Do Stores Lose Money When They Discount Products?

Many retailers and businesses engage in discount pricing to attract customers, boost sales, and clear out old stock. However, the common query is whether such discounts inevitably lead to financial losses for stores. This article delves into the factors affecting the profitability of discounted products and the strategies behind discount pricing.

Understanding the Factors

The profitability of discounted products is determined by several critical factors, including the Cost of Goods Sold (COGS), the volume of sales, the effectiveness of inventory management, and the strategic goals of the store. Each of these elements plays a crucial role in whether a discount leads to a loss or not.

Cost of Goods Sold (COGS)

The COGS represents the direct costs attributed to producing a product. If a store sells a product at a price lower than its COGS, it indeed incurr a loss on that particular sale. For instance, if the cost of production is $50 and the store sells the product at $30, the loss per item is $20. This scenario is particularly common with items that require significant production or purchasing costs.

Volume of Sales

While a single discounted product may result in a loss, higher sales volume can offset these losses. If a store can sell significantly more units due to the discount, the overall revenue and profit can increase. For example, if a store sells 100 units at $30 each, generating $3000, even if each unit incurs a $20 loss, the total loss of $2000 can be offset by other higher-margin sales.

Inventory Management

Discounts can help clear old or excess inventory, which is particularly beneficial for cash flow and space management. Holding unsold inventory can lead to additional costs, such as storage and spoilage for perishables. Clearing this inventory through discounts can prevent these losses.

Customer Acquisition and Retention

Discounts can attract new customers, and encourage repeat business, leading to long-term profitability. For instance, a 70% discount on clothing might still be profitable if the markup is 7 times the cost, resulting in a net profit exclusive of carrying costs. Additionally, discounts can build customer loyalty, which can translate to repeat purchases and referrals.

Market Positioning

Some stores use discounts as a strategic tool to position themselves in the market. They may accept short-term losses for long-term benefits, such as brand loyalty or competitive advantage. For example, a loss leader pricing strategy can attract new customers into the store, where they are encouraged to make additional purchases.

Dependence on Discount Percentage

The percentage of the discount plays a significant role in the profitability of the sale. For clothing, which is often marked up 7 times the cost of goods, even a 70% discount can still result in a profit. Similarly, if the retail price is twice the cost of goods, a discount of 49% can still yield a profit.

Strategic Use of Discounts

Not all discounted items result in losses. When a business intentionally discounts an item to a loss, it is often to entice customers into the store. These loss leaders are products that are sold at a loss to attract customers with the hope that they will make additional purchases. In such cases, the store aims to make up for the immediate loss from the loss leader through higher-margin sales of other items.

Conclusion

In summary, while discounts can lead to immediate financial losses, they are often part of a broader strategy to achieve long-term profitability. Effective management of COGS, volume of sales, inventory, and customer relationships can turn a seemingly risky discount into a profitable business move.

Keywords: discount pricing, cost of goods sold (COGS), inventory management