Home > Pricing Strategies > Discounting – A Primitive Sales Tool

Discounting – A Primitive Sales Tool

Victor Antonio Value Centric Selling Sales consultant and trainer, atlanta georgiaWhen you sell on price, sooner or later the client is going to ask for a discount.  It’s in their nature to do so.  Selling on price will always come down to who has the best comparable product and who can deliver the best prices.

Salespeople often focus on winning the deal, no matter the discount needed to win the deal.  Now, I’m not saying salespeople in general are reckless and will give the product away, but I’ve seen my fair share of scorched-earth policy of discounting.

Salespeople people who need discount approvals will go to management with all sorts of justifications and rationalizations:

  • We’re only going to discount the product this one time
  • Even if we break-even or lose a little money on this one, this product will get our foot in the door.
  • A variation of the previous justification is that the product is our ‘loss-leader’.  The goal is to upsell them or get them to buy our other products later.
  • If we get this client to buy our product, even at a loss, we can use this client to leverage others who are on the fence about buying (i.e., use this client as a reference).
  • I’m sure we’ll make the margins up in upgrades and maintenance fees.
  • If we don’t close this deal our competitors are likely to win the deal (do you want to win a deal or win an opportunity).

Salespeople will rationalize almost any excuse to close the deal, especially if they’re desperate and under a lot  of pressure to make quota.  To the average salesperson a discount on a product is no big deal.  In terms of making quota, if they discount this one deal they seek to make it up on another; so they hope.

If you win a deal due to heavy discounting, that’s not selling, that’s selling out!   Anyone can drop their price to win the deal.   Discounting is a surrogate tool devoid of intellectual capital (i.e., it doesn’t require talent or insight to lower your price).   Discounting is used by those who are incapable of selling or simply haven’t mastered the science and art of communicating the value of their product or service to the client.

One the biggest common sales misconception is that if I discount my products by 5% all I have to is sell 5% more to make up the difference.  In terms of absolute quota number that thinking would be correct.  In terms of direct cost, and how it impacts production and human resources in the organization, that thinking is absolutely wrong!

If were to follow the logic that if I lower my price, my customers would buy more, then that means that we’d have to build more widgets to keep up with this new discounted demand.  To keep up with this demand, this increase in volume means that more capital has to be invested to keep up with production and labor associated with manufacturing more these products will also increase.  Volume increases translate into more resources and capital having to be used to produce that added volume; direct cost goes up.

What salespeople don’t understand is that there isn’t a 1-to-1 relationship between price discount and net profits.  In other words, if I discount the product by 5% it will only impact the company’s bottom-line (net profit) by 5%.  That’s absolutely false!  The impact on the bottom line has a multiple effect.  To drive home the point, I’ve put together this financial model, for illustrative purposes only, to give you an idea of how discounting products has a multiple impact on the company’s net profit.

In this example, let’s say your sales quota is $100,000 a month.  During that month you discounted a few deals by an average of 30% to hit your goal.  Because you discounted your sales by 30%, your monthly sales figure was only $70,000  (B) against a quota of a $100,000.  The Direct Cost (D) associate with sales level at 100,000 and $70,000 is 50,000.  Which means that the company’s Gross Profits (E) went from $50,000 (A, D) to $20,000 (B, D).

Holding all Variable and Fixed Expenses (F) constant at $30,000, the company went from a Net Profit of $20,000 (G, A) to a loss of $10,000 (G, B).  That’s a $30,000 negative swing (i.e., from $20,000 to -$10,000) in cash flow for the company.  Multiply this number by the number of salespeople mimicking this discounting behavior and you’ll begin to see how this begins to impact the company as a whole.

From a sales stand, you may be thinking, all I have to do is sell 30% just to get back to my quota of $100,000.  If that’s what you’re thinking, you would be correct.  But you forgot to take into account the increase in Direct Cost (D) due to the increase sales volume.  Now, the Direct Cost for the increase in sales volume has move up from $50,000 (D, B) to $75,000 (D, C).   Which means that if you sold $100,000 at 30% discount, your Gross Profit would be $25,000 ($100,000 less $75,000) which translates to a loss of $5,000 ($25,000 less $30,000).

