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Discount Dangers

by fatweb

By Kate Pierson

It’s a sensory stimulant for consumers and can break budgets on a whim. With the ability to bend the will of even the most avid window-only shopper, it’s one of the most attractive concepts to the human eye – the discount. Making the eyes wide, the sales salivary glands water and the heart pit-a-patter in anticipation, it’s one of the most powerful signs in commercial language.

Yes, the discount, be it in malls, minimarts or markets, in the form of dollar deductions, percentage reductions, or ‘two for ones,’ is the magnetic drawcard for sales scouters and bargain-hunting buyers in a marketplace full of competing consumables.

But while its attractive facade has guaranteed its popularity in the sales sphere, the discount can also be what is described as a ‘frenemy,’ aka, the ‘friendly enemy’. Something which, on the surface, appears to the have all the qualities and characteristics to be a compatible friend to your business, but when you use it, undermines all that you hope to achieve.

Bottom line is, if you are going to announce a discount, you have to know the effect on your firm first and the NZ Institute of Chartered Accounts director of professional support, Tom Davies is adamant about this.

Davies says discounting and using it for your business’ benefit requires knowledge and an educated understanding of your operation first and foremost. His philosophy on discounting is, always analyse before you act.

“While discounting is a popular way to increase sales, what businesses need to remember, is that if they are discounting their products, they are giving away a slice of their profit. Therefore, before a discount is applied, people have to know their business and not just hope for an increase in sales and profit,” he explains.

“Before you discount, you’ve got to know how much the product is costing you and how much you need to keep your business going. Because trying to match a fellow competitors price without knowing these essentials can be disastrous.”

Davies says that businesses also need to take into consideration that repetitive discounting may result in consumer demand for a permanent reduction plan, also known as a loyalty programme.

Humphries and Associates Limited director, Michael Humphries corroborates Davies’ views on discounting, reiterating the importance of understanding the financial logistics of your business, prior to adorning shop windows with brightly coloured sales banners.

“It’s true that discounts are one way to reach customers and in some cases it can be effective. We see it being used to attract people into shops and stores and to generate marketshare, but it is a strategy that needs to be utilised carefully,” he cautions.

Davies adds that understanding how discounts can have an immediate impact on cash and profitability is also critical, because if businesses cannot sustain their discount position in the face of a price-reduction war, they may find themselves not only being out-priced by their opposition, but susceptible to financial failure.

“Businesses really need to know the cost structure of their organisation and whether they can sustain their position in a potential sales war. Discounting is a strategy that is really only available to the lowest cost producers, because if you don’t have a low cost production structure in place, you’re not in a position to drop your prices and you may end up compromising the quality of your product or service if you try to.”

Underestimating the relationship between discount and volume is also a common error. “To make up your gross margin when you decrease your prices, consumption has to increase,” Humphries explains simply.

And even if consumption increases enough to maintain a price decrease, significant costs may be attached to the investment of new staff and premises that are required to accommodate this consumption growth.

Beyond the potential implications for a business itself, discount campaigns running back to back can also negatively impact the economy due to deflation – something Humphries says has been happening in Japan for many years.

“These price wars that occur between businesses can create uncertainty for consumers because they expect prices to drop again and therefore won’t spend any money in anticipation of this happening.

“In business, a strong focus should be on unique selling points (USP’s). A USP is all about how a business can differentiate itself and where it will position itself in the market,” Humphries concludes.

For more information on discounting and how you can effectively implement this, or another sales strategy, seek advice from an accountant or a business consultancy firm.

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