Understanding the True Cost of Discounts: A Lesson in Long-Term Value

Discounting has become a common strategy for many brands, often used to attract new customers or boost conversion rates. However, the true impact of discounts on your business’s long-term value (LTV) may be more significant than you realize. Let’s delve into why discounting might be hurting your LTV and explore some strategies for finding the right balance.

The Double-Edged Sword of Discounts

Discounts might seem like a quick win, but they come with hidden costs that can undermine your business’s profitability over time:

  1. Immediate Margin Loss: Offering discounts eats into your immediate profit margins on each sale, reducing the revenue generated from the first purchase.

  2. Lower-Quality Customer Acquisition: Discount-driven customers often exhibit behaviors that contribute less to long-term profitability. They may be more focused on seeking out discounts in future purchases and less likely to become loyal, repeat buyers.

Crunching the Numbers

Let’s break down the impact of discounts using some simple math:

Full-Price Scenario:

  • Average Order Value (AOV): $100
  • Discount Rate: 0%
  • Expenses/Cost of Goods Sold (COGS): $70
  • Orders per Customer: 1.5

LTV = ($100 – $70) * 1.5 = $60

Discount Scenario:

  • AOV: $100
  • Discount Rate: 25%
  • Expenses/COGS: $70
  • Orders per Customer: 1.5

LTV = ($100 – $70 – $25 discount) * 1.5 = $10

As you can see, the difference in LTV between the two scenarios is staggering. While the full-price scenario allows for a break-even Customer Acquisition Cost (CAC) of $60, the discount scenario results in a significant loss of $50 per customer.

Finding the Right Balance

Here are some key considerations for navigating the world of discounts while preserving your long-term profitability:

  • Evaluate Your Unit Economics: Understand your costs and margins to determine how much discounting your business can sustain without sacrificing profitability.
  • Explore Alternative Discount Strategies: Get creative with your discounting tactics. Consider options like gift-with-purchase offers, product bundles, upgraded shipping, or cashback incentives on future purchases.
  • Segment Your Customers: Recognize that not all customers are created equal. Segment your audience based on their behavior and preferences, then tailor your discounting strategies accordingly.
  • Know When to Pull Back: Set clear boundaries for discounting based on what your economics can support. Don’t sacrifice long-term profitability for short-term gains.

Conclusion

Discounting can be a powerful tool for driving sales, but it’s essential to understand its impact on your business’s bottom line. By carefully considering your unit economics, exploring alternative discounting strategies, and segmenting your customer base, you can strike the right balance between acquisition and long-term profitability. Ultimately, brands that master this balance will emerge as winners in the competitive landscape.

 ————————————————————————————————————————————————————————

Have a look at our case studies, you can see how we implement our knowledge onto our clients.

Let's help you with your advertising today.

Call Now