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While reading P. Barrow’s The Best-Laid Business Plans, I came across an interesting argument he had against giving discounts as a small business. The reason for writing this post was to inspect the simple but condensed table of data he provided (”Pricing Ready Reckoner”) which in the space of less than a third of a page, makes a very clear case against discounting.

Here’s the argument. In order to maintain the same level of profit, you would have to sell much more depending on your original Gross Margin and the amount of Discount. The amount of extra sales needed in each case is summarized in the following table as percentages.

The math is simple if you do not claim a portion of the margin, you have to make up for the difference by increasing sales. But the engineer in me wants to make the calculations more formal:

G=gross margin (%)
R=retail price for unit
D=discount (%)
S=number of items sold, S’=number of items sold (in discounted case)

Without discount we have:
Gross margin=R×G
Cost of Goods Sold per unit=R×(1-G)

With the discount, on the other hand:
Sales revenue per unit=R×(1-D)
Cost of Goods Sold per unit=R×(1-G), remains the same
New gross margin=R×(G-D)

To make the same level of profit
S’×R×(G-D)=S×R×G

Which means we have to sell (S’/S-1) percent more to compensate for the discount:
100×[G/(G-D)-1]

The rest is easy: put the Formula in a spreadsheet and you get that nice table above. There is another table in the book which shows the flip side of the situation: price increase. But I spare you.

As a final note, I believe that you could still make a good case for giving discount on your products/services for a variety of reasons such as building relationship in hopes of recurring customers, gaining market share, etc. However, Paul’s argument is interesting and makes the assumptions that your customers buy from you because of the flexibility, quality, and the service provided. Further, I would like to add to this list the fairness and competitiveness of original pricing.