It doesn’t matter if you sell a product or a service, a small discount can have a big effect on your finances you may find surprising.
We’ve all been there – you can almost smell the sale, but the buyer is holding out for a little sweetener.
You know the line: ‘I really want to buy, but I need you to get just a little closer to what I can spend”, or “Come on, we both know you’ve got some leeway in the price – let’s do a deal”.
Of course, you do have some flexibility in the price.
You’ve allowed yourself a reasonable margin so trimming off 10% on the total won’t be a big issue – and if it closes the sale, well...
STOP RIGHT NOW!
Do you fully appreciate the true significance of what you are about to do?
It may seem obvious, but have you calculated the real impact on your business of just knocking off a relatively small percentage as a discount?
Please indulge me here – pick up a pen and, off the top of your head, write down how many more products you think you might have to sell if you discounted a batch of 100 by just 10% of your normal selling price.
And if you run a service business jot down how many more hours you feel you would have to work on a 100 hour project.
You can express this as a number of extra products or hours, or as a percentage – whichever comes most easily to you – but do get a figure down.
THE REAL MATHS
Okay, so now let’s do the real maths in round terms.
You are selling a batch of 100 of your widgets (or hours), each priced at £100 and you have a good margin of 30%, which works out as £3,000 profit on a total sale of £10,000.
If you discount the order by 10% your total sale price will reduce to £9,000, howeveryour profit will drop by a third from £3,000 to £2,000 because that 10% discount can only come from one place and that is your margin.
It cannot be taken from the hard cost of your widgets in any way as that is a fixed cost to you, and so your actual profit margin is now 20% rather than 30%.
If you provide a service this is just as true as you have hard costs to cover - from computer equipment and running charges to support staff and office space – however, understanding exactly what these are, and the money required per hour to cover them, is one of the biggest challenges facing smaller service business owners, and a topic for another day!
SO WHAT’S THE ANSWER?
Let’s return to our original question: How many more widgets (or hours) are you going to have to sell to make up the shortfall in revenue and profit from discounting by just 10%?
It’s not 10% is it? The answer is, rather shockingly, actually 50% - that’s 50 widgets more or, to put it another way, half as much again has to be added to your original sale – just to have the same amount of profit (£3,000) going into the bank as you would have achieved if you had not given away that small discount in the first place!
100 widgets at 20% profit = £2,000 for you + a further 50 widgets at 20% profit = £1,000 for you. Total 150 widgets at 20% profit = £3,000 for you.
This is the moment when most of my clients go very quiet and, in my experience, they are far from being alone in finding this a pretty sobering exercise.
The fact is that in our example you will now have to persuade your customer to buy 150 widgets (or hours) at a total cost of to him of £13,500 for you to earn the same money you would have done for the original order of 100 widgets at £10,000.
Even if you are able to achieve this (and it is unlikely as your customer has come to you with an order for 100 widgets, not 150), you will be effectively giving away 50 percent of your stock for no extra income, but with all the hassle, stress and time of re-ordering, storing, logging, managing, transporting etc.
If you are in a service business then you are going to have to work half as many paid hours again just to get back the money you have lost through that 10% discount on the original project.
Clearly this does not make sense from either a business or a personal point of view!
If your profit margin is 20% then you are going to have to sell DOUBLE the amount of product or hours to achieve the same profit as without that 10% discount.
And even if you were in the extraordinary position of having a profit margin of 50% you would still have to sell a quarter as much again.
Now have a look at the number you wrote down at the start – how close were you to the real figure for YOUR business?
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