Discounted selling prices have their place, but don’t let a sinking profit margin pull your business under water as well.
Discount with great care: fundamentals are called that for a reason
I was reminded yet again this week not to take things for granted, and that particularly simple things can have important repercussions.
A good friend, an intelligent and experienced business executive, was making a rather emphatic point to his colleague that their gross profit margin (GPM) was the same thing as their average mark-up percentage – it isn’t. What is interesting though, is that the percentages often seem to catch people unawares, and sometimes with devastating consequences.
So let’s clarify.
Mark up is the percentage increase in price between what you buy a product for and what you sell it for. You buy a product for $100 and sell it for $130 – that’s a 30% mark up on the cost price. But even without the inclusion of any other direct sales costs, this $30 mark up represents a gross profit of only 23%. So mark up and gross profit are of course different (the percentage is calculated against a different “base” – mark up uses the cost price and GPM uses the sale price).
Now you decide to have a sale. You discount the selling price of your product (it was $130) by 25% to really get things moving. Unfortunately, no matter how many units you sell, you will still be losing about $2.50 on each of these products sold. Of course you could use this product as bait (sorry, as a “loss leader”) to draw customers who will hopefully buy other products with healthier mark ups, but that’s another story.
I know of a pretty smart business that has a great product offering, but an overly complex sales pipeline. Now even though it was essentially a simple business, they managed to make a substantial deal with a “name” client. It was only later when they were less blinded by their own magnificence that they realised they were losing fifty bucks on every unit sold to this client. Metaphorically, that’s like taping a $50 note to each product before you ship it. Luckily it was only a three-year deal!
- Know how your percentages work – the Chinese (and others) are masters at this. They can offer a discount, bundle, recalibrate and nail the exact margin they want to get in the blink of an eye, or in their case, without blinking.
- Discounts need to be used judiciously and strategically.
- Simplify your systems so you know exactly what your input costs are.
If you would like a copy of a two-page document called “Margin Magic” I wrote many moons ago for a friend in retail, email me via comments below and I’ll send you one.
Mark Robilliard and business partners Peter Frampton and Carmen Mettler started a journey to find a new way for anyone to ‘get accounting’ and use it in their job and life to create value. Accounting Comes Alive was born and now provides workshops all over the world using their unique Colour Accounting™ learning system that really does work, for anyone.
To read more Mark Robilliard blogs, click here.
John Oxley writes: Please send me a copy of “Margin Magic”. Your generosity is appreciated.
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