When Is the Right Time to Sell at Lower-Than-Normal Margins?
“My sales are up 30 percent but profits are down 10 percent! What happened?”
This is something we hear all the time from our clients. All too often, business owners will try to boost sales and revenue numbers by selling products or services at discounted prices. They say they’ll make up for it in volume.
But if they actually calculated how much of an increase in sales volume it would take to make up for the discount, they would probably fall out of their chair. Discounts erode profit margins. In most cases, you make less money by cutting prices than you would if you made fewer sales at a higher margin. Gross revenues may go up, but profits typically go down.
The Painful Math of Price Cutting and Lower Profit Margins
Suppose your profit margin is 30 percent. You drop your prices by 10 percent. If you want to make the same amount of money, you would have to increase your sales volume by 50 percent. That’s not opinion. That’s simple math.
On the other hand, suppose you have that same 30 percent profit margin, but instead of cutting prices, you decide to increase prices by 10 percent. You could absorb a 25 percent decrease in sales volume and still make the same amount of money.
Another problem with cutting prices and ramping up sales is that you add overhead. At the same time, profit margins are lower, and you’re probably not increasing sales volume enough to cover the difference. In other words, the cost of doing business is increasing but you’re not making any more money. You start running out of cash because you don’t have enough money to support a high-volume sales model.
When you start down that path, you can “grow” yourself right out of business.
When It Might Make Sense to Sell at Lower-than-Normal Margins
Chasing sales at lower margins isn’t necessarily profitable. However, there are four types of situations in which selling at a lower margin could be a viable strategy. Of course, every situation is unique and there are always caveats, so proceed cautiously.
- If you have a product that hasn’t been selling for a long time or is close to becoming obsolete, it might be better to sell the product at a lower margin, or even no margin, to generate cash. This is obviously a better outcome than simply throwing the product away and taking a total loss.
- If someone is or has the potential to be a solid, loyal client, offering the occasional discount on your product or service can entice them to buy more in the future. It can also show your mutual loyalty and earn their respect.
- If you have the opportunity to generate significant additional sales volume by reducing your price, accepting a lower margin might make sense. As we mentioned earlier, the increase in sales volume required to make up the difference is probably higher than you think. But if the additional sales volume is significant enough to actually increase profits, a discount is worth exploring.
- If a lower-than-normal margin is expected to result in incremental business that won’t cause a spike in your fixed overhead costs, a discount might be warranted. In other words, you have the staff and capacity to handle higher sales volume without adding expenses, so the sales translate to pure profit.
Profit Margins Are More Important than the Number of Sales
When sales numbers are down or flat, the natural instinct for many small business owners and entrepreneurs is to sell their product or service at a discount. Even if this results in more sales and an increase in gross revenue, is the discount solving the problem? In other words, is higher sales volume translating to higher profits?
In many cases, the answer is “no.”
It’s extremely difficult for a small business to offer a high-quality product or service and achieve high sales volume with high profit margins. Realistically, you can’t do all three. You have to choose the model that works best for you and adds up financially. Just remember, the lower the margin, the less room for error. Think long and hard before you decide to sell your product at a lower-than-normal profit margin.