May 15, 2013

40% Off

This is pretty much the limit, as far as pushing the peanut on percentage off promotions.

I suppose you could go to 49% off plus free shipping.

Once you get to 50% off, you're in the realm of clearance, and that sets off a whole different customer mindset.

There are at least four theories, surrounding discounts and markup.

The first theory is that you are able to charge a high markup as a premium for offering highly desired merchandise.  The most successful companies I work with tend to earn gross margin rates that are in the low 60% range.  In other words, the $49.99 item that we purchase costs the business $20.  This business model works really well in fashion, and for proprietary merchandise (i.e. items that others cannot easily replicate/duplicate).

The second theory is that you charge a high markup, so that you can stimulate demand by marking down the item.  The $49.99 item that costs the business $20 is manipulated ... take 40% off ... so that the customer perceives that a $29.99 item that costs the business $20 is a great deal.  This is the JCP model.  Once you go down this path, you cannot reverse-engineer it.  You can't.  You've built a customer file that loves playing the game ... take the game away, and you take the customer away.  For this model to work, you need (in my example) three times as many customers to purchase the item to generate the same amount of profit.  This model can work well when merchandise is a commodity.  This model almost becomes the default when competition is stiff.

The third theory is that you charge a small markup, so that you can stimulate demand by offering everyday low prices.  The $24.99 item that costs the business $20 yields $4.99 profit ... you need to sell six times as many items to generate the profit you generate at $49.99 ... however, you change the marketplace by offering low prices, and this change drives out the businesses that offer comparable items at $49.99.  This is congruent with Wal-Mart, or Amazon.  This model results in what the pundits like to call "scale", and offers significant competitive advantages.  Of course, it's terribly hard to "scale", isn't it?

The fourth theory is desperation.  Business is not meeting expectations, so you simply start discounting.  10% off.  Sales increase.  Wow!  Next year, 10% off doesn't get you anything.  15% off.  Sales increase.  Wow!  Then sales flatten again.  Then it is 20% off.  25% off.  30% off.  35% off plus free shipping.  40% off plus free shipping.  You can pretty much take this model to 49% off plus free shipping before customer perceptions change.

The first three theories are viable business strategies.

The fourth theory aligns with what most of us do, and there are unintended consequences that offset the short-term sales increase you get from discounting.  Just analyze your customer file, and you'll see the unintended consequences, when viewed over time.