It is probably safe to say everyone in the rental business has experienced a business situation that involved discounting. If our competitors do it, we rail about how destructive tactical discounting is and how it destroys value; we also wonder why our competition can't compete on service, product or something other than price. If we're doing it, we are often very good at rationalizing why for this situation, for this client, for this cause, it is a smart strategic decision.
Discounting has a place when it increases your turns, as long as the real increase in your business exceeds the threshold needed to yield incremental gross margin dollars by specific product line. Just as each product line (dance floor, tenting, china, linen, heaters, etc.) has its own set of useful life, acquisition cost and labor component characteristics, each line has its own gross margin contribution. To deploy discounting across the board may result in sales, but it will consume a disparate percentage of your inventories' useful life, and it is a real cost that will have to be paid at some time.
A business focused on increasing its gross profit or gross margin as opposed to its gross sales or revenue is often a happier place for all concerned. If you have a business that averages a 40 percent gross margin by giving a 20 percent discount, you have in effect said to your organization, “Let's now do twice the work we would need to do if we booked business at full price.” Every discounted dollar directly reduces your gross margin but has zero effect on reducing costs.
Here, we will explore a variety of circumstances where discounting may be wise:
Is your market seasonal? In markets where you find you're off 50 percent or more some months, you may find that discounting prompts entities who are not your clients to consider using you.
Where do your clients come from? Destination locations differ from metropolitan locations, and those within the sphere of a metropolitan area differ from those directly in metropolitan areas.
Is your market segmented? Obviously, markets with a mix of large competitors and many small competitors have the worst of all worlds, and discounting may make sense to differentiate an operation where many options already exist.
How many niche suppliers are there in the market? Tenting, dance floor, linen, lighting and heating suppliers all “niche” the generalists and cause them to consider bundling options, as are found in other industries.
Who is adept at sourcing? Thanks to efficient sourcing, some companies have much lower equipment costs. In those cases, discounting can be a tool that can leverage against that.
How do clients view discounting? We see competitors who dismiss this, but fortunately, clients soon devalue that competitor's product quality.
What is the nature of the rental company's clients? Clients who are small businesses — say, primarily caterers or small venues as opposed to large hotels — are often desperate for savings and will look short-term for any financial advantage. In contrast, large businesses will try to extract permanent discounts using their market dominance.
Sometimes emotion rules over rational thought. Discounting might be retaliation to a current competitive action, it might be revenge related to a previous encounter, or it might just be based upon dislike of a particular competitor. Regardless of the reason, this decision isn't about margins or math or any other business principle. It's often mutually destructive but difficult to prevent.
If after keeping a few general rules in mind you still feel your objectives can be attained, then perhaps discounts should be a tool in your kit and something you plan for on a yearly basis.
Rule No. 1 Depending on your gross margin in a particular product line, a certain percentage increase in revenue must occur to justify your decrease through discounting your gross margin dollars. For products that have a gross margin below 45 percent, a 15 percent discount will require you to increase sales approximately 50 percent to remain margin-contribution neutral. For products with a gross margin above 50 percent, you can achieve margin neutrality when your revenue increases in that product line as a result of your discount by approximately 40 percent. Large, across-the-board discounts make it impossible to yield a positive contribution to your company's gross margin.
Rule No. 2 If you provide discounts, you should strive to make your overall revenue on a particular job increase from where it would have been without the discount. Your clients need to be your partners in this endeavor and help you help them by taking more products or some other action that creates a positive gross margin improvement on that transaction. Clients who take without giving are clients you should consider giving back to your competitors.
Rule No. 3 Discounting is a budget line item that needs to be reviewed just as you review other components of your business. Every client does not deserve the same discount. Every discount dollar is precious, and once you make a decision to give it, you are best served to make it count as if it is the last one you have to give.
It is the proverbial bird in the hand versus two in the bush. What is the cost of having an asset not in use? What is the benefit in doing an incremental transaction? How many more transactions do I need to achieve to get margin positive as a result of my discounting? These questions can be answered differently, and that is what keeps this a topical item in our business.
Marshall Bauer is president of Sonoma, Calif.-based Wine Country Party & Events; www.winecountryparty.com.