The dangers of discounting
You might think that offering discounts is a great strategy to use when sales are falling. In reality, you’re likely to be more profitable by holding your price and accepting the reduction in sales volume than discounting a product.
Here’s an example to show the difference in your gross profit if you discount your selling price by 10 percent compared to holding the price at $100 and accepting a 10 percent reduction in sales volume.
If sales are currently at 10,000 per annum at $100 per unit, your sales will be $1,000,000. With costs of $60 per unit, your gross profit is $400,000. Dropping the selling price by 10 percent might mean sales remain constant at 10,000 with a selling price of $90 per unit, so you’ll achieve $900,000 in sales. Costs remain at $60 per unit, so your gross profit will be $300,000.
If you were to accept the 10 percent drop in sales but hold your price at $100 per unit, your sales revenue will still be $900,000, but you’ll only have to pay for 9,000 units, so your gross profit will be $360,000.
In other words, holding your price and accepting the drop in sales results in a reduction in gross profit of $40,000 compared to a $100,000 reduction if you offered a 10 percent discount.
If you look at it another way, you can work out the increase in sales needed to maintain your original $400,000 gross profit if you offer a 10 percent discount. To calculate the increase in sales required, first calculate the gross profit for each unit: $90 selling price – $60 cost per unit = $30 gross profit per unit. This gives us a gross profit percentage of 33.33 percent ($30 gross profit / $90 selling price * 100).
To calculate the required increase in sales, multiply the previous sales volume figure by the gross profit percentage. To maintain your $400,000 gross profit, you’ll have to sell 13,333 units (10,000 units * 133 percent).
Discounting is simply not the answer – it’s a race to the bottom! Look for other alternatives to respond to a drop in sales – starting with what you can do to delight your customers so they keep coming back!
If you’re experiencing a drop in sales, get in touch so we can work with you to identify the reasons for this and explore alternatives to offering a discount.