What cost takes up the biggest share of the annual sales of almost every business (and it doesn’t appear in your annual financial statements)?
Annual financial statements for any company report sales net of discounts and promotions. That means the cost of those discounts and promotions is often not measured and forgotten.
We saw how reducing average prices by 10% for Eddie could be disastrous. Here’s a more high-profile case…
A salutary lesson
1931 was the start of a 77-year period where General Motors dominated the auto industry. They led the world in car sales for 77 consecutive years until 2008 when they fell to second place.
A few years earlier, in the Spring of 2005, business didn’t look good for General Motors.
Then the marketing teams at General Motors hit upon a revolutionary idea. They wouldn’t just offer the usual discounts or cashback incentives seen in the auto industry. They would offer their vehicles at the deeper discount normally reserved for its employees.
This was launched with much publicity on 1 June 2005 and the promotion continued for 4 months. Rather than the usual quantification of the discount, it declared, “GM’s employee price is what a dealer actually pays for a vehicle”.
Sales rocketed in June 2005 to over 40% of the sales of June 2004. July 2005 was almost 20% up on the previous July. This was such a significant increase in sales the marketing team were applauding themselves for this stroke of genius.
Sales then fell sharply over the next few months and General Motors eventually posted a loss of $10.5 billion.
Just 4 years later, in June 2009, this giant of the auto industry that dominated for 77 straight years, filed for bankruptcy. The discounting didn’t increase sales; it simply gave customers a reason to bring forward the purchase of their next car. Just like Eddie in the previous example, they destroyed their margins and killed off profitability.
Discounts are crazy!
You should never crash and burn on price by simply discounting. When you discount you undervalue yourself and you train your customers to haggle. Instead, maintain the integrity of your prices and be prepared to walk away. Discount regularly and customers become trained to wait for the next discount.
Reducing, or even eliminating, discounts can make a very significant difference to profits.
What if your customers only choose you on price?
Unless you really are only serving the price sensitive segment of the market, if your customers choose you on price it’s because you haven’t given them any other reason to choose you. You haven’t made your products or services sufficiently different or better. Customers see you as the same as everyone else, with the only thing that differs being the price – so they’ll choose the cheapest price. And that’s your fault, because you haven’t given them any reason to do anything other than choose the cheapest.
What’s more, if customers choose you on price, then they’ll probably also leave you on price. In other words, if they choose you solely because you are the cheapest, then as soon as another competitor offering an even cheaper price comes along you’ll lose them as customers.
There’s a double whammy from competing on price. You make lower margins. And you have less customer loyalty.
Of course, there may be occasions when you want to run promotions and offer discounts. So, let’s look at the right way to do that next.