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When a business owner considers how to price a product or service, they must weigh many factors—things like supply and demand, production costs, profit margins, customer behavior, and competitive research—to name a few. It helps to understand the most common pricing models, and when it’s best to implement each one.
In that spirit, we’d like to discuss a tried-and-true strategy used by all sorts of companies: discount pricing. Businesses that engage in discount pricing tend to do so only on occasion, and will alternate discount pricing with other pricing paradigms.
As we delve into the details of this powerful but potentially harmful methodology, you’ll quickly see why discount pricing should be used sparingly. We’ll show you not only how to avoid the pitfalls of discount pricing, but also how to effectively use this model to your advantage.
Discount pricing is deceptively simple. Reduce your prices, and you’ll sell more of your product. Unless your competition has you on the run, however, why would you deliberately decrease profits by lowering price? It turns out there are a lot of possible reasons. Here are some of the most common:
The hope, of course, is that you’ll reap the rewards later of cutting the bottom line now. We’ll explore below whether that’s a risk worth taking. First, let’s take an in-depth look at how discount pricing works.
Discount pricing is a generic term for a variety of methodologies that rollback price tags. We’ll examine each one in turn.
Many companies offer a lower price to those who buy in bulk, as a reward for customer loyalty. This discount might incorporate an incentive to purchase more product now (buy two, get one free), or it may include a cumulative reduction for those who make frequent purchases (come 10 times, and your 11th visit is comped).
This tactic is particularly useful if you’re a business-to-business (B2B) company, or if you sell your goods wholesale—both of which move a larger volume of product. In these cases, all parties benefit from such discounts. You sell more merchandise, and your customer receives a larger markdown, which they’re likely to pass on to their customer(s). It makes sense, then, to employ this strategy when you’re selling items with a higher profit margin, so you can afford to discount multiple items.
Loyalty discounts are similar to bundle and quantity discounts, but such incentives focus more on how long an individual has been a customer, as opposed to how many items they’ve purchased—though there are loyalty programs that are a hybrid of the two.
Loyalty discounts often take the form of special sales and promotions available only to these VIP consumers, and the idea is to make customers feel valued. Clients who believe they’re appreciated are more likely to exhibit brand loyalty.
Loyalty rewards are also an excellent way to upsell your existing clientele, using the data you’ve gathered about their purchasing habits. If the customer just bought a certain item, send them a loyalty discount for related items, and you’re likely to make another sale. After all, because they’re a long-term customer, you know what they’re willing to buy, and what they might need at this time. Use that information to your advantage, and personalize your offer(s).
Seasonal discounts are markdowns given at specific times of the year, or in honor of special festivities. Before and after Christmas, during three-day holiday weekends, and on Black Friday and Cyber Monday are well-known examples of this practice. Because consumers expect a price decrease at these times, you avoid the perils that can come with discount pricing (which we’ll discuss later in detail) when your company participates in such sales.
Customers also anticipate that you’ll clear out seasonal items at the end of their life cycle (bathing suits are deeply discounted toward the end of summer, for example), so you can dump excess or unwanted inventory during these intervals without raising any red flags. You might even increase your bottom line as you move a larger volume of product.
Seasonal discounts also reward clients who are willing to buy during off-peak periods, can generate buzz, and might lead to an upsell. If a consumer purchases sale items from you, use that opportunity to showcase your latest and greatest merchandise—and you might entice them to make a full-priced acquisition as well.
Promotional discounts are a catch-all term that encompasses all the discounts we discussed above plus any other short-term markdowns you might choose to offer. You might decide to lower prices merely because you need a quick boost in sales, but you’ll have better success with this tactic if you find a tie-in for your promotion.
You can offer special perks to first-time customers, unearth an Irish ancestor and discover a deep desire to celebrate Saint Patrick’s Day, or choose to fête your dog’s birthday. It matters less what the reason is, and more that you have one. Consumers are suspicious of discounts that appear with no apparent motive, and they may wonder if your company is either in trouble or is so profitable that it can afford to provide discounts at will.
Similar to how you might use loyalty rewards or seasonal discounts to upsell a client, loss leaders are deep markdowns designed to spark customer interest in your product, with the hope that they’ll also buy more profitable merchandise. Use popular brands as your loss leaders for maximal efficacy, and change them often. After all, you want to draw in the maximum number of consumers for the minimum cost, and keep them coming back for more.
You might choose to create your own club, or provide discounts for those who belong to special groups like AAA or who are military personnel, senior citizens, etc. Such reductions can buy goodwill with customers, and thereby pay for themselves.
There’s no one-size-fits-all formula for when to deploy discount pricing. Your strategy should vary based on the product’s history and its relationship to the market. For example, if demand for your merchandise is high, you needn’t consider discounts. However, if demand is low, the proper discount pricing strategy might provide a much-needed boost in sales. Here are some circumstances that may call for discount pricing:
We’ve discussed the upside of discount pricing, and when it’s best to employ this strategy. Now let’s look at the potential negatives of this powerful methodology.
Use discount pricing sparingly, as doing so too often may affect your market share and may ruin your ability to sell merchandise at full price. There are a few reasons for this possible backlash. First, if you constantly provide discounts, your customers may become hesitant to buy from you when there’s not a sale on, as you’ve trained them to wait for markdowns.
Second, many consumers associate low prices with low quality. If your brand is newer or less well-known, regular discounts may cause customers to perceive your product as inferior to that of your competitor. Many clients will pay more for an item they believe to be superior.
Finally, consistent markdowns may attract new customers, but they don’t necessarily breed brand loyalty. Those who choose your company due to low prices are more likely to jump ship when the newest game in town shows up with even lower prices.
Remember that it’s far more difficult for consumers to accept price hikes than decreases. Beware the race to the bottom when it comes to discount pricing. You may never again rise to the top.
As we’ve seen, discount pricing isn’t always an ideal paradigm. When it’s time to decide whether such markdowns are right for your business, ask yourself whether you compete with similar companies primarily based on price or on brand reputation.
If price wars are the norm in your industry, then discount pricing is probably a necessity. Be sure you follow the suggestions we’ve given above to avoid the common pitfalls of these markdowns, and to help make your strategy a success.
If, however, your business is all about reputation, think twice before you implement discount pricing. Most companies compete on a hybrid of price and standing, and carry products that can fall into either category. If that’s the case for your enterprise, apply discount pricing on a limited, item-by-item basis.
There will always be a bigger company that has greater buying power and that can furnish similar goods for a lower price. Ultimately, what will set your business apart is how well you communicate why your product differs from the competition. Emphasize in your marketing efforts the value proposition that you alone can present, and provide excellent customer service. These are the principles that build a loyal customer base.
Price is merely one element that consumers consider when they make a purchase, and it’s often not the deciding factor. Offer discounts on occasion, if you deem that appropriate, but focus on creating the best product or service possible. That is how small companies become large, successful corporations.