Unmasking the Gremlin: The Impact of Discounting 

Discounting often hides its true impact on the profitability of business, deceiving many into believing it's a simple reduction in sales price, and is “only costing 10%”. However, beneath the surface lies a more serious consequence: a substantial dent in profits. 

Consider this scenario: 

You purchase an item for R60 and sell it for R100, yielding a profit of R40. 

Now, introduce a 10% discount. 

The common misconception is to think the loss is merely R10. But, that R10 isn’t subtracted from the R100 sale price but from your profit. Thus, your profit dwindles to R30, while the cost remains R60. A 10% price cut translates to a 25% profit reduction!! The cost to you is not 10%, but 25%!! 

This fundamental misunderstanding catches many off guard. They do not realise how much discounting is actually costing them and the actual impact that it is having on their profit margin. 

But suppose you're aware of this profit hit and still opt to discount to spur sales. Is this a good idea? To answer this question let's delve into the repercussions of your proposed sale discounting strategy, so that you can answer your own question. 

If you have a 30% gross profit margin, reducing prices by just 10%, necessitates selling 50% more units to sustain the same profit level as pre-discount. The lower your margin the more you will have to sell – see table below to work out how much more you need to sell. 

Remember to take into account  the added expenses associated with scaling sales – increased cash flow for inventory; increased stock holding which requires more space, personal for handling the increased volumes as well as an increase in risk of damages and stock loss. 

These expenses drive up your overall costs. So, is discounting truly worthwhile?  

But what about “Loss Leaders” you might argue 

Many champion loss leading as a primary discounting strategy—a tactic wherein you sacrifice short-term profit to acquire new customers, for long term profits. 

Well again you are going to have to weigh up the cost of acquiring these new customers versus what you can expect to get back from them, after all marketing in maths – the cost of acquiring your customer versus the return on this investment. 

To answer this question you need to know, no only how much the discounting strategy is costing you, but also what on average a customer is worth to you, immediately and over the lifetime of the customer. From there you can calculate how many new customers justify the cost of acquiring them.  

Also, what's the actual value of each loss leader customer? Could discounting attract bargain hunters who spend sparingly, rather than loyal, high-value customers? 

Calculating Lifetime Value of a Customer  

Calculating the lifetime value (LTV) of clients involves estimating the total revenue a customer will generate for your business throughout their entire relationship with you. The formula for calculating LTV can vary depending on the business model and specific factors you want to consider, but a basic formula often used is: 

Where: 

• ARPU is the Average Revenue Per User (or Average Revenue Per Unit, depending on your business model). 
• N is the average number of months (or years) a customer continues to purchase from you. 
• CR is the Customer Retention Rate (expressed as a decimal). 

Here’s a story that further brings this point home.  

This is a real life example of one of our coaches, who had a gumball machine at one of his restaurants.  

Initially, it accepted R2 coins. When you couldnt put it off any longer due to the increase in cost price of gum balls, he upgraded the machine to accept R5 coins. 

The outcome? A notable drop in c customer count. However because of the increase in profit margin the machines profits increased substantially.  

So be aware of the discounting gremlin—it seldom yields favorable returns. It can very quickly eat into your profits, drive up costs and attract the wrong target market. Remember you are in business to make a profit, not to increase sales.