This article is for Executives who still think that discounting is a way to grow a business. Be prepared to be amazed. Here we go…
Our Base Case Scenario.
The first image below illustrates our base case in this scenario. I have purposely kept the numbers simple to make it easy to get the point. In this base case scenario, we assume that you sell a product or service for $100, while it costs you $60 to produce.
Your gross profit therefore is: $100 - $60 = $40. Then we subtract your fixed costs, admin and direct selling expenses, and end up with your base case Profit before Tax (PBT) of $10.
based on “Managing Top-Line Computer Applications”; Stephen P. Hindman & John J. Sviokla; Harvard Business School Publication # 9-192-098, rev 7/9/92
So, in this base case scenario, on sales revenue of $100 you make $10 profit before tax. So far, so good. Below, we will now make three different adjustments, each by just 5%, to illustrate how you can achieve dramatically different financial outcomes, depending on which lever you pull. Here we go:
Lever 1: Reducing Your Direct Selling Expenses.
Based on the base case scenario above, the table below shows the impact on your bottom line if you reduce direct selling expenses by 5%.
based on “Managing Top-Line Computer Applications”; Stephen P. Hindman & John J. Sviokla; Harvard Business School Publication # 9-192-098, rev 7/9/92
As you can see, reducing direct selling expenses by 5% improves profitability by only 3%. The improvement to your bottom line is only minimal. In fact, to me, this does not seem a hugely effective way to improve bottom line results.
Lever 2. Increasing Sales Revenue.
In this scenario, I make a different adjustment, also by just 5%, but in the other direction. Here, I will illustrate what happens when you increases your sales revenue by just 5%. In other words, what happens to your bottom line when you sell 5% more? Here it is…
based on “Managing Top-Line Computer Applications”; Stephen P. Hindman & John J. Sviokla; Harvard Business School Publication # 9-192-098, rev 7/9/92
In this scenario the business is now selling $105, i.e. $5 more than in our base case scenario. Leaving all other expenses the same as in our base case and just increasing your sales revenue by 5% makes a huge difference: Your bottom line improves by a massive 20%. That's a four-fold profit multiplier! But there's more: Something incredible happens when you do something perhaps a little counter-intuitive...
Lever 3. Raising Prices.
Look at what happens in this scenario if you were to lift your prices by just 5%.
based on “Managing Top-Line Computer Applications”; Stephen P. Hindman & John J. Sviokla; Harvard Business School Publication # 9-192-098, rev 7/9/92
The result can be a 50% improvement to your bottom line!
But: Discounting is a Huge Profit Killer!
The same dramatic effect above works also in reverse!
based on “Managing Top-Line Computer Applications”; Stephen P. Hindman & John J. Sviokla; Harvard Business School Publication # 9-192-098, rev 7/9/92
You see, discounting price by 5%, results in a bottom line profit result of just $5, which is a 50% DECREASE to your bottom line, compared to our base case scenario!
Discounting is a huge profit killer!
Discounting by 5% reduces your bottom line profit by a massive 50%.
So, think twice about cutting costs or discounting to win more sales, when you can lift sales and grow the business instead. Time You Review Your Sales Fundamentals.