Kicking the Discounting Habit

How many times have you felt the need to discount deals to meet your quarter or year-end sales objectives? We have yet to meet a client who could honestly say “never” to the discounting. When you have responsibilities to run a business, the pressure to keep the revenue flowing, to meet payroll, and to keep employees productive is tremendous. That pressure is sometimes alleviated when markets are growing and customers are plentiful. But when industries slow down, as they inevitably do, the pressure to discount goes up exponentially.

Let us be clear, the problem is not discounting. Sometimes lowering price is the optimum response. It's the habit of discounting—the unthinking and throw-caution-to-the-wind desperation—that's so destructive. It's the addiction to discounting and planning every sale to include one. The difficulty with discounting, as with all addictions, is that it is difficult to stop. Organizations get used to discounting. They defend it as “industry practice.” Our clients tell us, “We have no choice but to discount because our competitors are discounting.” In fact, the competitors just look like they are unreasonable because they have the same addiction. By the way, the competitors describe you to their customers the same way.

A good place to start in kicking the discounting habit is to calculate what the habit is costing the organization in profitability and lost opportunities. This is not an easy calculation to share because it requires a number of awkward conversations that have the goal of the organization acknowledging it has a bad habit. Denial is a powerful force. What's required is a disciplined and fearless pricing team that is good at tracking the discounting. If you want to even think about challenging a habit, a good first step is to invoke the price/volume plot described in Rule One.

Cycles of Desperation

Take a look at the situation from the point of view of the salesforce. When salespeople get their objectives or quotas for the year, they base their ability to deliver results on a number of assumptions of their own. Assumptions such as having the right product mix, delivering products on time, and getting a feel for what competitors do. This is where the wheels begin to fall off the wagon. Nothing ever happens as projected. Interest rates go up. Currency exchange becomes unfavorable. Product delivery is interrupted. Competitors drop prices (imagine that). Customers get more price sensitive. When things don't go as expected, it leads to what we call cycles of desperation.

Suppose the salespeople have been trained to negotiate well. Or they have a limit to how much they drop price. In either case, the results are the same. Salespeople do the best they can to hold the line. Do they get rewarded for that? Nope. What happens is that at the end of the period—month, quarter, or year—if the organization is short of the projections, managers get off their collective behinds and go out to do what is necessary to close the gap. That means closing business with customers, whatever it takes. There's an old business adage that says that if the only tool you have is a hammer, all problems look like nails. So it is with managers who need to make the numbers. They have a problem, and the only tool they have is price. Hence the reflexive discount.

The White Horse Syndrome

Managers today want to be regarded as heroes, saving the day, avoiding awkward questions. Instead what they usually do is drop prices. And far from solving their problems, they undermine the organization's value proposition. We call this the “White Horse Syndrome” in honor of television shows in which a complicated problem of long duration is resolved when a hero such as the Lone Ranger rides into town in a cloud of dust on a white horse to save the day. Then, as quickly as he arrives, the hero departs, saving everyone the unpleasant task of asking awkward questions such as, “How did we get into this mess in the first place?”

One manager refused to play this no-win game until the division president got desperate. It was a business downturn, and the division president's bonus was at risk if the division did not deliver on goals. The executive's reaction was predictable. He authorized an end-of-month discount to distributors who would buy forward. The results in the first month were great: The company made its numbers that month and the division president enjoyed his bonus.

The next month turned out different, of course. In order to take advantage of the generous discount, customers had placed the order to cover the needs of the current month so there was no order this month. What did the executive do in response? Yes, he ordered another discount for buyers to fill up the pipeline. This strategy is unsustainable, and we know that what is unsustainable will have to stop. Did the company make its numbers? No. Remember, they were in a business downturn. The company needed to adjust its expectations, not manipulate pricing to generate groundless numbers.

The company stopped its discounting lunacy in the third month and decided to face the music. In the last week of the third month, the distributors were clearly holding their orders, waiting for another price cut. When the additional price cuts didn't materialize, customers started calling, asking when the discounts would be coming. When they heard that there were no more discounts, they started placing their orders as they had done in the past.

Using price as the primary competitive weapon in most markets doesn't buy any additional business; it just gets customers to focus more on price and less on value. The executive missed his numbers and had to forfeit his bonus. But worse, the company lost hundreds of thousands of dollars in profits by offering discounts they didn't have to.

