Question

Topic: Strategy

Giving Away Margin?

Posted by Anonymous on 7/22/2008 at 3:20 PM ET 125 Points
I keep running into this argument from higher management in my company. It goes something like this:

"Don't feature and then put an item on special in the store, if they're already coming in for it. Then you're giving away margin."

I disagree with this completely. We operate on a 50% margin when other companies in our industry operate on a 42% margin. I believe lowering margin expectations slightly gives us the opportunity to entice a greater number of people (which will then make up that margin presumably lost in the first place). Also, how can you possibly predict what they're coming in for versus what special offer will drive them to come in?

So for example, when I write about a product in our e-newsletter and then feature it in our store with signage, I also want to put it on special (or offer a coupon) as an enticement just to get them in the door.

Is my argument fallible?
and if not, are there other arguments I can make to state my case? I'm sort of at a loss on this one....
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RESPONSES

  • Posted by Inbox_Interactive on 7/22/2008 at 3:27 PM Accepted
    I think the answer is, "It depends."

    I would not let your competition take the lead on how you price your product or service. Is there a compelling reason to drop your price by 15+%?

    If you think that volume will go up enough to bring about a higher return on equity, then you could consider lowering your price. But if you're already selling all you can sell at the current price, why reduce it?

    Either way, this question can not be answered in a vacuum. You might make the argument that cutting the price will bring a new customers who can then be sold other things...you might make the argument that cutting the price will make it impossible for your competitors to make money, so maybe they will get out of the business, etc.

    There are way more factors to this answer than the gross margin.

    - Paul
  • Posted on 7/22/2008 at 3:57 PM Accepted
    Hi there!

    Great question.

    I think you have received some great responses and they have wonderful value. I'm actually going to use some of those suggestions myself!

    For a different perspective, however, I ask myself this...

    Are you still making money on the product at the lower margin? The answer is yes, right? Here are my thoughts...

    Featuring an item in your e-newsletter is a perfect opportunity to truly educate your reader about the value of your product. Teach them about it, then "close" the sale with a special price. If your product is good, they will buy it next time at regular price. In other words...would you rather sell something at a lower price and develop a repeat customer or never sell that "something" at all?

    Hope my 2 cents is worth something!

    Kris
  • Posted by Frank Hurtte on 7/22/2008 at 4:04 PM Accepted
    The argument of Gross Margin vs Sales Volume is age old. Early in my own career as a sales engineer in the electrical industry, every request for lower margin was met with a 15 minute pontification on margin vs. volume. There is a place for cutting margin, but everyone involved needs to understand the ramifications.

    Ramification Number 1
    Cut the price once and people somehow believe the new price should have been the real price. For instance, I have purchased $39 containers of CD/Roms for $12 so many times, I no longer believe that they are really $39. If for some reason, I find myself paying the "real price", I feel like I have been cheated.

    What happens to the people who paid full price yesterday when you drop the price today?

    Ramification Number 2
    Volume vs. Margin Let's use the example of 50% Gross Margin vs. 42% Gross Margin. With Gross Margin defined as: Revenue from the Sale/Sale

    Asuume the part cost you $50
    50% Gross Margin = 50/50 cost + 50 mark-up
    42% Gross Margin = 36.21/50 cost + 36.21 markup

    Difference in revenue to the company
    50-36.21 = 13.79 per item sold

    How may extra must we sell to BREAK EVEN on revenue? Use the formula X*50 = (X +Y)*36.21

    We find that Y = .378X.

    Assuming we sell 100 today, we would need to sell 138 tomorrow to make the same money.

    What this does not take into consideration is: Cost of transactions, cost of warehousing, claims, shipments ect. These are part of another discussion but still worth considering.

    Now after this little (just shy of the 15 minute) pontification, what do you feel the impact to the company might be?

    My advice, think long and hard before messing with a good mover selling at a good margin.

