David Brown: Discount Costs

That little price cut means a lot to your bottom line.

BY DAVID BROWN

Published in the Febuary 2014 issue.

Getting asked for a discount is a way of life with retail. There doesn’t seem to be an easy way to avoid it with Internet-savvy shoppers becoming more knowledgeable and seemingly much better at negotiating than they were just a few years ago.

It’s worth taking a few minutes, however, just to think about the impact taking a few dollars off your sale can have on the bottom line.

Let’s say you’re selling a ring for $1,000 that has keystone on it — we’re talking a cost price to you of $500. If you sell it for full price your margin is 50 percent (($1,000 – $500) ÷ 1,000).

So far so good. So what if the buyer beats you down to $900? Margin will now drop to 44 percent (($900 – $500) ÷ 900).

Your 10 percent price cut (from $1,000 to $900) will have resulted in a 12 percent reduction in margin ((50% – 44%) ÷ 50%). If you reduce the price to $800 then the margin will drop to 37.5 percent (($800 – $500) ÷ 800), an overall reduction in margin of 25 percent on a price drop of 20 percent.

Obviously the drop in price has a far greater reduction in the profitability of each sale. Why? Because while the price is dropping, the cost of buying the item is unchanged, so a $1 drop in price has less affect on the selling price than it does in the gross profit which also loses $1.

So what if we bring expenses into the equation? Let’s say the average business makes a profit of 20 percent on its annual sales figure without discounting (if it can avoid it). That’s $200 profit after expenses for every $1,000 of sales. If the store averages a discount of 10 percent on all sales during the year it will effectively be halving its annual profit. That $100 discount on each $1,000 of sales will come straight off the bottom line meaning the profit will shrink from 20 percent to 10 percent — or effectively half what it was.

There is no cost savings from discounting. It doesn’t reduce the cost of buying that item. It doesn’t lower your wage bill or reduce your utilities. There is no offsetting reduction in marketing costs to compensate. By and large you wear that cost of the discount entirely on your own. Think about that the next time a customer asks, “Is that the best you can do?”