Groupon is not a marketing strategy – The effect of discounting on business
I’ve had a few conversations lately with several business owners who were considering discounting or reducing their prices as a strategy to increase sales. With the popularity of discount websites such as Groupon, Daily Deals, Living Social and others,
businesses are looking to these sites to help increase their sales. However, it’s important for business owners to understand the effect of discounting on their profits.
Let’s take a look at a quick example – say that a company sells a widget at $10/unit and their cost of sale is $7/unit. If they sell 100 units they will profit $3/unit or $300.
Sale Price = $10/unit
Cost of Sale = $7/unit
100 units sold = $1000 – $700 = $300 profit
Now assume that the business discounts their sale price by 10% making their unit sale price $9. Here’s how the numbers look with the discount – the question is how much more units does the business have to sell to maintain the original profit margin;
Sale price = $9/unit
Cost of sale = $7/unit
100 units sold = $900 – $700 = $200 profit.
By discounting the price by 10% the business would have to sell 50% more units to make the same profit – the business needs to sell 150 units (a 50% increase in sales) at $9 (the discounted price) to make $300.
15o units sold at $9/unit = $1350 – $1050 ($7/unit * 150 units) = $300 profit. In order for the discount to be worthwhile, it must generate at least a 50% increase in sales.
Obviously this is a very simplified case study. You would need to consider other factors, such as increase in overhead costs, but it makes the point. It’s important for business owners to understand the impact that discounting has on their business and monitor the results of their “sales” to ensure that they are not giving up profits for the sake of more sales.
Some people might argue that using the discounting sites increases brand exposure, allows people to try the product or service and may result in repeat clients. Fair enough, but it’s important to realize and plan for the impact this strategy will have on cash flow. Cash is still King!