As a startup, don’t give discounts lightly
Even modest discounts can have a dramatic effect on your bottom line — here’s the math to help figure it out.
A while ago, we were considering different ways of attracting additional customers to Triggertrap, and one of the things we came up with is ‘hey, people love discounts! Let’s give discounts!
Sounds like a great idea, yes? Well — not necessarily. Here is why.
The economy of a product
So, let’s take a hypothetical product scenario. You’re a product importer, and you run a webshop.
Say that you’re planning to start importing battery packs from China. You go on AliBaba, and you discover that you can buy the battery packs for just $9 when you buy 5,000 units. That’s a flippin’ bargain, you think, and you figure you can make bank here.
So: You order 5,000 units, and you import them into the UK. You’ve spent $45,000 on the units (~£29,100 at today’s exchange rate), another £1,500 on shipping, and you discover that 9% of the units don’t work (this is Alibaba, after all). Luckily, you magically discover this without shipping them to the end customers and having to take them in return for an exchange or a refund.
Anyway — you’re left with a final unit cost of £7.24 to you, as the units are in your warehouse.
Lovely.
You think you can sell the products at £19.99, and so your sales picture looks like this:
Brilliant, you have yourself a business. Now let’s sell the ever-loving tits out of this thing.
After a few months, sales are slowing significantly, because there’s other people entering the market. Not to worry, you think. I have a couple of tricks up my sleeve. And you break out the discounting knife.
The economy of discounting
At first, you try a 10% discount. That works pretty well, but other thing you notice is that your customers want free shipping. It’s only £1.50 per unit, so you figure eh — no problem. You’re making mad dollah here. You’ll chuck in the free shipping, too. Pretty cool, sales are going up. You’re now selling the product at £17.99. Bargain.
But of course, the competitors are still at your heels, so you decide to really go for it. First with a 25% discount. Then with a 40% discount. That’ll show them…
The customers are noticing that the prices are going down. Awesome! They are buying like crazy.
At some point, you’re noticing something: You’ve only reduced your price by a little bit, but you’re not making nearly as much money. What happened? Well…
You are giving discounts off your profits.
Whether you are giving discounts off your sales price or not, your costs don’t actually change. This means that when you’re reducing your price on a product, you’re giving away discounts off your profits.
To help you let that sink in, let’s take a closer look at that graph from earlier…
The green number is the number you care about. The green part of the graph determines whether your company is making a profit off that single product or not. That green part of the graph is your life blood.
Let’s take a closer look and isolate the profits a bit better:
In addition to that, of course, battery chargers don’t ship themselves, and you’re also going to need a couple of staff in your warehouse. The warehouse itself also costs money….
To the spreadsheets!
As soon as you’ve started looking at the numbers more carefully, you see why perhaps the discounting wasn’t such a great idea. Sure, dropping the price from £19.99 to £14.99 is only a £5.00 difference… But your profit per unit has now dropped from £12.75 to £3.26, and that ain’t pretty.
Adding your overheads (represented here as staff and warehouse costs) to the mix, it becomes obvious that even a relatively moderate discount has a huge impact on your operation.
As an aside: You know that flippant comment I made right at the top of this article, about the 9% product failure rate? Let’s talk about that, because it’s not as unrealistic as it might seem.
Imagine you did ship out those products, and you discover that you have to replace 9% of the products — 450 units — at your own cost. You’ll have to pay the £1.50 return shipping and the £1.50 to ship the new products out to your customers. In addition, you have to swallow the lost revenue from not being able to sell those 450 units you replaced… We’re talking about a £4,500 hit to your operation.
Does that mean to never do discounts?
Not at all — but do bear in mind what it means to give discounts. Break out a spreadsheet and take a closer look before you commit to them — and do some scenario planning for what your numbers look like if something unexpected happens.
Giving a 10% discount never means that your profits go down by just 10% — depending on your business model, your pricing strategy, and your overheads associated with the product, giving a discount could have dramatic effects on your bottom line.
Haje is a pitch coach based in Silicon Valley, working with a founders all over the world to create the right starting point for productive conversations with investors — from a compelling narrative to a perfect pitch. You can find out more at Haje.me. You can also find Haje on Twitter and LinkedIn.
