Discounts appear to be harmless at first glance. The system allows stock movement and customer service while giving sales teams real-time success data. The actual price of discounts proves to be substantial and enduring although it remains unquantifiable. The reduction of prices leads to changes in your profit margins and brand image and future market demand. When you perform the task without measurement you become completely unaware of what you are doing.
We need to create a straightforward method for cost visibility through basic mathematical calculations and straightforward guidelines which CEOs and CFOs can easily understand.
The perception of discounts as more expensive than their actual value remains a common phenomenon that affects many consumers.
A 10% discount seems insignificant to me. It isn’t. If your gross margin is 40%, a 10% price cut requires +33% more volume just to earn the same gross profit. Your business requires a 50% volume increase to reach a 30% margin level. Most promotions don’t deliver that lift. Therefore, the unmeasured cost of discounts is often a silent margin leak.
The discounts customers receive cause them to reset their internal reference prices. The initial lower price point creates an unfair perception of full price for buyers. Your standard promotional activities create market expectations about upcoming price cuts. The present small price reductions will reduce the company’s ability to set future prices.
The margin math, in one minute
- List price = 100; cost = 60; margin = 40.
The price reduction of 10% results in a final price of 90 while maintaining a margin of 30.
The original gross profit of 40 requires a volume increase to 1.33 times the current level.
This is the basic engine behind the unmeasured cost of discounts. You should evaluate your decision again if you cannot measure any performance improvements.
What you don’t see on the P&L (at first)
There are second-order costs that rarely show up in the campaign report:
The additional orders create excessive workload for fulfillment operations and call center services and return processing systems. Overtime and error rates go up.
- Mix dilution occurs when discounts attract customers to purchase lower-margin products or distribution channels which results in reduced profit per order.
The second major issue is cannibalization which means that you are moving up sales without increasing the total market demand. The upcoming month appears to have a gentle outlook.
- Customer quality: Deep-discount buyers often churn faster and have lower lifetime value (LTV).
The unmeasured cost of discounts keeps increasing because these costs emerge after the first discount calculation.
Reality check
The retail and e-commerce sectors have experienced rapid growth. The costs of logistics operations remain elevated while promotional efforts encounter growing market competition. The period of e.g. back-to-school season leads to increased discounting but the final delivery expenses will reduce the benefits when customers purchase fewer items. The documentation of VAT treatment for discounts needs to be accurate because any errors will reduce the net realized margin after making compliance adjustments.
Executives need to understand that they should track incremental gross profit after delivery and returns and VAT effects instead of focusing solely on top-line sales when they use seasonal discounting to reach their targets.
How to measure discounts properly
You cannot manage what you don’t measure. Create a basic shared scorecard for this purpose.
Define “incremental” before you launch
- Baseline: expected sales without the discount.
The sales performance consists of two components which show sales results above the baseline (units and revenue).
The net gross profit results from subtracting all costs from total revenue including discounts and COGS and logistics expenses and projected return amounts.
Track mix, not just units
- Margin by SKU (Stock Keeping Unit) and channel.
- Attachment rate (did the discount pull in full-margin add-ons?).
- New vs. existing customers, and their 90-day LTV.
Protect price integrity
- Cap discount depth and frequency by segment.
- Use targeted offers (loyalty tiers, bundles) instead of site-wide cuts.
The price should remain constant while preventing sudden price swings between sale and regular prices.
Add these fields to your BI dashboard and require a post-mortem within 14 days. The company needs to stop all promotional activities which produce less than enough gross profit to meet their expenses during promotional times.
What to do instead of broad discounts
Demand can be shifted through alternative methods which prevent organizations from bearing the complete expense of untracked discount costs.
The company should keep its headline prices constant while providing more value through package deals and warranty and service extensions. The reference price remains protected through this method.
The company needs to create special offers that give students and new customers temporary price reductions but keep standard rates for all other customers.
The company needs to establish inventory-led pricing by performing end-of-life SKU reductions through controlled markdowns that require proper documentation.
The company needs to implement non-price strategies for improving delivery speed and stock availability and post-purchase service support. Customers give their money in exchange for guaranteed results.
- Earned benefits: Points and store credit and future-dated perks are available. These retain value without resetting the cash price today.
The sales incentives should be based on profit rather than revenue. The payment structure for representatives should remain constant when they offer discounted deals because this would lead to increased discount distribution.
A simple executive checklist
Use this before you approve any promotion:
- The expected incremental gross profit serves as the main performance indicator instead of revenue in isolation.
- We need to determine the volume lift which will enable us to reach breakeven at our present profit margins.
- The changes in our reference price will have what impact on our reference price for the upcoming quarter?
- The following expenses will increase: fulfillment costs, return costs, support expenses and payment processing fees.
- Do we protect premium segments and core SKUs?
- How will we exit the promotion without whiplash?
- What is the 90-day LTV for new customers acquired?
The last step requires you to document the rule which states that discounts should only be given after creating a test plan and establishing a control group and defining specific profit goals.
The bottom line
Discounts function as operational instruments for businesses yet they do not constitute a complete organizational strategy. The current loss of profit margins through discounts will lead to reduced pricing ability in the future. Measure, cap, and target them. The saved money should be used to improve the value of the business through better service and faster delivery and more reliable operations. The most affordable promise to make becomes achievable when there is no need to reverse it.
References:
Internal Links
https://3msbusiness.cloud/understanding-cost-driver-mapping-uncovering-what-moves-your-margins/
External Links
- McKinsey — Pricing Insights
https://www.mckinsey.com/capabilities/growth-marketing-and-sales/our-insights/pricing
- Harvard Business Review — Pricing Topic
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