In the course of marketing strategies, some small businesses may consider reducing prices or offering a discount as a sales incentive. Two critical questions come to mind.
- Will lowering the price drive enough sales to make up for the loss of income due to the reduction?
- Will the current operational structure support the increase in volume of sales driven by discounting?
When adopting a price incentive strategy, it is important to understand the variables in profitability and how that impacts on the actual dollars earned. Whether you offer a discount or reduced price, the profit earned will be directly reduced dollar for dollar.
To off-set the dramatic sales volume increases required to top up the dollars lost due to the discount, it is advisable to identify ways to reduce the cost of goods sold. Ideally, the offer of any price incentives directly reflects new found efficiencies within the business operation.
In managing the loss of net profit due to a reduced selling price, it is valuable to understand the volume of sales increase necessary to replace the lost income. An essential question inquires how much more work must be done in order to, at the very least, maintain the same dollar for dollar income?
FACT: When the cost of goods sold remains the same, a 20% reduction to the selling price means a 400% increase in volume of sales will be required to make-up the shortage inherent in the loss of income dollars.
The following table serves as a guide for evaluating your revenue impact.
|Discount offered||Retention||Percentage to raise Sales||Actual Unit sales Req|
|3%||100%||13.6 % more volume||100 TO 114 UNITS|
|5%||100%||25.0% more volume||100 TO 125 UNITS|
|10%||100%||67.0% more volume||100 TO 167 UNITS|
|15%||100%||150.0% more volume||100 TO 250 UNITS|
|20% reduction||100%||400.0% more volume||100 TO 500 UNITS|
Confused? It is a mathematical reality.
To aid in explanation, a ‘unit’ may represent an hour of time or a table centrepiece or service for which a selling price is assigned. The selling price includes the cost of the unit as well as the income to be earned by providing that ‘unit’ of product or service.
This part is simple. The selling price of each unit is $100.00 with the Cost of Goods Sold (CGS) being $75. The earned income of $25 represents the actual value of a 25% profit found in the $100 selling price. This $25 may also be expressed as a 34% Mark-up (MU) on the $75 Cost of Goods Sold(CGS)
How does a 10% discount or a new selling price of $90.00 impact on the earnings outcome?
50 units cost $75 ($,3500) with 34% MU (= $100 SP) earns $25 per unit = $1,250 earned
50 units cost $75 ($3,500) with 20% MU (=$ 90 SP) earns $15 per unit = $ 750 earned
Offering a 10% discount on the selling price results in a 14% loss of Mark-Up revenues or $ 500 less for the same expenditure.
How many extra units must be sold to maintain the original earnings of $ 1,250?
The $500 loss divided by $15 income earned per unit = 33 units sold to earn $495.
Accounting for the original 50 units plus the additional 33, a total of 88 units would need to be sold to earn $1,250 dollars at a $90 selling price. These 33 units represent a 67% increase in overall sales volume. Can your existing operation support this volume increase?
Let us not forget that the sale of 88 units at full price would net an income of (88 units x$25) $2,200. With numbers like this, a strong case can be made for holding your prices and offering an increased value-proposition that does not impact the original cost of goods sold. The effort to sell 67% more units could be well re-directed towards adding 67% greater ‘perceived’ value in your business service through increased customer service and efficiency.
No doubt, some small event businesses may find a discounting incentive strategy is viable for them. However, it may not be suited to all service operations.