General introduction to discounts
This article series describes different types of discounts and their effects on your customers and your business. So if you are providing your services as a freelancer or selling things online, this guide is for you.
Before we talk about discounts on services or products, we need to define what a discount is and how it affects a buying decision. We also need to understand the long-term effects of discounts and keep them in mind if we provide a discount.
What is a discount?
A discount is everything that reduces your price to get to a buying decision. It starts with the well-know discounts by x percent or a specific value like $10 that we all know and ends at discounts which provide a free month or more for a service with the option to get on a paid plan later. We will have a look at all these discounts separately but dig into some general assumptions beforehand.
If we talk about discounts, we also need to talk about customers. In general, giving discounts implicitly includes the assumption that your customer compares your price with the price of someone else or another product. This is rarely the case, especially if you are in a very big market where the customer has lots of choices and can't make a fully informed and rational decision anyway.
As an example, we take the buying process for a new fridge. This is something most people have done in their lives and they likely think that they made a completely rational decision there. The problem is that for a rational decision, they would need to know the whole market of fridges. How does a rational decision look like? We need a way to compare all fridges with each other in a way that gives objective results. But how do we do this in the first place? They all have different features and it's nearly impossible to compare them and assign a value to every feature itself. Sure, there are very general features like the space they have and the energy that they consume but what's the value of an ice machine in comparison to more space on the inside of the door? Is there a rational value that you can assign to vertically- or horizontally-split doors?
If you have these things in mind, it does not only come down to personal preference but also to your experience in the past. Maybe you had a fridge with an ice-machine and never used it.
These are things that have a huge impact on the buying decision but they are completely separated from the price. So giving a discount won't change your buying decision here and it's pointless from a selling perspective–the only effect it has is this: It reduces your margin.
Discounts also have psychological long-term effects on your customers. So if you are giving discounts regularly, your customers will expect them in the future and only buy if your products and services are discounted.
A good example of this is the car industry where you don't buy a car from a dealer without a discount. Sometimes, you don't even ask for the discount but get offered one automatically. The reason for this is that all car manufacturers (except Tesla) offer discounts on their cars if you just ask for them. They mostly have a list so that every car dealer can give you the same discount on the same model with the same features and you can't go to two dealers and get different offers for the same product.
As a result, their whole industry is broken and can't have comparable list prices on their websites as this won't be the price that you pay eventually. It also means that it's very hard for them to change that–if they try to sell you a car for the price already on their website, you won't buy that car because you are afraid that they cheat you.
Discounts also come with legal boundaries and business implications. This is the reason why most of them have a small asterisk and long terms and conditions attached. If you are giving a discount, you have to make sure that it can't hurt your business. So if a product costs $100 to manufacture and usually sells for $110, a discount of 50% off does not only lower your margin but costs you with each sale.
This might be obvious, but if you are running a SaaS and providing the service to an average customer costs $5 a month, it will cost $5 per customer if you are giving away the first month for free. If you somehow attract only power users with your discount, this cost can skyrocket and have a massive impact on your cash flow, especially if the attracted customers only stay in for the free month and do not convert to paying ones later.
Most of the complex discounts with many legal implications will be covered in the part about SaaS because you need to make sure to limit the discount to specifics groups there and mitigate negative long-term impacts.
This post is the first post in a series on discounts. You can find the other posts in my developers guide on discounts:
- You are here
- Discounts on services
- Discounts on one-off products like software, (e)books and online courses (soon)
- Discounts on SaaS platforms (soon)
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