    If you would like to talk in more detail contact me via my profile.
  • Posted by CarolBlaha on 7/22/2008 at 4:06 PM Accepted
    Running a special with the featured item creates a degree of urgency. It can move the customer off the fence and get him/her to move from "thinking about it" to "buy now". Their logic "they're going to buy anyhow" may not be logical. They might buy elsewhere, they may postpone the purchase. What will inspire them to move from just looking to buying-- for me, when all things are equal-- a special deal.

    I recently bought my fiancée a big screen TV. Competition here is fierce-- and everyone is running a special. But when one store gave me free financing on top of a good deal-- I bought. I don't "need" another TV and it wouldn't have caused me any pain to wait another 3 or 4 months. But that offer created the urgency that made me write the cheque.

    Your combining it with a feature in a newsletter is a perfect double punch. You create interest with your newsletter-- you create urgency with the special.

    Sell Well and Prosper tm
  • Posted on 7/22/2008 at 5:27 PM Accepted
    Franks post is very important to understand, how much more volume will you need to make the same money. Can it be done? Will other customers feel like suckers?

    In most cases I never discount the price, I add other things as free extras, or I give a cash coupon worth a certain amount, both with an short expiration date.

    Or if they buy the product now, they will get a coupon good for their next purchase.

    You can also say; buy now at this price before an expected price increase takes place.

    As the newsletter writer and promoter, these give you plenty of options to offer a special deal without cutting price.

  • Posted on 7/22/2008 at 6:00 PM Accepted
    According to studies done by the Professional Pricing Society, as a general rule prices have to change by at least 25% one way or the other to significantly affect a buying decision, I remember some years back I lowered a services marketing course by 25% in March. At the end of the year, I exactly 25% less revenue.
    If you need to move something for whatever reason, discount more than 25% but don't do it to increase your profits.
  • Posted by Tracey on 7/22/2008 at 6:00 PM Accepted
    How about doing a split test? That's what you'd do on the Internet, so why not in a store?

    Try it your way one month, your boss' way another month (assuming they are comparable months in typical sales volumes -- no big holidays) -- then you have some quantitatve data.
  • Posted by Jay Hamilton-Roth on 7/23/2008 at 10:00 AM Accepted
    It depends on your customer's behavior. If you advertise a "loss leader", then you'll get more foot traffic. However, if the result is people simply grabbing your cheap offering and leaving (making no additional purchase), then you've got a problem. If you can convert their visit to additional purchases, then you'll be covering your margin with volume and creating long-term customers.
  • Posted on 7/28/2008 at 8:05 PM Author
    Great responses from everyone. Thanks for your input. Excellent food for thought....
  • Posted by steven.alker on 7/29/2008 at 6:36 AM Member
    Every sales organisation agonises about giving away margin in order to boost turnover. Few bother to do the simple calculations presented by Frank and even fewer know what the elasticity of demand (Which defines the relationship of Price with Volume) actually is. It’s hard to measure because of unconnected variables, such as linking it to an advertising campaign.

    If you set out in a table, your possible selling prices, your fixed costs and your variable costs, you will end up with a matrix of figures which will allow you to calculate how many discounted products you have to sell in order to exceed your profits at a higher price.

    As you have no way of knowing where you are on this curve (Or taken as a whole, these curves) the best you can do is to look at the credibility of your scenarios. If at the moment you sell 1000 to make $10,000 in profits, it might be unlikely that you would sell 1,000,000 were that to be the number the equation dictates you must achieve, were you to discount, say, by 30%

    Linking a promotion with a discount is a red herring. If the figures indicate that you won’t make the numbers with a transient promoted discount, because they are unrealistic, you might as well not do it. You may not be losing money but you will be making less than you could make for the sake of a short-lived promotion which will tie your hands on price for as long as people will remember it.

    Tim Smith – known here as Wiglaf – is a pricing expert and he has written extensively on discounting for volume – with or without an accompanying campaign. The advice; over and over is to do the numbers and then look at the credibility of the scenario. If this is good enough for pricing at Unilever, it sure should be OK for the rest of us!

    Steve Alker
    [URL deleted by staff]
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