If there’s one piece of advice I’d offer to any entrepreneur starting out, it’s this: Never discount—no matter how much you may be tempted to— always look instead to add value.
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Many seasoned entrepreneurs discount as a way of doing business, without ever really looking at their numbers or the real costs of cutting their prices. They’ll point to “discount” success stories like Wal-Mart or complain that the competitive landscape forces them to cut prices. While Wal-Mart, one of the great retail success stories of all time, has built its brand on low prices, most business owners don’t see the very real distinction between “low price” and “discount.”
First off, a company like Wal-Mart knows every margin to the “nth” degree and can deliver low prices because it has created scalability based on the huge volume of products it sells. But very few companies have such pricing power. Unless you do, there are better ways to play the retail game than looking to compete against Wal-Mart.
If you don’t really know your margins or have any scalability on the cost side, straight discounts are a ticket to disaster, not only in terms of finances but also in people costs. In a discount environment, you are essentially setting your team up to work more for less money.
Here’s how …
Let’s say you’re selling a widget for $10 a unit, and your net cost is $7. Your net profit on each widget sold would be $3. If you sold 10 widgets at full price, your net profit would be $30.
Now let’s say you decide to have a sale with a 10% discount offer. After selling 10 widgets at $9, you have revenue of $90. The net cost for widgets remains constant at $70, but your net profit has decreased to $20.
That doesn’t seem too bad. Until we realize we need to sell 50% more widgets just to keep our profit dollars even, at $30.
Take a look: 15 units X $9 = $135
$135 - $105 = $30 profit
The numbers look worse the more we discount. At a 15% discount, we’d have to sell 100% moreunits (a total of 20 widgets) to keep our profits at $30:
20 units X $8.50 = $170
$170 - $140 = $30 profit
Would you really want to run a company where the pressure is on day-to-day to sell 100% more units just to stay even?
Now you can start to see why failure rates of businesses that continually discount are so high and why the burnout rates of their owners are equally bad.
Playing the discount game means you’re literally going into your company everyday to price yourself right out of business.
So what’s the solution?
1. Know your numbers and margins and protect your margins at all “cost.” This simply means you need to know your cost basis at every level of your company and look to lower it where you can. Then, at least, if you decide to offer a price incentive, you’re not cutting your own throat to do it.
2. Add to your value proposition at every opportunity. While you shouldn’t discount, you should always look to add value, both real and perceived. That could mean bundling options or packages, or it could mean a better customer service experience. People are more willing to pay for good service these days than ever before.
3. Develop a growth rather than discount mindset. The reality for any business is that you won’t ever be able to cut your way to success. You can cut costs only so far before some aspect of the business suffers. Growth is really your only option. So start to think of ways you can leverage your current resources in new or innovative ways. Reposition products or services, for example, with a private label at a higher price point.
Whatever you do, think twice about the ramifications of running a 10% off sale, unless you got a really great deal on your inventory. Just remember that “small” 10% discount means someone in your organization has to work 50% harder to earn the company the same dollars. At least in the beginning, that person will most likely be you.
Don’t fall into the trap of thinking if you don’t give discounts, you’ll lose sales. Look to add value and deliver an incredible experience for your customers. You’ll discover new ways to increase profits, while others find themselves caught in the discount trap -- and soon out of business.