounts can be used to achieve different business goals:
Clear inventory If you have a lot of inventory that you need to sell, you can offer a discount to clear it out. This is a good way to make room for new products or to generate cash flow.
Attract new customers If you are a new business or are trying to reach a new market, you can offer a discount to attract new customers. This is a good way to get people to try your products or services for the first time.
Increase sales during a slow season If you have a slow season, you can offer a discount to boost sales. This is a good way to keep your business profitable during the off-season.
Promote a new product or service If you are launching a new product or service, you can offer a discount to promote it. This is a good way to generate excitement and interest in your new offering.
Do please also bear in mind some of our Dos and Don’ts about discounting:
Don’t discount too often. If you offer discounts too often, customers will start to expect them and may not be willing to pay full price for your products or services.
Don’t discount too much. If you discount too much, you could end up losing money. Make sure you still have a healthy profit margin after offering a discount – unless, that is, it is a blatant play to ‘buy’ new customers.
Be transparent about your discounts. Let customers know why you are offering a discount and what the terms and conditions are. This will help build trust and credibility with your customers.
So, on to the numbers. And we need to look at something called the Price:Volume Dynamic.
How the Price : Volume Dynamic works
Logic surely dictates that if you raise prices (and don’t change anything else) that you will make more profit; in fact, every penny more you charge goes straight to your bottom line – happy days!
So if you were to put your prices up by 5%, just how much volume could you afford to lose and still be as profitable as you were before you put them up?
Surely it would be fair to assume that if you put your prices up by 5% then you could lose 5% of the volume and be back where you were before – WRONG (usually)!
Of course, every business is different – but the rule of thumb if you are a manufacturing business making a Gross Profit of, say, 30% is that you can “afford” to lose 14% of your volume.
And it gets better! If you were working at a 15% gross profit % and increased your prices by 5% you could “afford” to lose a whopping 25% of your volume – that’s a quarter of what you are doing now!! Or, in other words, you could be working at three quarters your existing level and still show the same profit – goodbye, busy fool!
Tectona Tip: There is a sinister flip side to this coin: your sales team might quite possibly say to you “we must reduce our prices to get business”. Before you do anything – THINK!
If you are making a 15% gross profit and you followed the advice of your sales team and reduced prices by, say, 5% – then you would have to sell 50% – YES, that is 50% – more stuff (units/hours etc.) just to stand still. Have we got your attention now??
Click here to read the full article about the mathematics of both raising and discounting your pricing.
And click here to download our handy laminate showing the numbers for your business.
If this is all meaningless gobbledegook or you see this as nothing more than a theoretical exercise – please think again.
You simply must understand this dynamic and how it affects your business – especially if you are contemplating reducing prices.
Tectona Partnership helps business owners sleep at night by embedding one of our 17 commercially minded finance directors in your management team.
Very often, a part time finance director is the most effective solution.
We make sure you have the necessary management information and strategic insight to make informed decisions and reduce risk; and we will absolutely tell you what you need to know, when you need to know it.