‘Common-sense’ says that discounting is bad for business or a necessary evil that we tolerate only when necessary. We create sales cultures that promote the idea that salespeople shouldn’t discount their wares. Testosterone-fuelled sales managers disdain sales reps who discount deals perceived as ‘too low’ and sales reps themselves play games of bravado sticking to price that put deals at unnecessary risk. We need to change this attitude, because compared with sales reps “leaving money on the table”, a rigid pricing culture is a bigger problem.
Let’s say you’re hell-bent on getting a specific price out of the market. The simplified diagram below shows you selling Q1 products at your P1 price with your average cost (AC) against a demand curve showing all demand for quantity Q at price P. Pretty simple – the more you charge P, the less quantity Q you will sell because there are fewer people with a willingness to pay the higher price.
The blue rectangle represents the total profit you can pull out of the market at that price. The small red triangle is the amount of money you’ve “left on the table” because these people were willing to pay a higher price than you sold at. The people in the larger triangle to the right of the profit rectangle are the people who need your product but won’t pay your price.
Now there might be a couple of reasons why you would choose not to pursue the available market at lower prices:
1) You can’t produce or provide more than Q1 units of your product.
2) There are limited substitutes for your product or service. How often does Louis Vuitton have a “SALE!” sign in their store window? Why doesn’t Apple discount their products to the public more than 10%? The substitutes for either are limited. If you like OS X vs. Windows, you need a Mac from Apple. Apple has done a great job of making their experience unique vs. buying a Windows machine – whether it be the experience of buying in their store or using the Apple products.
3) You have a very small number of customers making very large and public deals and price integrity will affect your profit on your next deal. If you’re Boeing and selling a bunch of planes, your customers will know generally who paid how much for what.
In the vast majority of cases selling technology, I expect you can sell as much as you want and you’re in a competitive business with (from a customer’s perspective) nominal differentiation between you and your competition.
Discounting at the field sales level can have strategic importance for your business. By distributing the discounting down to the field rep level, the company gains the ability to capture buyers with a willingness to pay at different price points. The diagram below shows how a lot of individually-negotiated deals can conceptually capture more profit available in your market:
There is a lot of opportunity to use discounting to strategically capture more profit. Rather than derided as an incompetence, it should be integrated into the sales strategy.
Willingness-to-pay (WTP) is going to depend on customer size, value and importance of the business problem being solved, geography, competition, and a number of other factors too numerous to control. One could say that it is unrealistic to expect that your list price is anywhere close to finding the right number of customers willing to pay that amount and therefore discounting is essential.
Some companies that understand this concept set their list price near the maximum WTP and know that the discounts will slide along the demand curve until it meets their average cost + minimum profit, at which point they have a ‘floor’ set for their sales teams. You can see examples of this approach where you see discounting in markets that typically lands between 30-40% or more.
The challenge is one of ensuring your salespeople accurately identify the willingness-to-pay for each of their customers. This is an issue of sales and negotiating skill, and perhaps where sales managers should spend more resources developing in their sales teams and manage via a profitability KPI. Explain to your salespeople that discounting is a strategic tool used to identify the WTP for each of their customers, and that their job is to carefully negotiate to accurately identify that WTP on each deal.
As a manager, you should see some variance on a salesperson’s deals based on each customer’s different WTP. If you see abnormally low priced deals from one sales rep, you need to find out why. You may have a sales rep who is taking the easy way out and selling cheap and fast to turn volume. That’s the one to worry about. You might legitimately see ‘clumping’ between geographies and vertical markets as they will have specific common attributes – New York City’s corporate mix and WTP is likely different than the mix in Wichita, Kansas. But it shouldn’t be in the basement for only one rep for a sustained period.
Sales reps ARE going to leave some money on the table here and there due to variance in negotiating skill, but it will be insignificant compared with the larger market share you’ll obtain.
We need to strategically embrace discounting as a business tool, make it strategic, and capture more profit for our business. We don’t need to blame weak salespeople when in fact they might be doing exactly what they’re designed to do.