Sometimes Discounting Leads To Positive Results

The secret to discounting is to generate more gross margin dollars and build a stronger customer file (for some, it is to liquidate merchandise, but that is a topic for another day). The goal should never be to steal market share, because honestly you'd have to be a ten billion dollar brand (or larger) for that to even make the slightest difference.

So, if you choose to sell a $50 item with a $20 cost of goods for $35 via your promotional/discounting program, you must sell twice as many units to equalize gross margin erosion.

I worked with a smart brand who knew what this relationship looked like, and they discounted only enough to make the math work (or, in this case, come very close to working). In their case, I created regression models that predicted how much customers would spend next year on items selling at/above their historical average price point, how much customers would spend next year on items selling below their historical average price point, and how much gross margin dollars customers would generate next year.

For customers who spent $100 on items at/above their historical average price point and spent $0 on items below their historical average price point ...

• $64.41 spent next year on items at/above the historical average price point.
• $8.44 spent next year on items selling below their historical average price point.
• $73.05 spent next year, total.
• $45.37 gross margin dollars generated next year.
• 62.1% future gross margin.

For customers who spent $0 on items at/above their historical average price point and spent $100 on items below their historical average price point (discount-centric customers):

• $56.51 spent next year on items at/above the historical average price point.
• $28.74 spent next year on items selling below their historical average price point.
• $85.25 spent next year, total.
• $44.27 gross margin dollars generated next year.
• 51.9% future gross margin.

This company comes really, really close to getting the math right. Full price customers generate $73.05 next year while discount-centric customers generate $85.25 next year. Discounting led to customers who spent 16.7% more in the next twelve months. However, full-price customers generate a 62% gross margin next year while discount-centric customers generate a 52% gross margin next year. Full-price customers generate one extra dollar of gross margin in the next year.

This is one way to make discounting work. As long as gross margin dollars are equal/greater and as long as the customer file is stronger, the math "can" work. I have a responsibility to share this fact with you.

But you have to do the math, perform the analysis, and understand the tradeoffs. At minimum you have to take the math down to future gross margin dollars. In a smarter world, you'd include pick/pack/ship information as well, and take into account any additional p&l metrics that matter.