This is the second in a three-article series on business basics and digital advertising.
In this article, we will apply principles learned from our sales experience before and after launching our agency more than 15 years ago. We will include examples to explain the points raised.
Just because a discount can be done does not automatically make it a good idea. If an established business lowers their revenue stream from their everyday existing products or services without having a specific goal in mind, they may work harder, yet suffer a loss in revenue.
Point #1: Why / When to Discount
A good starting point is to take a high-level assessment of your business situation. Are your working with a new business launching a new product or service? Or a mature business with a specific, tactical goal you need to accomplish? Or something in between?
Example Business Situations
- Starting a new business to sell a product, a service or both
- Existing business needing to gain market share or launching a new product or new service territory
- Need to reduce excess or short-dated products, or utilize excess capacity
- Service business needing to get more leads to keep their employees busy during an annual slow season
- Mature business need to achieve a specific goal such as to increase Return on Ad Spend (ROAS) without lowering current sales volume.
- Promote a seasonal product or holiday
2 Key Initial Questions: What incremental activity or outcome is needed? What possible pitfalls that need to be avoided?
Point #2: What / How Much To Discount
- Dollars off are not always the only or best way to promote
- One key reason: discounting the selling price has a larger effect on gross profit, because selling price includes the cost of goods.
- Sometimes including a free related service or product with a required purchase has higher perceived value to a customer than a $ discount
- Calculate how existing sales volume and revenue will be impacted. More on this below.
- List what non-desired outcomes might be possible, and how to avoid or mitigate those.
How Much Does a 10% Discount Cost the Seller in profits? The answer depends on several factors: The overall cost for discounting a new product with no existing sales is less than the impact on existing product movement and its revenue. Refer to “The Calculation” section below that includes cost of goods.
Business Scenario: A mature snack food manufacture has a new product to launch and promote.
- Mature snack manufacturer with 10 current products (SKUs), and steady monthly wholesale sales of $100K (at full price).
- Manufacturer direct cost of goods and production is 50% of their selling price.
- Manufacturer is about to launch their 11th product (SKU).
- All their snack products are perishable, and have a 90-day shelf life before expiring.
- The manufacturer’s customer (distributors) put the product in retail stores.
- The distributors also pick up expired products from the stores, and “charge back” the manufacturer for products that are unsold and expired.
- Distributors will often aggressively “forward buy” at the end of a discount period, then buy less than normal in subsequent months. This pads their margins, but the manufacturer gets no benefit and some unwanted issues.
- Their distributor is requesting a “customary line drive of 10%, 30 days” for all 11 products, saying it will increase excitement and sell more product overall.
Manufacturer’s tactical goals
- Get shelf space for the new product in the stores
- Get existing and new retail customers to try the new product.
- Jump start sales by generating retail excitement and incremental displays.
Pitfalls to be Avoided
- Losing revenue on existing product orders, that the manufacturer would otherwise get at full price.
- Losing revenue on existing product orders after the promo, due to forward (discounted) buying from distributors near the end of the promo period.
- Increase in manufacturer charge backs from retail stores starting 90 days after the promo ends due to forward buying by distributors and resulting increase in stale products.
- Possible retail price and profit margin erosion on the existing line, due to discounting too frequently.
Simple Example of The Calculation:
The calculation needs to take the cost of goods into account.
How much does the proposed 10%, 30-day discount of the manufacturer’s full line of products affect their profits?
- $100,000 x .50 ( to cover cost of goods) = $50,000 gross profit per month at full price.
- 10% discount on $100,000 in product sales = $10,000 less revenue. So, before any incremental revenue, and with the 10% off the selling price, cost of goods stays the same, but gross profit is now $40,000.
- Stated another way, 10% of all existing sales in one month = 20% reduction in monthly Gross Profit, due to cost of goods.
To break even (get at least $50,000 in gross profit) at a 10% lower selling price requires the discounted promo to generate $125,000 ($25,000 or 25% more in increments sales volume) over the same period.
How much does discounting the single new product cost?
There are more variables here, but it the impact of discounting a new product is less. The difference is there is no existing revenue stream that gets discounted. Cost of goods still matter, but with a new product, it is important to jump start customer purchases. Especially on a product with a relatively short shelf life.
Existing products: No discount – it does not make sense to discount existing products just because a new product is being launched.
New product: Deeper discount than requested on the new product (that has no current volume). Make it 33% off or a BOGO rather than a mundane 10% that generates little excitement. This will hopefully show support for the new product to the distributor, and the discount is deep enough to get retailers to create a stack or endcap display. These help generate incremental volume needed.
TopSide Media’s Summary of Top 5 Steps
- Assess your business situation, and define the specific goal you need to accomplish
- Define the outcome(s) you want to avoid (pitfalls)
- Plan the sale / promotion to accomplish 1 and 2
- Execute the promotion
- Recap and document the results for future use
Our next blog post, part 3 of 3 in this series, will be on customer intent in search keywords, and custom intent audiences in display ads. If you have questions or experiences to share on discounting, please let us know.