Over-Discounting: Taking a New Approach to Discounting Can Add Millions to Your Bottom Line

Is my company over-discounting?

In an effort to keep customers coming back, many retailers are now using discount offers and coupons in almost all of their customer communications. And while offering discounts can be an effective strategy that drives traffic and purchases—always a welcome result in these difficult economic times—marketers would be wise to consider the downside of discounting as well.

The most obvious disadvantage to discounting is that it makes your business less profitable. Giving away profit margin may help to stimulate sales in the short run, but it is not a sustainable strategy. Many retailers justify the practice by arguing that it increases market share—which should lead to better profitability in the long run. However, the problem with that rationale is that it’s simply not true.

“Anheuser-Busch Cos. said its future earnings will be hurt by its decision to match price discounting by competitors in an effort to improve its market share. The company’s shares dropped 5% on the news.” – ST. LOUIS BUSINESS JOURNAL

Research on companies that are the market share leaders in their respective industries reveals minimal correlation between market share leadership and profit leadership.

In addition to the negative pressure on the profit margin, there is a price you pay beyond the cost of today’s discount. The harsh reality is this: By constantly discounting, you are training your customers to anticipate and wait for deals—reducing the likelihood that they will buy at full price in the future. Inevitably, it becomes a dangerous and expensive trap whereby companies feel the need to discount in order to create sales because their customers are expecting it. And delivering discounts reinforces their expectations—making it even more likely that they will wait for discounts in the future.

So how do I break out of the “discount trap”?

Even retailers that use discounts sparingly may be over-discounting if they’re not varying their offers based on the type of customer they are targeting. Marketers need to recognize that not all customers are the same when it comes to discount offer sensitivity. Some are impulse buyers who are more willing to pay full price. Others are “coupon clippers” who won’t buy anything at full price but will buy something they don’t necessarily need if it’s on sale—a great target audience for clearing merchandise. And in the end, many are somewhere in between. The key is to understand the differences among customers and to use that insight by varying your offers based on how sensitive they are to discounts.

What do I need to know to implement this strategy?

There are a few ways to approach offer differentiation by customer—but all of them require a history of purchase transactions at the customer level. And this analysis will be difficult to execute if you don’t have your data organized properly.

One simple way to differentiate by customer is to look at the percentage of total items purchased at a discount for each customer. Another way is to calculate margin percentage at the customer level. And a third way is to evaluate each customer’s responsiveness to communications with a discount vs. those without.

Any one of these methods will help you determine “discount sensitivity” at the customer level. And once you have one of these measures in place, you can experiment with replacing discount offers with more relevant, full-price offers for those customers who appear to be less sensitive to discounts. Over time, you will find just the right mix of discount- and non-discount-oriented communications—and your ROI will benefit for it.

“Macy’s, whose price markdowns gnawed away at its profit margin, reduced its fourth-quarter earnings outlook to 90 cents to $1 per share from previous guidance of $1.10 to $1.30.” – TAMPA BAY BUSINESS JOURNAL

In Conclusion: If you have the nagging feeling that you may be over-discounting, you probably are. The key to breaking out of the discounting trap is analyzing customer behavior related to discounts and developing a new discounting approach based on that research. And while this will require some time and effort on your part, it will be worth it in the long run, when you can track the benefit straight to your bottom line.