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The Potential Pitfalls of Discount Pricing

By Anthony Taylor - July 22, 2011

In an episode of the office (if you don't watch the Office, you should!) Michael and his new company, The Michael Scott Paper Company, realized that despite gaining many new customers from their main competitor by discounting their product, this business model was not viable long-term. Their key value proposition was being the cheapest paper in town, cheaper than other big retailers. Although they thought this would work on a fixed cost structure, they were operating with a variable cost structure, which meant that as their company grew and incurred additional expenses, their profit margins would be stretched and not sustain their growth.

That's one reason that you don't want to be a discount retailer: you can't grow on slim margins.

There are many retailers that do very well on a discount model, however they almost always operate with economies scale, and have additional value that they provide aside from being the least expensive.

That said, if your key value that you bring to you customer is being the least expensive, what is stopping a competitor or new entrant to the market to undercut you? There goes your unique value proposition (UVP) and your company will lose its customers to this new lower price offering.

Another potential pitfall of having a discount pricing strategy applies to services billed at an hourly rate. By undervaluing your service, it has a drastic effect on your income over time. For example, this here is a difference between 2 fee structures for the same services: one charges 50$/ hour and the other 40$/hour. Although there is a significant difference at the beginning, the disparity increases over time, assuming a year over year income increase of 10%. By year eight, there is already a 20$ disparity, or double the original difference between them.

Another example comes from the corporate world, with Subway sandwich shops. They discussed this topic on a Harvard business review podcast, and I thought it was worth sharing. When Subway had their 5$ foot long promotion to boost sales during the recessionary period, it definitely increased sales, but had negative impact at the end of the promotion. Customers got used to paying that discount price, so when prices returned to normal, they weren't willing to pay more for what they had been getting for 5$.

Conversely, Quiznos offered a new line of smaller sandwiches, at a cheaper price point. As opposed to cheapening their high quality products, they increased their offerings to have something that fell into that discount umbrella to compete with Subway, without suffering from that post promotion sales drop.

These are just a few examples of how a discount strategy can hurt you in the long run if you don't plan appropriately . That being said , if you have good relationships with buyers and suppliers, or if you have great supply chain your business can potentially benefit from a discount pricing model . The most important thing is that you have a good strategic plan, and that you don't rely solely on your discount strategy as the value that you offer your customers.