The folly (or possibly the wisdom) of discounting

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By Francis Moran

I doubt if there’s a single business ever that hasn’t been asked at some point or other to discount its prices. For startups, it’s almost an inevitable part of the process in bringing their technology to market. There are pros and cons to discounting but, as you can probably guess from the headline, I’m not a big fan.

Here are some circumstances where discounting most often comes into play.

1. To win early customers

I’m of two minds about this. Many startups discount their product — hell, some of them discount it all the way down to zero — to get those critical first customers. If you’re going to cut your pricing for early adopters, you need to make certain you get something in return. From a marketing perspective, the best thing you can get is honest customer feedback that helps you improve the product and so make it worth more to subsequent customers and, when you’re ready, enthusiastic endorsements you can use in marketing and media materials.

The greatest downside of this strategy is that it sets pricing expectations for the future, certainly for those first customers and potentially for the marketplace as a whole.

I am with Mark Evans in not being a fan at all of startups giving their product away for free, and I’m highly skeptical of the freemium model. That’s not discounting, per se, but it comes from the same mindset that says our product isn’t good enough to get people to pay for it. I much prefer the “bold, confident revenue model” that Rick Spence wrote about yesterday.

2. To win the business, period

I am currently involved with a group of partner companies in a competitive process for a large piece of business. As part of our submission, we had to list our hourly rates. Because ours is a partnership of more than one agency, we have several senior people on the bid, all listing our grievously exorbitant rates. The prospect has come back to us to say that this looks bad compared to single-agency submissions where there may be only one or two senior folk listed. So, for political purposes as much as anything, we have agreed to nominally ratchet back our rates.

A past mentor of mine used to caution me about “buying the business;” that is, discounting to the point necessary to get the business but at the expense of ever showing a profit on it. We saw this a lot in our industry in 2009 after the economic upheavals sent every client fleeing for safe harbours, which usually meant slashing marketing budgets. Business volumes crashed and those clients that were spending were in the driver’s seat, pricing-wise. We saw some of the largest multinationals come in on proposals at prices that were way below ours, and at a fraction — perhaps as low as 50 percent — of what we knew to be their normal rates. With huge overheads and all kinds of infrastructure they had to keep lit, these outfits were literally buying business so as to cover their massive sunk costs.

3. To win volume

This can be a defensible strategy but you must be certain that there is still a healthy margin after you’ve discounted for volume. As a cleverer wag than me said, “It’s not a good business model to sell a dollar for 89 cents and try to make it up on volume.”

This whole blog post was sparked by a lament from a marketer I know who complained that once again his company had been suckered into giving a discount on a volume purchase that never materialised. “Time and again, we say yes when someone says, ‘I’m going to buy 20 so give me a discount.’ Then they buy the first one or two at the discounted price and we never hear from them again.”

You can protect yourself from customers using this shady practice by insisting on full price for the first one or several of your product that you ship, with the price declining gradually as their orders actually come in for the promised number.

4. To liquidate excess inventory

Industries where inventory becomes immediately perishable at a fixed time — think of an airline or a hotel where any level of revenue for a seat or a room is preferable to having it be empty when the plane takes off or the night rolls over — have developed very sophisticated models for predicting exactly what their ongoing inventory levels are going to be and they use complicated discounting strategies designed to maximise revenue on their inherently perishable products.

Few B2B technology companies are in such a situation, but they may still see merit in selling off excess inventory — products that are about to be replaced with updated versions, and so on. If you’re doing this often, however, it’s a sign that there is something broken in your planning processes.

5. Don’t just roll over

Like I said at the outset, being asked to cut your prices is almost inevitable, and it most often happens when the negotiations get down to the short strokes. If you know it’s coming, be prepared for it, and as any good negotiator will tell you, don’t give in without getting something out of it. Determine in advance how much of a discount you are prepared to give to close the deal and exactly what you want in return. I’ll give up a few points to get faster payment terms, for example. Since you know they’re going to ask anyway, why wouldn’t you have your answer ready?

Image: iView Systems


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