In order for you to get back to a Gross Profit of $50,000, you would have to increase your sales to $125,000 (C).  Which means that at a 30% discount on products, you would have to go from $70,000 in sales to $125,000 in sales in order for the company to get the same Net Profit (G) results (i.e., without discounting), you would have to increase your sales by 78% ($125,000 lies $70,000 divided by $70,000)  In short, a 30% discount requires that you sell  78%  if the company is to make the same Net Profit without discounting.

(A)List (B)Discount 30% (C)Sales Increase
Sales Volume 100,000 70,000 125,000
Direct Costs (D) 50,000 50,000 75,000
Gross Profit (E) 50,000 20,000 50,000
Variable & Fixed Expenses (F) 30,000 30,000 30,000
Net Profit (G) 20,000 (10,000) 20,000

Let’s take a look at how a 20% discount might affect the company’s Net Profit.  Notice that the Direct Cost went from $50,000 to $70,000.  Why $70,000?  Less volume would be required to meet the demand of products discounted at 20% as apposed to 30%.  Notice in this case the increase in sales needed to compensate for a 20% top-line discount is 56% ( $125, 000 – $80,000 divided by $80,000).

AList BDiscount 20% CSales Increase
Sales Volume 100,000 80,000 125,000
Direct Costs 50,000 50,000 70,000
Gross Profit 50,000 30,000 50,000
Variable & Fixed Expenses 30,000 30,000 30,000
Net Profit 20,000 0 20,000

To generate the same Net Profit by selling at a 10% discount, you would have to sell 28% more in sales ($115,000 – 90,000 divided by $90,000) will have to

AList BDiscount 10% CSales Increase
Sales Volume 100,000 90,000 115,000
Direct Costs 50,000 50,000 65,000
Gross Profit 50,000 40,000 50,000
Variable & Fixed Expenses 30,000 30,000 30,000
Net Profit 20,000 10,000 20,000

A seeming less harmless discount of 5% means the salesperson has to sell 15% more in order fort he company to gain the same profit margins.

AList BDiscount 5% CSales Increase
Sales Volume 100,000 95,000 110,000
Direct Costs 50,000 50,000 60,000
Gross Profit 50,000 45,000 50,000
Variable & Fixed Expenses 30,000 30,000 30,000
Net Profit 20,000 15,000 20,000

Numbers aside, the point of this exercise was to illustrate the following:

  • There is not a 1-to-1 relationship between discounted sales and the company’s net profit
  • Discounts increase Direct Costs and reduce a company’s Gross Profits through an increase in demand (i.e., more materials and/or labor required)
  • You have to sell a multiple more for every percentage given away

A good Rule of thumb that I use is the 5-15 percent rule.  For every 5% discount you give away, assume that you have to sell somewhere in the range of 15% or more in order for the company to maintain their profit margin.  This isn’t a hard and fast ratio as company costs and accounting practices may very from one company to the next.  But the point is clear; discounts increase costs that ripple throughout an organization.  Discounts affect costs at the manufacturing level, the human labor level or some form of indirect cost, discounting impacts a company’s profit and the impact is not proportional to the level of discounting given.

Finally, if every salesperson in a large organization adopted the mindset that discounting is the way to close more deals, I would imagine the increase in Direct Cost and both Fixed and Variable would increase steeply requiring the company to generate more sales just to achieve the same Net Profit.

Salespeople control the financial levers of a company.  They can do one of two things to help a company stay profitable:

  • Sales people can help a company by increase the number of deals they close without having to discount their product or service.  For example, commit to increasing future sales by 5% without discounting
  • You can also help your company out by committing to use the discount option less frequently and be more frugal in your discounts.  Commit to decreasing your discount levels by 5% for future sales.
Categories: Pricing Strategies
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