In this second of a two part examination of return on investment Brian Conway of Channel Sales Mastery reveals the alarming impact discounting has on your business and what alternatives you have to make you more profitable.
Last month we defined R.O.I. and looked at why a “Discount” is one of the first things a customer asks for. We saw how it’s the easiest way for them to improve their financial justification; but it’s not the only way. The problem is, if you don’t know any other ways, then discount is the only tool at your disposal to try and close the business.
The issue with discounting is that you carry all the risk. It’s your margin that you’re giving away. Granted there are some benefits to using this tactic, I can’t deny that, but let’s look at why we should make this the last resort, not the first thing we do.
If you truly understand what I’m about to explain, you’ll never want to discount again…
Let’s say we have a deal worth £150k and your cost of sale is £115k This would leave you with a nice profit of £35k and a margin of 30%.
Let’s say our customer asks for a 10% discount, which we agree to give them. Our deal value would now be £135k, our costs stay the same, so our profit becomes £20k, giving us a margin of 17.4%.
On the face of it, there’s nothing too alarming there, we gave away 10% and we lose just over 12.6% of profit.
But… if we want to make up the profit we’ve lost from discounting, i.e. the £15k, we would need to sell an additional £86,250 because we are now working on a 17.4% margin. Our order value would therefore have to be £221,250!
That’s a deal size increase of 64% just to stand still…… all because we gave away 10%.
That would require some serious selling to find that additional 75% of order value!
So here are three alternative things you can do that will improve the business case without the need to discount.
1. Spread the cost
In other words look to avoid a large capital upfront payment by the customer, but instead look at leasing or a deferred payment programme. In Fig.1 you’ll see that by spreading the cost, each year achieves Payback and a positive R.O.I.
2. Find more value
If you are more consultative in your selling and look to truly understand how and where in your customer’s business your technology creates value, you will grow the positive returns. As you can see, this creates Payback sooner and provides a 35% R.O.I. in year 2 compared to 0% based on the standard figures.
3. Bring the Benefits Forward
If we can find ways for the customer to start realising the benefits sooner, for example through the use of Professional Services to shorten deployment timescales, or through training to improve customer adoption of things like collaboration tools, then the returns will be realised sooner.
There are two benefits to doing this. Firstly, this further increases the value we mentioned in point 2, which will continue to increase the positive returns for each year and improve the R.O.I. and Payback as we’ve seen. But there is also an additional benefit…
As we know, simple inflation means that money today is more valuable to us than money we have years from now. Businesses take this into account when they credit the proposed returns to the business case, by discounting their value in the future. This is called Net Present Value; N.P.V. So in a more sophisticated R.O.I calculation, the returns in years 2, 3 and 4 will be less than our simple R.O.I. model shows.
Therefore, the sooner the returns are realised, the less this discounting impacts the proposed value they bring in, and the stronger your business case. The stronger your business case, the less you have to discount your price at the front end.
In summary, discounting your price to the customer is not a healthy sales practice. It has a significant negative impact on your business as you’ve seen, and there are alternative.
Discounting is a habit our industry seems to have embraced, which has led to commoditisation and a market of resellers trying to undercut each other on price. Armed with the above information, stop, the next time a customer asks for a discount, and ask yourself how can you improve the business case without giving away margin, profit and your business success.
Brian Conway – www.ChannelSalesMastery.com