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Price Discounting – How To Identify The Impact On Your Profit Margins

Price discounting is not new. But the sense of urgency and fear which grips business means many SME’s are getting involved with price discounting schemes. clickfunnels pricing discount

The key issue is that any business must be aware of the potential impact on its profit. As there are many examples of businesses which have lost money using voucher schemes indicate some confusion over the anticipated outcomes.

And there are two distinct areas:

  1. Failing to identify extra sales units required to compensate for price reduction.
  2. Cost of fulfilling extra demand

Sales profit margins are directly affected by discounts because they take a direct hit. Sell for $10, discount by 10% and the new sale price is $9. If the cost of sale is $7, then instead of $3 profit, you make $2.

To claw back the profit you need to increase the volume of sales by 50%. Which seems crazy. Why do you need to sell 50% more product?

Here’s how the numbers work out.

Normal sales of 100 units give (100 x $10) = $1000

Cost of sales are (100 x $7) $ 700

Standard margin (sales less cost of sales $ 300

10% discount (100 x $1) $ 100

Margin made on sales $ 200

So the margin has dropped from $300 to $200 when the headline price is $9. The desire to bring in more sales through discounting means the business needs to sell 50% more units just to stay the same. And in this example we assume the business needs $300 of margin to cover expenses and/or make a net profit.

The quick calculation shows that instead of 100 x $3 it now needs to sell 150 x $2 to make $300.

Some businesses don’t understand this so end up in a cycle of losses. Even just selling 50 more units is not an easy task, especially if you’re not a volume producer or large retailer. And even they take these hits as loss leaders making a profit on other products to cover the loss.

It is a risky strategy if a business does not get its strategy right.

Cost of fulfilling extra demand.

Issue is that incremental cost of production is greater than the sales value. Or in other words – you gave too much discount away so the sales price is less than the cost.

Take as an example: cup cakes. Popular, but not cheap to make. As our second example let’s use these numbers.

Normal sales price per unit $5

Cost of production $2

Margin on sale $3

And we’ll assume that there is a big sales push with 50% off. (And this does happen.)

Let’s just pause to take on board this point. The cost of production is based on: cost of materials; labor cost; volume produced; and time taken. And normally a business will also have other costs, such as rent, energy, depreciation which we refer to as fixed. It is often assumed that they stay the same as they are fixed. It’s important to remember that they are only fixed for a certain level production and a certain period of time.When volume increases beyond that level those fixed costs will also increase.

If we extend that idea then a 50% discount could see sales go through the roof. If so the total cost of production increases. This means that every unit produced loses money. And the more sales, the bigger the loss.

The structure would now look like this:

Sale price after discount ($5 x 50%) $2.50

Cost of production 30% increase ($2 x 1.3) $2.60

Loss per unit sold $0.10

Sell 100 units with this discount and the business loses $10. Sell 1000 units and it loses $100. Basically this businesses loses on every sale it makes. The more the business sells the bigger the loss. And in such a case sales of this item could wipe out the entire business profit.