Discounts: a viable strategy or the beginning of the end for your business?

Competition, be it from direct competitors or substitute products, is a challenge all entrepreneurs must face. Many respond by offering discounts, in some cases massive discounts. But is discounting the best option? Is it viable in the long-run to keep offering discounts?

For consumers, competition is obviously beneficial. It leads to reduced prices, improved quality and increased innovation. Producers fall on the other side of the coin. Fierce competition leads to reduced customer retention, condensed profit margins and an amplified cost of innovation. In the long-run, some businesses tap-out, while others, the luckier ones, may end up merging to stay afloat.

In attempting to cope with competition, the majority of entrepreneurs resort to discounts and end up engaging in price wars. Whereas the discount may be occasionally good in the short run, it is definitely not a strategy for small businesses. Customers are of course easily persuaded by price cuts and discounts, but a bigger and stronger competitor will easily overrun your discount and you will see yourself forced to offer yet another bigger discount.

But for how long can you endure offering bigger and bigger discounts? The simplest mode of shedding light on this is by checking the impact the discount will have on your profitability.

Imagine you get 500 customers every day who purchase goods worth KES 100 each with 33% mark-up; hence making daily revenues of KES 50,000 and a net profit of 12,500. A new competitor joins the market offering the same good at KES 90 and immediately steals all your customers. In an attempt to lure them back, you have no option but to give a 20% discount, lowering the price to KES 80. Whereas your revenue falls the same 20% to KES 40,000, your profit plummets 5 times to meager KES 2,500.

To maintain your profits requires more than simply getting 5 times more customers. To get more customers, the business will have to increase marketing, research and innovation costs. These increased costs will in turn lower your profits thereby adding to the problem.

As soon as your competitor realizes you have snapped out his customers, the competitor opts to once again reduce the price to KES 70 and once again the cycle continues. The further and further this price war goes on, the more the businesses get hurt. Costs of running the businesses becomes too high and the increased price cuts eat into profits. Both businesses will fight till none no longer exists. The intended remedy turns venomous.

Price wars have claimed many victims and your business could easily be one of them.

The truth is, it is only large corporations that can sustain price wars. They are able to set prices at significantly lower ranges in an attempt to ward off competition. They are able to price products at cost, maintain this price for a long spell, yet remain profitable. SMEs on the other hand have to set a specific margin in order to meet their expenses (salaries, rent, utilities, SGA expenses etc.).

When you employ a temporary solution in an attempt to solve a permanent problem, you are simply postponing and prolonging the problem. The truth is you need a more sustainable solution. At ISBI we enlighten entrepreneurs with various viable alternatives to tackle competition. We offer proven alternatives that are long-term and sustainable.

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