A common thought among most business owners is that if you want to increase sales volume and increase profits, you should lower your price or offer discounts. That type of thinking and strategy could not be further from the truth. While sales volume could occasionally increase with discounting, it very rarely leads to increased profits. More times than not, it will substantially decrease the profits of a business without the owner realizing what’s happening until it’s too late.
Case in point was JC Penney back in 2012. New CEO Ron Johnson had eliminated the occasional sales and promotion model and moved to the everyday low price strategy. The hope being that it would simplify the marketing and drive customers through the doors on a regular basis, thus increasing sales volume and profits.
Results of Discount Pricing
The strategy backfired and JC Penney lost $3.3 billion in sales in the first year of Johnson’s turnaround plan. Its net loss in the quarter ending Feb 2, 2013 widened to $552 million from $87 million a year earlier. Annual revenue slid 25% to $13 billion, the lowest since at least 1987.
If a multi-billion dollar retailer can’t make a low price strategy work, how do you think the everyday small business can?
Many businesses work on the principle that when you discount, you will make less profit but the increase in sales volume will make up for it. Maybe that is so, but you better make sure you know what that increase in volume needs to be, otherwise you are setting yourself up for a loss.
Here is a before and after sales forecast showing what effect discounting will have on gross profit and what sales volume increase is needed to achieve the same profitability prior to the discount.
Here is the price, cost of goods and gross profit of a product based on a sales volume of 100 units.
Here is the same product but with a discounted price of 20% from the original sales price of $130.
Notice the severe drop in gross profit after the discount. In order to make up for that decrease in gross profit, sales volume would need to increase by 750% just to achieve the same gross profit as before the discount! Can you imagine trying to increase sales volume by that much to make up for that loss in gross profit?
Now, you may say to yourself that with the anticipated rise in sales volume you could potentially get a lower cost of goods (volume discount). That may be so, but in order to increase that sales volume, you would most likely need to increase marketing costs and other expenses, such as payroll to hire more people to accommodate for the increased workload. These added expenses will most like negate any decrease in the cost of goods.
How Do You Increase Profits?
So how do you increase the profitability of your business if discounting isn’t the answer? First off, I didn’t say, “never discount.” You just need to know how it will affect the profitability of your business and what type of increase in volume you need to achieve.
However, before reaching for any discounting strategy, you will want to develop other marketing strategies that will have a much more positive effect on profits. One of those strategies is value based pricing.
Value based pricing is an age old way of determining the value that your product or service brings to the market that most businesses have strayed from over the last several decades. This is a pricing strategy that the majority of century old businesses implement, which every business should understand and utilize.
Click back here next month as I illustrate how to determine the correct price for your product or service and see how it will increase the profits of your business with this “simple” correction.