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Morris Kaplan
Smarter Writer

Morris Kaplan is a former finance and venture capitalist who writes for entrepreneurs and professional services firms

Morris Kaplan
Smarter Writer

Morris Kaplan is a former finance and venture capitalist who writes for entrepreneurs and professional services firms

Why slashing your price tickets isn't a good long-term strategy for your business.

Discounting can be dangerous to the financial health of a business. Discounting isn’t generally a wise long-term strategy. If your strategy is to win new business by being the cheapest, you only have the advantage until a competitor reduces their price to be less than yours. It is not sustainable unless you have a cost advantage over your competitors, and your product or service is very sensitive to price changes.

Many people don’t realise the extent of the volume increases they need to compensate to make up for discounting. It doesn’t take a complicated financial analysis to see how much your volume needs to increase by to achieve the same amount of profit when you reduce price tags. Typically, if your gross margin is 30% and you discount price by 10%, your volume needs to increase by 50% just to retain your starting profit. Most businesses will find discounting is a valid strategy to clear old inventory, to stimulate slow sales periods or to entice new customers, but not as a general strategy.

cartoon discount tags

Buying on value

People do not buy on price. They buy on perception of value.

Marketing guru Dan Kennedy in his ‘Magnetic Marketing’ package says that one of the most important skills a small business owner can learn is to create ‘widgets’: the things you can do to add value to a product or service to change the way it is perceived in the marketplace.

A good place to start when figuring out your widgets is to ask the question: “What is it that everyone dislikes about doing business with any operator in my industry?”

Let's look at the plumbing industry for example, everyone hates being bumped by plumbers who don't show. A plumbing business could boost their reputation and customer wins and promote themselves with a rock-solid guarantee of service to actually turn up at the agreed time. If your serviceman does run late, send a text message and give your client a call to notify them of the situation with an estimated arrival time. The level of customer service you provide will be appreciated compared to the offerings of your competitors.

Understand your numbers

  1. Overall profit margin
  2. Cost of every product
  3. Volume of each product

Other considerations

  1. In terms of good management and especially in terms of managing for growth, it is an imperative to know how much an individual product may be contributing to the business bottom line. This should raise crucial questions for growing revenues.
  2. By knowing overhead costs and the profit margin you want to achieve, you can determine the level of sales required. For best control, you should break that down so you know the sales you need to achieve each day.

Cutting costs can hurt 

When things are tight people look at how to reduce costs, but they should always be careful about cuttings costs that could be detrimental to the business such as marketing spend and material, and display props.

For example, a poorly managed café cuts their costs by cutting back on the quality and range of food that is displayed in a glass cabinet and countertop. But to a potential customer, the downgraded visual display actually makes the food look unappetising. Rather than growing revenues, they lose potential sales.

It’s the role of the business owner to develop financial skills as intuitive systems so knowing the rate for which you can slash costs or apply discounts can be worked out quickly. Make it easier for yourself and invest in a customisable accounting system, which could help keep track of records, cash flow management, understand the relationship between costs and sales, and identify where expenses can be reduced.

Growing revenue

It all boils down to a four-pronged approach.

  1. More customers
  2. Sell more to each customer
  3. Increase frequency of visits
  4. Bigger profit margins

Verdict

This is not to say that cost cutting or discounting has no place in business. They certainly do. If, for example, you were able to secure a discount from your supplier by prompt payment or by a larger order, then you have capacity in your gross margin to apply a discount without suffering the consequences outlined earlier.

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