Shock! Discounting Just 5% Can Hurt Your Bottom Line By a Massive 50%!
This article is for Executives who still think that discounting is a way to grow a business.
Be prepared to be amazed.
Here we go…
Our Base Case Scenario.
The first image below illustrates our base case in this scenario. I have purposely kept the numbers simple to make it easy to get the point.
In this base case scenario, we assume that you sell a product or service for $100, while it costs you $60 to produce.
Your gross profit therefore is: $100 - $60 = $40.
Then we subtract your fixed costs, admin and direct selling expenses, and end up with your base case Profit before Tax (PBT) of $10.
based on “Managing Top-Line Computer Applications"; Stephen P. Hindman & John J. Sviokla; Harvard Business School Publication # 9-192-098, rev 7/9/92
So, in this base case scenario, on sales revenue of $100 you make $10 profit before tax.
So far, so good.
Below, we will now make three different adjustments, each by just 5%, to illustrate how you can achieve dramatically different financial outcomes, depending on which lever you pull.
Here we go:
Lever 1: Reducing Your Direct Selling Expenses.
Based on the base case scenario above, the table below shows the impact on your bottom line if you reduce direct selling expenses by 5%.
based on “Managing Top-Line Computer Applications"; Stephen P. Hindman & John J. Sviokla; Harvard Business School Publication # 9-192-098, rev 7/9/92
As you can see, reducing direct selling expenses by 5% improves profitability by only 3%.
The improvement to your bottom line is only minimal. In fact, to me, this does not seem a hugely effective way to improve bottom line results.
Lever 2. Increasing Sales Revenue.
In this scenario, I make a different adjustment, also by just 5%, but in the other direction.
Here, I will illustrate what happens when you increases your sales revenue by just 5%.
In other words, what happens to your bottom line when you sell 5% more?
In other words, what happens to your bottom line when you sell 5% more?
Here it is…
based on “Managing Top-Line Computer Applications"; Stephen P. Hindman & John J. Sviokla; Harvard Business School Publication # 9-192-098, rev 7/9/92
In this scenario the business is now selling $105, i.e. $5 more than in our base case scenario.
Leaving all other expenses the same as in our base case and just
Increasing your sales revenue by 5% makes a huge difference: Your bottom line improves by a massive 20%. That's a four-fold profit multiplier!
But there's more: Something incredible happens when you do something perhaps a little counter-intuitive...
Lever 3. Raising Prices.
Look at what happens in this scenario if you were to lift your prices by just 5%.
based on “Managing Top-Line Computer Applications"; Stephen P. Hindman & John J. Sviokla; Harvard Business School Publication # 9-192-098, rev 7/9/92
The result can be a 50% improvement to your bottom line!
But: Discounting is a Huge Profit Killer!
The same dramatic effect above works also in reverse!
based on “Managing Top-Line Computer Applications"; Stephen P. Hindman & John J. Sviokla; Harvard Business School Publication # 9-192-098, rev 7/9/92
You see, discounting price by 5%, results in a bottom line profit result of just $5, which is a 50% DECREASE to your bottom line, compared to our base case scenario!
Discounting by 5% reduces your bottom line profit by a massive 50%, discounting is huge profit killer!
So, think twice about cutting costs or discounting to win more sales, when you can lift sales and grow the business instead.
Time You Review Your Sales Fundamentals.
It’ll give you clarity.
Peter Strohkorb
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