When does a discounting strategy make sense?

August 10, 2010

Unless your product is a “perishable” product like a hotel room, airline seat, or bananas, discounting for the purpose of generating revenue without adequate profits is a bad idea.

DiscountDiscounting strategies do make sense in certain circumstances.

If your product or service has a perishable life then it may be a candidate for using discounting strategies. I am not talking about selling bananas but they certainly are a kind of product that suits itself to this strategy. I am really talking about products like airline tickets, hotel rooms, rental cars, and other products where the business has a pretty high fixed cost and low variable costs to provide.

Certainly hotel rooms qualify because the costs of a hotel mortgage are quite high (fixed costs) and the variable costs of the running the hotel is low in comparison. When a hotel is located in a high demand area it makes a great deal of sense to discount in the week or so prior to the expiration date of the potential booking. The time when it would not be a good strategy is during a period when occupancy is expected to be near capacity, like during a weekend festival when many out of town visitors will be renting hotel rooms.

Companies like Hotels.com make sense because they aggregate deals for cities you may travel and need to stay at a hotel. The catch is you have to pay in advance, so if your trip is cancelled for some reason, the amount of money you spend (less Hotels.com commission) is nearly pure profit for the hotel and helps a hotel owner get to and pass its break-even point.

Recently I discovered a website that shows one deeply discounted product or service for the day for a given community. www.livingsocial.com is a simple website that lists one “deal” per day in 16 U.S. cities. It gets the word out via a daily email. On the day I looked at the advertised specials on Living Social’s websites around the country I found a 50% coupon for a rock climbing gym, 50% off Brazilian bikini wax services (ouch!), 55% off a session of bowling, and 52% discount off of home maid service. Each of these discounts features a service that has a high fixed cost model and a low variable cost component.

For these companies that have high fixed costs and low variable cost, discounting may make sense to promote your company or service. With a service like Living Social, they may sell quite a few pre-paid services which do help cash flow and potentially increase customer awareness of the company having the promotion.

Since Living Social shows how many people purchased a specific deal during the day it was offered, I looked at one deal where the average price paid was $90 for a popular $180 normal price, I calculated that the merchant promoting their service brought in real cash of about $135,000 in the deal. The pre-paid service offer expires on December 31, 2010 and it is likely that there will be quite a few unused services at the end of the year. For this merchant that has a seasonal business, the strategy is perfect.

With the use of the Internet and social media, certain kinds of companies like I have described have a perfect opportunity to integrate a discounting promotional strategy into their overall business model.

Topics: Sales, Management, Blog Posts, Strategic Planning

Sam Thacker

Business Finance Solutions

Sam Thacker is a partner in Austin Texas-based Business Finance Solutions. He has spent the last 16 years in the banking and finance industry as a commercial lending officer, banking consultant and advocate for small business financing. He has originated over $400 million in loans to hundreds of businesses in many industries. Sam has been on the financing end of numerous businesses over his banking career. Sam is a nationally respected working capital finance professional and writer. In addition to helping small companies obtain working capital financing using a variety of assets, Sam writes a widely read finance column which appears three times a week in many traditional and online news outlets throughout the United States. He writes about the challenges of small business finance, accounting, and best business practices. He has been praised by readers for his ability to explain a complicated financial concept in easy to understand terms. Sam also writes a once a month business column for the Austin Business Journal . Sam regularly teaches classes at Texas State University’s Small Business Development Center (SBDC) on financing small businesses, financing government contracts, and other topics of interest to small businesses.
Read more articles from Sam Thacker

Guide to Business Borrowing

Learn what banks are looking for when they prepare to make loans. Our guide covers what business owners need to know when they prepare to borrow.

BBoT-COVER-GeneralBorrowing

Download eBook