Business: “The Destructive Power Of Discounting” by Alan Goswell

THE DESTRUCTIVE POWER OF DISCOUNTING

Part of my role as a freelancer is to manage a small ad sales team for a local publisher. We recently took on a new sales guy who had significant experience in the industry.  However, an incident left me thinking more about discounting and it’s destructive powers.

The incident in question was noting that a competing publication had ‘gone under’, and whether we should offer a 50% discount to tempt their advertisers to our publication. On the face of it, this would seem like a sensible response, after all, we’d increase our client portfolio, and thus revenue. But when you dig deeper, the idea is so wrong on so many levels.

Firstly, these potential clients clearly value print advertising, and they relied on the competitor’s publication to get their message ‘out there’. Now, their chosen medium no longer exists. However, the need to get their message out  won’t have gone away. In fact, they’ll be feeling some pain and panicking.  The correct response is probably the first rule of selling – just show up!  Then take them through how our publication can meet their needs, thus solving their pain instantly. As for pricing, this should be a hygiene factor not a sales driving factor!

Secondly, what does 50% discount really mean in financial terms. To work this out, we need to look at incremental sales, margin and net profit.  Consider the following table which shows a standard P&L, then the incremental discounted sales etc, and then the new totals…

Monthly

Current

Incremental

Future

Sales

100,000

20,000

120,000

Cost of Sales

50,000

20,000

70,000

Gross Profit

50,000

0

50,000

Gross Margin

50%

0%

42%

Overheads

40,000

0

40,000

Net Profit

10,000

0

10,000

ROS%

10%

0%

8%

The incremental sales yield no incremental profit nor margin. Why? Because it was all given away to get the new clients on board.  Return on sales dropped 2%. Ever slimmer net profits eventually leads to losses, and for what… just to buy business which the sales team should be closing anyway.

The next problem is that in a perfect market (and advertising is close to perfect in that pricing and competition is fairly open), these price expectations filter through to existing customers who will now expect the same lower level of pricing.  Effectively, by buying the revenue, you diminish the market.  Let’s consider the same P&L, but show what happens if we discount existing sales by 10% (Assuming we’ve managed to get the sales team to talk their way out of the 50% hole).

Monthly

Current

Incremental

Current disc by 10%

Incremental plus new pricing

Sales

100,000

20,000

90,000

110,000

Cost of Sales

50,000

20,000

50,000

70,000

Gross Profit

50,000

0

40,000

40,000

Gross Margin

50%

0%

44%

36%

Overheads

40,000

0

40,000

40,000

Net Profit

10,000

0

0

0

ROS%

10%

0%

0%

0%

The sales team would be patting themselves on the back for increasing sales by 10% (“pretty good considering the economic crisis”), but in fact they’ve put the whole comapny out of work, and destroyed the market value in the process.  Pretty destructive if you ask me!

At the end of the day, your product has value that can be measured in so many more ways than the price.  Good sales people (and if you are a sole trader that means you), will talk about price last.  They focus on understanding the clients needs, and their pains, matching goods and services to those needs and solving those pains, and ascribing a fair value to that (the selling price).  In most cases, the price becomes irrelevant so long as you aren’t perceived to being greedy.

So next time you think “10% should just swing it”, stop being lazy and doing yourself and your company a disservice. Talk up the value of what your offering and demand a fair price in return!

Alan Goswell

alan g