Discount Strategy Causes Financial Problems
The internet allows consumers to do quick price comparisons. For companies that sell similar products/services pricing becomes front-of-mind for the consumer. In response, many business owners lower prices to get the customer in the door. They believe the discount will be “made-up” on future sales. While is it true that large corporations successfully deploy discount strategies, they do not discount below cost—this includes all cost. The CFO’s of these firms calculate the cost to product and allocate an amount for overhead. The pricing discount is approved only after such considerations have been met.
Smaller companies lack financial sophistication and often make the mistake of only considering the obvious production cost. They do not include overhead items such as rent, marketing efforts, sales commissions, administration and insurance. Whereas the large companies are discounting the amount of profit, the smaller companies are unknowingly losing money on every transaction. Eventually this becomes evident in the cash flow, as the amount of cash slowly diminishes every month in spite of an up-tick in sales.
If not executed properly, discounting can be a deadly strategy. Reducing the profit margin to gain market share can be an effective short-term strategy. However, if you are discounting below the company’s cost structure, the financial loss on each transaction can reduce the company’s overall profitability. It allowed to continue, eventually it could destroy the company’s financial health and lead to insolvency. Prior to deploying a discount strategy, a true assessment of the cost structure must be considered.
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