The
financial press of late has been full of stories of how the economy is turning
for the worse, how China’s downturn will be bad news for Australia and how
unemployment is set to rise.
As I was
reflecting on this news, I recalled a recent shopping expedition. My better
half and I spent a lovely day in the city utilizing all the gift cards I had received
as Christmas presents. I was simply amazed by the number of stores offering
massive discounts on their products. With the increase of For Lease signs in
shops, it is not hard to tell that retail has been tough. However, the amount
of discounting on offer was something I don’t recall having seen quite at this
level before. (I humbly admit I am not an avid shopper, so that doesn’t
necessarily mean much.) Having had a retail arm at a previous business I owned,
I was really feeling for them, knowing full well the level of damage
discounting does to your profitability.
While there
are a small number of legitimate reasons for discounting in some industries
(fashion, for example, when the current stock is out of style), in general
terms I abhor discounting. And in fact even in fashion, superior supply chain
management and inventory control can help prevent the need for clearance sales.
Discounting places substantial pressure on profitability.
The level of
damage done can be clearly demonstrated by examining the widely used profitability discount matrix. In
summary, this is a traditional matrix that shows the gross profit (GP) percentage
on one axis and the percentage of your price cut on the other. The intersecting
cells indicate the increase in sales volume that is required in order to make
up for the discount you have provided. Let me repeat that: The increase in sales required to make exactly the same level of
gross profit. Not more, but exactly the same amount.
For example,
if you are operating with a 25% gross margin and you reduce your sales price by
10%, you will have to increase your sales by 66.7% to make the same dollar profit.
This is also assuming you can accomplish the following things:
a) You are actually able to achieve a 66.7%
increase in sales as a result of the discount.
b) You are able to achieve this increase without incurring any increase in other
operational costs, such as additional sales people or delivery costs. A
detailed “cost to serve” analysis will help you here. (If you don’t know what
cost to serve is, give me a call—you’re missing out big time.)
The increase
required to cover the reduction escalates rapidly the higher the discount goes.
For example: Again your GP is 25%. A discount of 13% requires an increase in
sales of more then double (110%). So for an additional 3% increase in the
discount, an additional (approx.) 30% increase in sales is required to make up
the difference.
Hopefully,
you can quickly see why competing on price is the scourge of business. My
philosophy is always to compete by providing extra value, not a lower price.
When times are competitive, look for ways of adding value to your customers’
experience rather than reducing the price. If you don’t have a copy of this
discount matrix, send me an email at david@davidogilvie.com.au with “Discount
Matrix” in the subject line, and I will forward you a copy.
© David Ogilvie 2015 All Rights
Reserved
David is a
global expert in profitability improvement and maximising investments in ERP
systems.
Contact
Details:
Email: david@davidogilvie.com.au
Phone: +61
(0)438 787 759
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