The Hidden Math of Discounts
Discounts seem straightforward: take 20% off, sell more. But the math tells a different story. When you discount, you're not just reducing revenue. You're disproportionately reducing profit.
Consider a product that sells for $100 with $40 cost (60% margin). A 20% discount means:
- Before: $60 profit per unit at 60% margin
- After: $40 profit per unit at 50% margin
- Profit drop: 33% reduction in profit per unit
- Volume needed: 50% more units just to break even
This is why discounting can be dangerous. A seemingly modest 20% discount requires 50% more volume to maintain the same profit.
How Discounts Erode Your Margins
The lower your original margin, the more devastating discounts become. Here's how different margins respond to the same 20% discount:
70% Margin
+40%
Volume needed for break-even
50% Margin
+67%
Volume needed for break-even
40% Margin
+100%
Volume needed for break-even
30% Margin
+200%
Volume needed for break-even
At low margins, deep discounts are nearly impossible to recover from through volume. A 20% discount on a 30% margin product means you'd need to triple your sales just to break even.
When Discounting Makes Sense
Despite the math, there are legitimate reasons to discount:
Clearing Excess Inventory
When products are tying up capital or warehouse space, selling at reduced margin can free resources for better-performing inventory. The alternative of holding costs may exceed the discount loss.
Customer Acquisition
First-order discounts can be justified by customer lifetime value. If a customer's LTV is $500 and you offer a $20 first-order discount, that's a small acquisition cost for a valuable long-term relationship.
Seasonal or Perishable Products
Products that lose value over time (seasonal items, trending products) may be worth discounting rather than holding until they're unsellable.
Competitive Response
Sometimes you need to match competitor pricing temporarily. Just be strategic about how long you maintain discounted pricing.
Alternatives to Price Discounts
Bundle Discounts
Offer discounts when customers buy multiple items. This increases AOV while providing perceived value. A "buy 2 get 20% off" deal typically performs better than a flat 20% discount.
Free Shipping
Free shipping is often perceived as more valuable than an equivalent price reduction. Customers hate paying for shipping. Use free shipping thresholds to maintain margins.
Gift with Purchase
Offer a low-cost item free with purchase. The perceived value often exceeds the actual cost, especially for items with high perceived value like beauty samples or accessories.
Loyalty Rewards
Points or future credits encourage repeat purchases without immediately reducing margin. Not all points are redeemed, and those that are come from repeat customers with higher LTV.
Smart Discounting Strategies
Set Volume Thresholds
Use this calculator to determine break-even volume, then only maintain discounts if you're hitting those targets. Cut unsuccessful sales quickly.
Time-Limit Promotions
Urgency drives action. Short promotions (24-72 hours) generate concentrated sales and limit the period of reduced margins.
Segment Your Discounts
Don't discount for everyone. Target inactive customers, first-time buyers, or specific segments that need an incentive to convert. Avoid discounting for customers who would buy anyway.
Track True Incrementality
Many discount-driven sales would have happened anyway. Measure whether discounts actually drive incremental purchases or just shift timing.
Frequently Asked Questions
The 'safe' discount depends entirely on your margin. For high-margin products (60%+), discounts up to 20% are typically manageable. For moderate margins (40-60%), keep discounts under 15%. For low margins (under 40%), even small discounts can be dangerous. Always calculate the break-even volume increase before running a promotion.
Track three metrics: volume increase (are you selling more units?), revenue (is total revenue up despite lower prices?), and profit (is absolute profit maintaining or growing?). A successful discount shows all three improving. If volume is up but profit is down, the discount isn't working.
Selling below cost (loss leaders) can make sense in specific situations: clearing dead inventory that has holding costs, acquiring customers with high LTV, or driving traffic to buy full-priced items. Never use it as a regular strategy, as it's unsustainable and can damage brand perception.
It depends on price point. Research suggests consumers prefer percentage discounts for lower-priced items and fixed amounts for higher-priced items. For a $50 product, '20% off' often sounds better than '$10 off.' For a $500 product, '$100 off' may be more compelling than '20% off.'
Train customers with consistent pricing by making sales rare and unpredictable. Avoid regular sale cycles that customers can anticipate. Use personalized discounts for specific segments rather than site-wide sales. Consider loyalty programs that reward full-price purchases instead of frequent public discounts.
References
- Shopify - How to create discount codes that drive sales without destroying margins.
- Harvard Business Review - The hidden costs of discounting and pricing strategy.
- McKinsey - The power of pricing and impact of promotional strategies.
