Archive for the ‘Pricing Strategies’ Category

Value Attribution – The Discount Deception

by Victor Antonio

Victor Antonio Value Centric Selling Sales consultant and trainer, atlanta georgiaUniversity of Ohio did an interesting study that I thought you might find interesting especially if you’re a proponent of giving product or service discounts.  The school had a theatre department that sold season passes for 10 shows that were put on during the semester.  The folks at the university wanted to test the effect of discounted ticket prices on the show’s attendance for that particular semester.

When a person approached about buying season tickets for $15, they were offer one of three types of season passes.  Out of the 60 students in the test group, one group was sold a season pass at full price.  The second and third groups were sold season passes with a discount of $2 and $7, respectively.  The two groups receiving the discounted passes were told they were receiving a promotion discount from the theatre company.  All three groups had access to good seats.

The folks at the University wanted to see if offering discounted passes as opposed to full price passes would make a difference in the attendance for the ten shows.  The results would be as one might expect.  Those who paid full price showed up more often than those who received discount passes.  Now on first glance you might attribute this attendance effect to sunk cost; those who paid full price wanted to recoup their investment (i.e., get the most out of their passes by going to the performances) after having spent $15.

The proverbial fly in the empirical ointment was that those who received the $2 and $7 discount missed equally as many performances.  If the sunk cost was truly in effect, those who only received a $2 discount should’ve attended a few more shows than the group who received a $7 discount.  But that didn’t happen.

What happened is something called Value Attribution; which simply means the inclination to superimpose or imbue a thing with certain qualities or characteristics based on our initial perception.    Our initial impression of a thing causes us to view that very thing in such a way that is consistent with our initial impression.  Simply stated in the case of the discounted season passes, if it’s a cheap ticket, then it must be a cheap show.  Therefore, buying something cheap causes us to devalue or view the object as having little to no value.

In selling the tendency sometimes is to provide the client a hefty discount as an inducement to buy our product.  But given the University of Ohio’s study I think it’s worth pausing for a moment to reflect on how the buyer might view your proposal.  We’ve all been in a situation when someone offers us such a good deal that we wonder, ‘What’s wrong with this picture?’  So it should come as no surprise that your buyer upon receiving a very low price (big discount) may think, ‘Why are they selling it so cheap?  What’s wrong with it?’   Even if the buyer does make the purchase, they may choose not to use it thinking it’s not worth much since the price was so low.

For example, I remember buying a leather jacket that was selling for only $55.  At the time I wondered why it was so inexpensive.  Was it the quality?  Something must be wrong with it!  Whatever the reason, the result was that I hardly used the jacket and after a few months I decided to donate it to Goodwill.  What happenned?  From the very moment I made the purchase, I had already devalued the jacket in my mind.  That perceived devaluation guided my behavior in such a way that I never used the jacket.  Now imagine how my attitude, hence my behavior, towards the jacket would’ve been different if I had paid $250.  I’m sure I would’ve used it more often and it would probably still be hanging in my closet today.

Buying something at a price that’s too good to be true may setup in the buyer’s mind a discount deception.  Just like the season ticket pass holders (or my leather jacket), the buyer may choose not to use the product even after the purchase (i.e., devaluing the item from the beginning).

Value attribution is about controlling perception and the last thing you want is a buyer to associate you (or your company) with selling cheap products or services.  The unintended consequence of heavily discounting a product may be that the buyer, sensing little value, chooses not to buy any other products in the future.  Be careful!


A Freebie By Any Other Name is a Discount

by Victor Antonio

Victor Antonio Value Centric Selling Sales consultant and trainer, atlanta georgiaIn every exchange of commerce there is a mental buyer and a mental seller.  If a salesperson tries to sway his client to buy the product, than the salesperson is really the seller.  But if the buyer convinces the salesperson that, ‘Now is not a good time’ Or ‘Let me think about it and get back to you’ then the salesperson has been sold by the buyer on the fact that they can’t buy.  The buyer has sold the salesperson on his or her inability to make a decision.  And if the salesperson accepts that position, then the salesperson has been sold.  An ironic point of view don’t you think?

