How to Use Discounts in Retail Without Cutting into Profits

Running a discount offer can be one of the most effective ways to boost sales. For example, discounts (Black Friday sales, for example) help make the holiday season the busiest sales season of the year, accounting for 30 percent of annual U.S. retail revenue. Smart business owners leverage the power of discounts by running sales at strategic times to boost revenue throughout the year.

But discounts can hurt your business if done incorrectly. If you pick a price point that’s too low, you may end up losing money. Mishandled discounts can also hurt your current customer base or overwhelm your staff and inventory. Here are some key ways to run an effective sales promotion that drives profits while avoiding unprofitable pitfalls.

What Are Some Reasons for Running Discounts?

Before you offer a discount, you should specify your goals. You can run discounts for a number of reasons:

• To increase sales demand by offering a lower price
• To attract new customers with a low-priced offer
• To generate repeat business from existing customers
• To cut losses from excess inventory

These goals call for different tactics. To increase sales, you’ll need to know how low you can discount your product without falling into unprofitable sales margins. But to cut inventory losses, you don’t have to worry about this. For attracting new customers, you’ll want to gauge the profit margin effects of your discount against the cost of acquiring new customers. For existing customers, you’ll want to weigh profit margin losses against a customer’s lifetime value.

How to use Discounts in Retail

Discount offers can be structured in multiple ways:

• Standard percentage discounts on individual items
• Volume discounts on multiple units of items bought together
• Bundled discounts on groups of items sold together
• Buy one/get one free discounts
• Seasonal discounts on everything in your store
• Prepayment discounts on advance orders
• Free shipping

These methods can be used individually or in combination.

Which methods you choose depends on your goals. To increase sales, standard, bundled, or seasonal discounts are all viable. To attract new customers, seasonal discounts and buy one/get one free discounts work well. To generate business from existing customers, offering free shipping as loyalty rewards can be useful. To dump inventory, volume discounts and bundled discounts can be effective.

How Do I Pick a Price Point That is Still Profitable?

A discount can risk cutting too far into your profit margin to make your sale worthwhile. To avoid this, it’s critical to consider some key variables. Your accountant can help you crunch these numbers, or you can find templates online:

• Your break-even point is where revenue exceeds fixed and variable costs, calculated by taking total fixed costs (such as rent and labor) and dividing by contribution margin (revenue generated per sale after subtracting variable costs such as commissions).
• Break-even units are calculated by dividing total fixed costs by difference between price per unit and variable cost per unit.
• For break-even price, first determine variable costs percentage per unit by dividing total variable costs by the sum of total variable and fixed costs. Then determine total fixed costs per unit by dividing total fixed costs by total units sold. Finally, divide 1 by the product of the quantity of 1 minus total variable costs percentage per unit times the quantity of total fixed costs per unit.

These numbers reveal how many sales you need to make at a given price to stay profitable. These figures depend on costs and profit margins, so you can improve them by lowering costs or increasing sales. For instance:

• Limit your marketing budget by using low-cost methods, such as promoting to social followers or email lists.
• Limit your offer to segmented groups such as first-time buyers or dormant customers, minimizing the amount you lose on discounted sales.
• Increase revenue per discounted transaction by bundling discounted items with full-priced items or selling full-priced up-sells.
• Increase sales activity by comparing how many sales you’d need at your current margins to hit a target revenue with how many you’d need at your discounted margin; increase your marketing activity proportionately.

After crunching numbers for different sales targets, you may find your discount sale could achieve significantly higher revenue if you increased marketing activity through more advertising or promotions. In this case, you may want to consider applying for a business term loan or line of credit to cover your promotional costs so you can achieve your goals.

How Do I Keep Discount Traffic from Undercutting Revenue from Regular Customers?

Another risk when running a discount is that increased sales success may actually backfire. For instance, a Groupon promotion to attract new customers may bring in mostly existing customers, who then pay less for something they would have been buying anyway. In the process, lowered prices may create a perception that the value of your product has fallen.

Avoid this by running different promotions to acquire new customers or reactivate dormant customers. Consider offering a discount on something different than your usual offerings. This will avoid cutting into your bread-and-butter income.

When targeting existing customers, you might discount upsells rather than what they usually buy. Or you might temporarily discount something they normally buy, but only if they buy additional items. Likewise, you might bundle discounts with cross-sells.

How Do I Keep Discounts from Overwhelming My Staff and Store?

Another discount trap is allowing your staff or inventory to get overwhelmed. You may find additional orders make it harder to keep up with customer service, diminishing service quality and hurting your reputation. This can drive away loyal customers as well, since they may get fed up with poorer customer service. Or you may find you didn’t order enough inventory to keep up with demand, creating irritated customers.

You can avoid running out of stock by making well-informed inventory estimates, supported by good inventory management practices and use of inventory management software. Similarly, you can use automation tools such as chatbots and IVR (interactive voice response) to handle increased customer service loads. Alternatively, depending on your business model, you may wish to temporarily hire additional help or outsource customer service.

For more information on how to strategically grow your retail business, check out “Maximizing the Value of Financing for Retail Businesses.”