White Horse Syndrome Effect on Sales Force

How about the effect of the White Horse Syndrome on the sales force? The salespeople quickly learn that if the managers are going to focus on price, they should, too. They stop focusing on value. They worry less about being good negotiators. When a customer asks for a lower price, they either give it to them or say they have to check with their manager. In either case, the customer knows they have won. Salespeople begin to have less regard for what is in the long-term interests of the company. They stop listening to the value rhetoric coming out of senior executives' mouths.

To make matters worse, the firms that buy into the White Horse Syndrome begin to develop systems that formalize the dysfunctional process. Forms and policies are created to dictate who can control price. Whole departments spring up to support the process. Price exception requests accumulate. Everyone learns how to play the game. Smart salespeople learn how to be the internal squeaky wheel that demands and obtains the lower price for their customers. Uncontrollable discounting becomes part of the corporate culture, embedded in the corporate DNA, unexamined and unexaminable. Confidence in any pricing strategy goes out the window.

Then the gross rationalization starts. Executives mistake the difficult conditions they have created for a state of affairs they cannot control. The mantra becomes, “Boy, it's a brutal industry we're in.” Pessimism becomes a badge of honor. Talk about value is dismissed as irrelevant. “Hah! Value selling will never work in our industry. It's too tough here,” they say. Fortunately, nothing could be further from the truth.

Here's an example of how this works. We were recently collaborating with a senior executive interested in kicking the discounting habit in his business unit, a division important to the large conglomerate. We helped the executive build price/volume plots for several product lines. He and his team calculated the plots, considered the outliers, and figured out which customers they could expect the sales teams to control. Did he get pushback? Sure, he got a lot of resistance. But with only a very few exceptions, he used his authority to create the confidence his sales teams needed. The result? Dramatic increases in both units sold and prices paid. In part, his work made his division the star of the conglomerate.

Never in a Vacuum

Discounting never occurs in a vacuum. Companies and managers develop systems and processes that allow discounting to flourish. Discounting occurs despite vigorous attempts to control it. Many companies have implemented systems that place barriers on salespeople who want to offer discounts. Managers do that because they think it limits the discounting. The company institutes a deal exception process to review requests for deeper discounts These processes get more cumbersome and more people in the chain of command review deals. The president of the business unit must sign off on discounting requests. Soon that becomes 80% of their workload.

It's this discounting mindset that gives customers the entry point for obtaining lower prices that are often not necessary to close the sale. We don't blame customers for negotiating for discounts. We blame the discounting habit. We've seen discounting justified in every conceivable way. Some companies justify it by customer. These companies start off by giving discounts only to their largest customers. These are the big customers, perhaps the marquee opportunities in the industry, and they order lots of products and services. Perhaps the volume of business they transact legitimizes the discount. But invariably the companies succumb to discount creep, the expansion of a project or mission beyond its original goals, often after initial successes. Then the midsized and smaller accounts start getting discounts, too.

Many companies justify discounting by product. In these cases, discounts are offered only for commodity products with intense competition. Again, discount creep kicks in. Pretty soon, the company's newer technology, innovative high-value offerings start getting discounted, too. Sure, there are some justifications, such as the ability to get the low-value commodity products put on the purchase order as well. But the results are the same. Companies end up leaving money on the table in the negotiating process.

We worked with a SaaS company that provides data to enable its customers to target consumers for precise marketing campaigns. The company was founded by two engineers who developed an innovative algorithm-based data solution. Like most engineer founders, their focus was not on pricing but on data manipulation and their delivery platform. The founders spent all their energy growing the company and partnering with each customer to increase usage metrics. After hitting a milestone of $100 million in revenue, the founders realized that their pricing strategy wasn't keeping up with innovation in technical areas. They asked us to make recommendations about how they could optimize pricing.

We did an assessment and immediately discovered something we didn't expect. The company was exceptionally good at resisting demands for discounts from new customers. In fact, the company was really good at onboarding new customers willing to pay the undiscounted list price. Then we looked at historical pricing data. Now the situation became problematic. We were able to demonstrate that the longer the company served a particular customer, the more likely the customer would get a discount.

This behavior might be justified if the discounting generated more volume per customer. To evaluate this hypothesis, we overlaid the discounting behavior against the volume per customer. Guess what we found. Change in price had no significant impact on volume. The sales team was just giving price away to keep their best customers happy.

