In the 100+ conversations we have with clients each month, we frequently hear them say, “We’re having to discount more, to respond to poor trading” or “we want to reduce discounting”.
Let’s be clear – discounting is a choice. And at the right level, it’s a sensible, rational choice that can lead to greater profits. But at the wrong level, the retailer becomes a hostage to discounting, damaging not just their margin but their brand equity, future profits and enterprise value.
How does this happen? Let’s take a look at the choices that retailers face in an ever-competitive environment.
Discounting at the right level
As a tool, discounting can make you more money and free up working capital from your stock to re-invest in the business. The basic equation is:
Actual £ gross margin achieved on the discounted order
Marketing cost to generate the order (variable cost to pick, pack and ship the order)
£ contribution to overheads.
Compare this to a ‘full price’ order, and if your discounting results in a greater contribution to your overheads, it is a sensible decision. This is because the increased response/conversion rates reduce the marketing cost per order.
Do the math, by asking yourself: ‘Does my cost of marketing reduce more than my £ GM decreases?’ In essence – is the discount a profit contributor, or not?
Discounting at the wrong level
From your calculations, according to the equation above, if you are discounting without it driving an incremental contribution – that is, when your return does not cover your costs and make a profit – you are clearly discounting at the wrong level.
Simple? In theory, perhaps. Of course, if it was this simple in practice, everyone would be doing it.
The complexity of this simple equation
The math is simple. Used discerningly, discounting is a tool to make marketing more efficient and shift products that are not sufficiently appealing to sell at full price. It is a simple, blunt tactic to drive operational efficiency.
But discounting goes wrong when:
- Aggressive sales targets are set without the necessary customer-based evidence that the targets can be hit. Therefore, stock has been purchased, and sales are discounted to liquidate the stock.
- Product / Proposition is not as compelling as it was in previous years.
- Marketing doesn’t hit the mark, in relation to appeal, pricing or contact strategy.
- Customers are trained to wait for a discount. This creates a ‘cycle of despair’ – when discounting beyond a point that is economically sensible becomes the answer to achieving the sales target (as illustrated below).
Once you’ve entered the Discounting Cycle of Despair, it is hard to get out of it without drastic action. Offering discounts with regularity trains customers to wait for and to expect further discounts. It becomes a game of brinkmanship. You believe that your product and brand is worth more than the customer has been trained to pay. Price and quality are largely perceptions, and repeated, relentless discounting is not just damaging your current gross margin, but your customer profitability in years to come. This is the hardest part of the Cycle to recover from.
Let’s be clear – your discounting actions today impacts on future customer profitability and your ability to trade at lower discounts in the future.
Getting it right
To recap: sensible and rational discounts can drive improved profitability – as long as the reduction in £ Gross Margin per order is more than compensated by a reduced marketing cost – and therefore more profit per order and customer (after marketing).
It goes wrong when sales budgets are incorrectly set and sales are ‘chased’ by discounting, at the expense of orders and customer profit. This process of unprofitable discounting sets customer expectations that are hard to change and so, the Cycle continues.
The key to success is a customer-centric plan
Budgets and targets need to be built by establishing what the existing customer base will deliver in revenue, and by the number of new customers the business can realistically acquire, correlated to the marketing, channel and product plans.
Unless you simply want growth at any cost, avoid benchmarking sales growth on a % basis against previous years. Start with the customer and you won’t go wrong… And measure everything by increments, not averages (i.e. identify the incremental cost and benefit of an activity or outcome).
To get out of this Cycle, your sales budget or short-term growth expectations may need to be reduced. This might be the right decision if your goal is medium-term sustainable growth and profit. Your alternative might be to spend more on marketing to counterbalance the effects of short-term reduced revenues.
Having a good stock disposal channel is critical in enabling you to confidently buy to your forecast without liquidating your stock at brand-damaging rates in the event of trading problems. As an example, you might consider selling through discount stores in other countries if it helps you to maintain margins with your core customer.
And of course, the most important enabler to changing your trading metrics is to improve your measurement. All too often, retailers measure in silos and normally at revenue rather than contribution level. Change your reporting to measure customer profitability, understand the drivers of this and make it someone’s responsibility.
All in all, stop peddling at a loss and put the brakes on the cycle of desperate discounting. Discount mindfully, with your eye on the prize, and you will speed your successful growth.