Discounts are easy to give and hard to take back. A discount that looks small on a price tag can cut your profit by far more than it appears, because it comes straight off your margin and not off your costs. This guide shows how to test a discount before you offer it and how to choose ones that earn their cost.
See the real effect on profit
Suppose a product sells for 50 and costs 30. The profit is 20 per unit, a margin of 40%. A 10% discount takes the price to 45. Costs have not changed, so the profit falls to 15, and the margin to 33.3%. A 10% cut in price has cut your profit per unit by 25%. A 20% discount takes the price to 40, leaves a profit of 10, and halves your profit per unit.
How much extra volume do you need?
A simple formula tells you how many more units you must sell just to stand still. Extra volume needed = discount ÷ (margin − discount), with both as percentages of the original price. With a 40% margin, a 10% discount needs 10 ÷ 30, or 33% more units. A 20% discount needs 20 ÷ 20, or 100% more units, double your sales. If a promotion cannot realistically deliver that, it will reduce your profit, however busy it feels.
Types of discount
Volume discounts reward larger orders. Early payment discounts reward paying quickly. Seasonal and clearance discounts shift stock. Loyalty discounts and coupons bring back customers or attract new ones. Bundles sell more by combining items. Each has a different purpose, and judging them by that purpose is better than asking whether the price is lower.
Testing a volume discount
Take a product that costs 11. Selling 1 to 9 units at 20 gives a margin of 45%. From 10 to 49 units at 18 gives 38.9%. From 50 units at 16 gives 31.25%. Each tier still earns a profit, but the larger the order, the more you must rely on the extra work being saved. Check each tier against the costs you really save, such as packing and handling, and be sure the volume tiers are not set so low that most customers qualify for the discounted price.
Early payment discounts
A discount such as 2% for payment within 10 days on a 30-day invoice works out to a high annual cost, around 37%. It may be worth it if you need cash and the alternative is expensive. Otherwise it simply gives away margin. We explain this in how to get paid faster.
Clearance and seasonal sales
Discounting slow stock can be sensible if the alternative is holding it for months. The relevant comparison is the discounted price against what the stock will be worth if it stays unsold, not against the original price. Releasing cash also has value. See inventory turnover for how to find the stock that needs this.
Protect your brand and customers
Frequent discounts can train customers to wait for the next sale and weaken the perceived value of your product. If you do discount, give the sale a clear reason and an end date, and consider discounts that do not change the shelf price, such as bundles or gifts with purchase.
Control discount codes
Codes spread. A code meant for newsletter subscribers can end up on a coupon site. Set limits, such as one use per customer, an expiry date, or a minimum order, and review how much of your revenue is being discounted. If more than a small share of orders use a code, it is no longer a promotion but a price cut.
Show discounts clearly on invoices
On an invoice, show the discount as its own line, with the percentage and the amount, so the customer sees what they saved and your records show it clearly. Our invoice generator has a discount field that does this and recalculates the tax and total.
Work it out before you promote
Use our discount calculator to see the sale price and saving, and check your margin at that price with the markup calculator. For the pricing side, see markup vs margin. This guide is general information, not financial advice.