We also found that their market was not very elastic based on how their customers used their product. Customers were either going to use the SaaS product or they weren't. Rarely did a high or low price determine how much of the product they were going to use. Basically, the volume they were getting was consistent while the pricing fluctuated. We chatted with their customers and determined that they can in fact increase price based on the value they were providing and not lose any volume based on how the customers used their solution. The company put a stop to such discounting and saw increases in revenue and profits.

Desperation Pricing During Inflation Won't Work

We are in the worst inflationary period in four decades. Every expectation is that inflation will be with us for quite some time. Based on the calls we are getting; we understand that many of our clients are concerned about operating in inflationary times. Here's our first piece of advice: You are not alone. No one has experience operating in inflationary times. Moreover, there's nothing you can do about general inflation. It's bigger than any individual corporation. It's bigger than any individual nation. It's truly a global dynamic.

Companies with a culture of discounting will really struggle to implement effective price increases. These increases to cover increased costs are vital. All customers must take the increase. If not, the company will suffer from Dumbbell Pricing, that is, high prices for some customers and low prices for others. This will cause your most loyal customers to lose trust in you and drive your overall base to poker-playing behaviors.

Our second piece of advice about inflation: realize that you can't “price” (i.e., discount) your way out of inflation. Why? We'll talk about that in Rule Five: Strategy Sets Direction. All discounting will do is attract the price-sensitive customers who you probably won't want to deal with because such buyers tend to be unprofitable. And that's the best scenario. The worst scenario is one that happened recently with one of our clients.

We were engaged by a professional services company, which confronted both an increase in costs (inflation) and a slowdown in demand. What did the company do? It started discounting to make up for the decline in demand. Of course the strategy failed to address the business problem. After we reviewed the situation, we understood two things. First, we saw that the company was discounting without benefit. In other words, the discounting did not generate the uptick in demand it anticipated. Second, the impetus for the discounting was coming not from the sales team closest to the customers but from the increasingly desperate senior leaders of the organization. The problem, we understood, was worse than just discounting. The company had actually started a price war with its competitors, leading a race to the bottom where demand was as elusive as profits and revenue. The solution was to develop some Selling Backbone (Rule Nine: Build Your Selling Backbone to Increase Profits).

The third piece of advice: stop and think about what you are doing. When in the midst of a crisis, its leaders may be sorely tempted to do something, anything. But rather than reacting to the problem, first stop and consider what may be the actual root cause. Think through the problems of discounting and look for a better way. In some situations a company must hunker down, cut costs, and possibly survive during the problem years. That's how we and many of our clients got through the pandemic and the last recession.

Inflation imposes a unique set of challenges. The worst response is to do nothing for too long and then decide that the only way to survive is a drastic price increase. The results are usually predictable. The departure of your best customers and a dramatic decline in profitability. Even if the discounting succeeds in onboarding new customers, they tend to be price buyers. These customers tend to fill up your business with special requests, complaints, returns, and other demands that overload your service teams. Meanwhile, the service teams have less attention to your best, most loyal customers, causing some of them to jump ship for better customer service. It's difficult to convert price buyers into the kind of loyal, profitable customers that companies depend on.

What to do in times of inflation? Raise prices surgically as soon as you see your costs rising. Don't make the mistake of annoying your customers with incremental price increases. Raise prices and justify the increase with an apology, a justification, and a commitment to use the increase to find ways to continue to provide better products and services. Most customers have done the same thing with their customers, so they will understand. And while you're adjusting for inflation, take a hard look at the price buyers who may have crept into the customer mix. Most of these price buyers are probably unprofitable for the company. Fire them, and let your competitors have the honor of losing money on them.

None of This Is Easy

We understand that as readers consider the lessons of this book and our associated advice, they may think, “It's easy for you to say.” It isn't. Just like you, we have a business to run, customers to service, payroll to meet. None of the advice we give is predicated on the idea that any of this is going to be easy.

The second objection we often hear is, “You don't know our industry.” The truth is, both sets of objections are raised by people who resist change. Now, change isn't easy. We tend to focus our energies on clients who see the need for change and want a hand in understanding what change is needed and how to make the transition as smooth as possible. We never tell clients that the change will be easy. As for those who resist change, our first task is education. We want to communicate the benefits that might derive from a change in how the organization confronts issues about pricing, competition, and discounting. We've learned that, irrespective of product or service or location around the world, the habit of discounting can be brought under control if the firm's leadership sets their mind to it.