Lesson #364: Do Major Holiday Discounts Help or Hurt Your Business?

 

What is it about Memorial Day, July 4^th, Labor Day and the Christmas season?  They bring out all the big discounts, which gets shoppers flooding to the malls to save money, especially on big ticket items like cars and mattresses, as examples.  And the sellers of those products bring out their best prices during these holiday seasons, trying to capture has much market share against their competitors as they can.  But the question I ask is: why?  Yes, you are driving more revenues, with the holidays often representing 30% of their total annual volume.  But, if you are sacrificing material bottom-line profits by slashing prices in the process, why play that game?  This post will dive deeper into whether you should or should not deeply discount your products, during the holiday season or in general.

The Psyche of the Typical Consumer

 Before trying to address this topic, it is important to understand the psyche of the typical consumer.  Throughout the generations of shopping, retailers have trained consumers to expect certain behaviors, including when to expect discounts.  One example worth calling out is J.C. Penney.  J.C. Penney was one of the most successful retailers in history, commanding a dominant market share at their peak.  But retailers like Kohl’s and Target starting to take market share away, through better quality products and better prices.  Kohl’s was particularly effective with their Kohl’s Cash, that would give the consumer a credit on their next order at the same time they were checking out on their current order, giving the customer a reason to return to the store for another purchase before losing their cash.

J.C. Penney tried to combat this, and save their company, with an “everyday low prices” approach, getting rid of discounts altogether.  But that strategy did not work.  Consumers were simply too trained by the other retailers to look for discounts, that they only shopped from the stores offering them, even if the net prices of the products were exactly the same.  This “no discounting” strategy may work well for a high-end brand like Nordstrom, serving an affluent demographic that is less price conscious.  But it does not work well for penny-pinching, mainstream consumers.  So, the point here is:  discounts definitely play a major role in the psyche of the mainstream consumer, and you need to decide when and how best to use them.

The Typical Economics of a Holiday Sale

Let’s look at the mattress industry, as an example, that runs heavily discounted promotions during each of the major holiday seasons.  Let’s say the average mattress costs $1,000 at regular prices.  And, that price drops to $750 (25% off) during the holiday sales.   And let’s say a mattress seller is doing $100MM in revenues per year, with 30% of their annual sales happening during the holiday periods.  That means their typical gross profit margin of 50%, may drop to 25% during the holiday sales.  And their bottom line net income margin may drop from 20% to -5% during the holiday sales.  What that suggests is that $70MM of their revenues at full price are driving $14MM in bottom line profit, and $30MM of their revenues at the discounted price are driving a $1.5MM loss, for a total net income for the year of $12.5MM (a 12.5% blended profit margin).

My Initial Reaction

I feel we, as businesspersons, are so focused on scaling revenues and market share, that we don’t put enough thought behind, “at what cost” did those revenues come.  To me, I could be perfectly happy, not participating in the discounting seasons.  Yes, I would end up with a much smaller revenue business, leaving 30% of potential revenues “off the table”.  But my bottom-line net income and profits margin would actually have been $1.5MM higher, by not “giving the product away” at deeply discount prices.  The point here is:  just because everyone else is doing it, doesn’t mean you have to do it too, as profits may be a much better metric to maximize than revenues, depending on your goals.

What You Risk By Not Discounting

Profits is not the only metric you need to concern yourself with.  There may be some downside risks of not participating in the holiday discounting seasons.  That includes: (i) there are certain individuals that cannot afford your full price, and can only afford your discounted price, so you are consciously leaving that demographic unserved; (ii) by not getting your brand name front-and-center during the holiday sales, your competitors are getting more “mind share” of leading brands in the industry, potentially leaving your future brand awareness in the rear-view mirror; and (iii) you are not taking into consideration the lifetime value of the consumer—yes you lost money on the first sale, but you will make it back with their customer loyalty on the second, third and fourth sales.  Many of the major retailers just swallow the bitter discounting pill for reasons like these.

Concluding Thoughts

So, the real question here is: should you or should you not be heavily discounting your products during the holiday seasons?  I think the answer to that question largely depends on the market you are serving and what your competitors are doing.  If you are a high-ticket product, discounts can be very helpful to acquiring customers that would otherwise have been lost.  But if you are a high-end brand where customers are less price-sensitive, they most likely would have still purchased at the higher price.  To me, discounting is a tool you can use to clear out distressed inventory.  But it should not be a tool you use to capture market share at all costs.  Sometimes it is better to stay out of that battle and live to fight another day, at much higher profits.  That said, if you are a high repeat purchase product, acquiring customers at a deeply discounted price can be a great way to accelerate longer-term revenues and profits through repeat sales from those customers.  Good luck making the right decision for your business.  It will come down to which metric is most important to your business—near term revenues or profits, or long-term revenues or profits.

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