Taking it one step further, if a buyer convinces that salesperson that he should get a better price, then the buyer has sold the salesperson on the fact that his money has more value than the seller’s product.   When a seller can only close a deal on price, then it is almost with certainty that the seller has been outsold by the buyer.

A discount is proof of ineffectual selling; proof that a some sort of sales injustice has been committed.  The heftier the discount the bigger the crime.  Ideally, for a true value centric salesperson, a discount is the nuclear option; used only in cases of extreme emergency when all other options for closing the deal have been exhausted, including the sale of value first.  Then and only then should a discount be used to close the deal.

When we think of a price discount we typically think in terms of how much the price was reduced; by what percentage.  But discounts come in many different forms.  And sometimes these alternative discount methods are not categorized as such, which is why they’re overlooked or ignored but the impact on the bottom line is just as deleterious as if an actual discount were granted to a client.

real cost of discounting price

Not Really!

Clients like to ask for ‘goodies’ when they buy our product or a service.  There’s often an entitlement mentality on behalf of the client who asks and ‘expects’ the salesperson to sweeten the pot with a few extras if they want the order.   From a sales perspective the request may seem harmless, but the impact the company is anything but nonetheless.

Discount alternatives come in all shapes and sizes which is why we need to be aware of what they are and how they impact the company’s bottom line.   Here are a few discount alternatives to put on your radar:

  • Free Training and Resources:  By offering free training, you company has to absorb the cost associated with training your clients at no cost.  The facility cost where the training will be held, the cost of the instructor, the cost of the material produced and to top it off, the opportunity cost of doing free training instead of working on something else that could drive revenue.
  • Free Online or Phone Support: The personnel required to answer the phone and provide client support is another cost that reduces margin.  The cost of a maintaining a phone system and creating an online support system which my have to be integrate with the company’s existing Customer Relationship Management (CRM) or other client maintenance database system will add to the cost.
  • Extended payment terms or Financing:  By deferring when the company gets paid, the opportunity to use that cash flow to either earn interest or utilized for other expansion projects will cost the company money.  By not having cash on hand, the company might have to tap into the line of credit at a higher interest rate.
  • Multi-year Contract with Price Discounts:  By offering the client a price sliding scale over a given period of time only serves to exert more pressure on the company to maintain the necessary margins to make the business line or product profitable.
  • Volume purchases with volume discount levels: Given discounts based on a high volume purchase assumes that the direct cost with manufacturing a product will not go up. False.  Driving more volume through the factory impacts production time, increase material demands and requires more man-hours to meet the demand.  These are just some of the direct costs associate d with higher volumes.  To discount for higher quantities only serves to exacerbate the pressure on maintaining good product margins.
  • Free product or software upgrades: All product (software) upgrades cost time and money to create.  Giving away upgrades may be impacting your margins more than you think.  Although the developer can rationalize that the cost of the upgrades will be spread across a larger client base and will therefore be minimal is a legitimate way of thinking.  But when you start adding up a lot of ‘minimals’, over time they don’t become so minimal.
  • Zero Inventory:  Offering to carry inventory for the client ties up your company’s money.  Slow inventory turns impact cash flow and uses up valuable inventory space.  Salespeople need to see every product on the shelf as a stack of dollar bills with a ‘do not touch or use me until sold’ sign to really understand how high inventory equates to a warehouse of stored money that can be use and loses value every day it sits on the shelf.  A client’s value, or perception, of a product goes down over time. The longer you hold the product the less likely it is the client will pay you what you original asked for.

A Value Centric mindset requires salespeople to start thinking about discounts not only as a percentage of a price, but also becoming aware that giving away free services or extending payment terms is another form of discounting.  And whether it’s a price discount or some sort of free deal, all contribute negatively to the company’s cash flow and margins.

Categories: Pricing Strategies

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