Discounts are often misused, miscalculated and overvalued.
To get people into their product, many companies turn to discount pricing to increase acquisition. They think that they can raise prices later, once these customers see the value in the product. But you’ll see that rarely ever does happen.
After spending so much time perfecting your product and your pricing, you shouldn’t be using discounts as a “quick fix” to bump up your revenue. Let’s walk through some stats and understand why this is such a painful process.
In this article, we’ll discuss:
- Are discounts increasing sales, or should you better re-invest the otherwise lost margin into acquisition?
- How discounts hurt acquisition and make ROAS targets unachievable.
- What impact can discounts have on customer lifetime value?
- Considerations on when & how to use discounts
Are discounts eating into your margin?
Discounts are based on your sales price, not on your margin.
Let’s put this into perspective.
The higher your margin, the less relative impact a discount has on your margin. So if you margin is 75%, a 20% discount results in -27% margin.
On the other hand, if your margin is already low (especially prevalent in the F&B space), discounts could hurt you even more. If you’re struggling with 35% margins, a 20% discount means your margin now drops by -57%.
Here we see visually how discounts impact margins for a high margin product vs a low margin product.
There are times when top line (revenue) targets are more important than bottom line (profitability).
Like in the case of increasing cash flow by increasing acquisition of customers.
However, before pricing anything, calculate both revenue and margin for both scenarios – using vs not using a discount.
In the scenario when you DO USE A DISCOUNT, ask yourself: How much additional revenue and additional profit could you generate with this, compared to re-investing that margin in other growth activities?
Other things to consider are:
- Is your audience price sensitive?
- How regularly do you discount?
- What is the existing perception of your brand?
- Will this price drop affect the way you run future campaigns?
Can discounts increase sales enough to cover your lost margins?
There’s no question that discounts push sales.
But will the increased sales and higher conversion rate make up for the lost margin that you would otherwise have gotten, without this discount?
Often, the numbers don’t add up though. This is more painful for brands with weaker product economics. They require a much higher ROAS to break even on the margin.
There’s a simple test to know if discounting is right:
Will a discount result in a higher ROAS?
No? Don’t discount.
Yes? Calculate your increased ROAS target, based on your discounts and margins (not sales). Are you able to achieve that?
The long term impact of discounts
That said, even after knowing this, many brands still decide to ignore margins.
Just by looking from the surface, it seems that the aggressive sales tactic may be the better choice because they exceed their goal at the end of the quarter or holiday season.
However, limiting your view to only this small window of time means you miss the significant repercussions that are going to hit you right in the face like a freight train.
Lower willingness to pay
This is a psychological problem that’s very difficult to change once the perception is set.
1) The price has been anchored
Their price threshold is set so low that when the price is brought back up, customers face price sensitivity and are less likely to repurchase at full price.
2) You attract bargain hunters
Customers who want “cheap and good and fast” usually aren’t the best customers. While it’s true that a purchase is better than no purchase, they’re not going to stick around as much. These types of customers are usually hopping from brand to brand, in search for the cheapest alternatives without sticking to your recommendation. So they might not receive full value from your product. This is especially true for FMCG products.
Lower lifetime value (LTV)
Following the rise in price, rather than renewing their subscription or repurchasing the product, customers are more likely to churn. A higher churn rate means you have a large number of customers that you spend money to acquire, that don’t stay with you.
In such cases, you’re not growing your customer base very much month-on-month. Without a large pool of customers (those who make at least 3 orders) to bank on, you face unstable, unpredictable growth.
Is there any advantage to discounting?
Alright, we’ve bashed discounting enough. As we said earlier, discounts definitely do drive sales.
So the question is “how do we discount in the right way?”
The point of a discount is to lower the initial activation energy needed for someone to close, but then your product should convince them that the full price is worth it. With that in mind, it makes sense that the best way is through a segmented approach.
A discount can be used to win back a lost customer. Or convince a prospect to become a first-time buyer.
Both very different use cases and very different mindsets, that require different treatments.
A discount used to thank high-value customers who haven’t purchased in the past 6 months would also be different from how you would incentivise a customer who’s spent $100 in the past year.
You get the idea.
What to keep in mind when discounting
- Be discrete. Don’t broadcast to everyone that you’re offering the same product at a lower price. Those that just paid full price may feel cheated or undervalued.
- Leverage urgency. There is hardly anything as powerful as a deadline. Make sure you communicate it and stick to it.
- Vary your offers. Making your offers predictable will cause customers to expect it and wait for the discount to go live rather than pay the full price now.
- Split test discounts. $5 off for orders above $50 vs 10% off vs free item worth $10 for orders above $50 may yield different results and affect your margins differently.
- Consider alternative incentives. Promotions don’t have to be price reductions or free gifts. It could be as simple as an extended warranty, expedited shipping or even exclusive access to a product line.
When used correctly, discounting can give customers that extra push needed to convert, but it should be used as more of a secret weapon, rather than the first resort, whenever a campaign needs to be run. Remember, discounts and margins, not just discounts and sales!