Say your organization needs 40 percent gross profit margin to operate. And imagine you want to run a 10 percent discount special to push through some year end deals. Do you know how much you’d need to increase your sales to make up for the discounting? A whopping 33.3percent. “In other words, you have to increase sales revenue by one-third to maintain the same 40 percent gross margin that you had before,” explains corporate strategist Graham Foster in his book, The Power of Positive Profit (John Wiley & Sons, 2007). “Why would you want to work 33.3 percent harder for nothing?”
Here’s another example from Foster that underscores the enormous impact discounting has on a company’s bottom line: If a $100 million organization on 40 percent margin typically foregoes 20 percent through discounts, it should be doing $120 million. And 40 percent of that missing $20 million is $8 million, which means the company is losing out on $8 million in net profit through its discounting practices. But how do you reverse that trend, particularly if your sales strategy has long relied on discounts to close sales? Foster offers these ideas to get you started:
1. Educate your reps on the bottom-line impact of discounting. In most cases, salespeople don’t know how their discounts affect the company. Salespeople are trained to make sales and they typically view any sale as a good sale. When you show them the numbers (how discounts at each level affect profits and margins) and the implications (smaller bonuses, lack of budget for new equipment, etc.) they’ll think about pricing in a whole new light.
2. Update the compensation plan to maximize profits instead of volume. Switch the plan to a margin basis, or at least a blend of volume and margin, to counter the discounters on your team.
3. Require that all daily transactions pass the average margin test and contribute to the bottom line. “Manage by exception in this area,” cautions Foster. “Require that any transaction priced below the budgeted company margin must be approved and signed off.” Then have a margin catch-up plan to recover those losses.
4. Document favors in a logbook so you’ve got a written record of the value you provide and use it to justify your higher, undiscounted prices. Customers will pay more if they understand you bring certain value to the deal. Foster tells the story of a world-class chemicals supplier who lost a big account to a discounting competitor. When the client called his new supplier late on a Saturday night with an urgent request, the discounter was nowhere to be found. Desperate, the client called his former vendor, the world-class supplier. The sales rep took the call, got out of bed, opened the warehouse, and drove two drums of the needed chemicals 100 miles away. Not surprisingly, the rep soon had his big client back and happy to pay the higher prices.
5. “C” customers pay in full. By now you know the theory – every company has A, B, and C customers. Your A customers are the big, top tier customers who make up the bulk of your revenues. On the other end of the spectrum are your C customers, the ones who demand deep discounts, overload your service department, and pay their accounts as late as possible. Starting now put all your Cs on full list price with no discounts. When your reps complain that they’ll lose these customers, show them it’s a good thing: if you lost most of your Cs, your bottom line would improve.
In conclusion, keep in mind that Foster isn’t saying you should never discount. Certainly there are, and always will be, occasions when it is appropriate. The message here is to be aware of how discounting affects your margins and net profit, and to make your discounting decisions with that knowledge rather than with a simple desire to close the sale.