What is it about Memorial Day,
July 4th, Labor Day and the Christmas season? They bring out all the big discounts, which
gets shoppers flooding to the malls to save money, especially on big ticket
items like cars and mattresses, as examples.
And the sellers of those products bring out their best prices during these
holiday seasons, trying to capture has much market share against their
competitors as they can. But the
question I ask is: why? Yes, you are
driving more revenues, with the holidays often representing 30% of their total
annual volume. But, if you are
sacrificing material bottom-line profits by slashing prices in the process, why
play that game? This post will dive
deeper into whether you should or should not deeply discount your products,
during the holiday season or in general.
The Psyche of the Typical Consumer
Before trying to address this
topic, it is important to understand the psyche of the typical consumer. Throughout the generations of shopping, retailers
have trained consumers to expect certain behaviors, including when to expect discounts. One example worth calling out is J.C.
Penney. J.C. Penney was one of the most
successful retailers in history, commanding a dominant market share at their
peak. But retailers like Kohl’s and
Target starting to take market share away, through better quality products and
better prices. Kohl’s was particularly
effective with their Kohl’s Cash, that would give the consumer a credit on
their next order at the same time they were checking out on their current order,
giving the customer a reason to return to the store for another purchase before
losing their cash.
J.C. Penney tried to combat this,
and save their company, with an “everyday low prices” approach, getting rid of
discounts altogether. But that strategy
did not work. Consumers were simply too
trained by the other retailers to look for discounts, that they only shopped
from the stores offering them, even if the net prices of the products were
exactly the same. This “no discounting” strategy
may work well for a high-end brand like Nordstrom, serving an affluent
demographic that is less price conscious.
But it does not work well for penny-pinching, mainstream consumers. So, the point here is: discounts definitely play a major role in the
psyche of the mainstream consumer, and you need to decide when and how best to
use them.
The Typical Economics of a
Holiday Sale
Let’s look at the mattress
industry, as an example, that runs heavily discounted promotions during each of
the major holiday seasons. Let’s say the
average mattress costs $1,000 at regular prices. And, that price drops to $750 (25% off)
during the holiday sales. And let’s say
a mattress seller is doing $100MM in revenues per year, with 30% of their
annual sales happening during the holiday periods. That means their typical gross profit margin
of 50%, may drop to 25% during the holiday sales. And their bottom line net income margin may
drop from 20% to -5% during the holiday sales.
What that suggests is that $70MM of their revenues at full price are
driving $14MM in bottom line profit, and $30MM of their revenues at the
discounted price are driving a $1.5MM loss, for a total net income for the year
of $12.5MM (a 12.5% blended profit margin).
My Initial Reaction
I feel we, as businesspersons, are
so focused on scaling revenues and market share, that we don’t put enough
thought behind, “at what cost” did those revenues come. To me, I could be perfectly happy, not
participating in the discounting seasons.
Yes, I would end up with a much smaller revenue business, leaving 30% of
potential revenues “off the table”. But
my bottom-line net income and profits margin would actually have been $1.5MM higher,
by not “giving the product away” at deeply discount prices. The point here is: just because everyone else is doing it,
doesn’t mean you have to do it too, as profits may be a much better metric to
maximize than revenues, depending on your goals.
What You Risk By Not
Discounting
Profits is not the only metric you
need to concern yourself with. There may
be some downside risks of not participating in the holiday discounting
seasons. That includes: (i) there are
certain individuals that cannot afford your full price, and can only afford
your discounted price, so you are consciously leaving that demographic
unserved; (ii) by not getting your brand name front-and-center during the
holiday sales, your competitors are getting more “mind share” of leading brands
in the industry, potentially leaving your future brand awareness in the
rear-view mirror; and (iii) you are not taking into consideration the lifetime
value of the consumer—yes you lost money on the first sale, but you will make
it back with their customer loyalty on the second, third and fourth sales. Many of the major retailers just swallow the
bitter discounting pill for reasons like these.
Concluding Thoughts
So, the real question here is:
should you or should you not be heavily discounting your products during the
holiday seasons? I think the answer to
that question largely depends on the market you are serving and what your
competitors are doing. If you are a
high-ticket product, discounts can be very helpful to acquiring customers that
would otherwise have been lost. But if
you are a high-end brand where customers are less price-sensitive, they most
likely would have still purchased at the higher price. To me, discounting is a tool you can use to
clear out distressed inventory. But it
should not be a tool you use to capture market share at all costs. Sometimes it is better to stay out of that
battle and live to fight another day, at much higher profits. That said, if you are a high repeat purchase
product, acquiring customers at a deeply discounted price can be a great way to
accelerate longer-term revenues and profits through repeat sales from those
customers. Good luck making the right
decision for your business. It will come
down to which metric is most important to your business—near term revenues or
profits, or long-term revenues or profits.
For future posts, please follow me on Twitter at: @georgedeeb.