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What a Discount Really Costs You, Shown in Margin Math
A 20% discount sounds like a fifth off the price, yet for a business that keeps 40 cents of each dollar after supplies and commissions it removes half of what the visit earns.
At a glance
- The break-even volume for a discount is how many more customers a business needs to earn the same dollars after lowering its price, and the formula is discount ÷ (margin − discount).
- At a 40% contribution margin, a 20% discount requires twice as many visits, a 100% increase, just to stand still.
- In a Rice University study of 324 businesses that ran daily deals, only 19.9% of deal customers came back to buy at full price, so the extra volume a discount brings rarely stays.
Every dollar of discount comes out of what the visit earns
A discount comes entirely out of the part of the price a business keeps, because supplies, product, card fees and commissions cost the same whether the customer pays full price or not. That kept portion is the contribution margin, the price minus the costs that rise with each visit, and it is usually far smaller than the price, which is why a modest markdown takes such a large bite out of it.
Pricing research shows the same effect from the other side. McKinsey's analysis of the average S&P 1500 income statement found that a 1% price increase with steady volume would raise operating profit by 8%, more than three times the effect of a 1% increase in volume; a small business with thinner margins feels the arithmetic even more sharply, since each point of price is a larger share of what it keeps.
The break-even formula follows directly. If the margin is m and the discount is d, each discounted visit earns (m − d) instead of m, so the business needs d ÷ (m − d) more visits to earn the same dollars.
| Contribution margin | 10% off | 15% off | 20% off | 25% off |
|---|---|---|---|---|
| 30% | +50% | +100% | +200% | +500% |
| 40% | +33% | +60% | +100% | +167% |
| 50% | +25% | +43% | +67% | +100% |
| 60% | +20% | +33% | +50% | +71% |
| 70% | +17% | +27% | +40% | +56% |
At a 40% margin, a 20% discount needs twice the visits
Take an illustrative service business with an average ticket of $100 and $60 of costs that rise with each visit, such as product, supplies, card fees and the stylist's or technician's commission. Wages paid by the hour or salary regardless of bookings are fixed costs and stay out of the margin, which is why the margin should be calculated from the costs that truly change per visit.
| Input | Full price | 20% off | Source |
|---|---|---|---|
| Price per visit | $100 | $80 | Assumption; discount price calculated ($100 × 0.8) |
| Variable cost per visit | $60 | $60 | Assumption |
| Contribution per visit | $40 | $20 | Calculated (price − variable cost) |
| Contribution margin | 40% | 25% | Calculated (contribution ÷ price) |
| Visits per month | 100 | 200 | Assumption at full price; calculated at 20% off ($4,000 ÷ $20) |
| Monthly contribution | $4,000 | $4,000 | Calculated (visits × contribution) |
The discounted month needs 200 visits to match 100 at full price, which means twice the appointments on the schedule and $12,000 in variable costs instead of $6,000, all for the same $4,000. If some of those 200 are regulars who would have paid full price anyway, the business needs even more new visits to make up for the discount it gave them.
The deal research suggests the extra volume does not stay long. Of the 324 businesses in the Rice University study, 55.5% made money on their deal and 26.6% lost money, and fewer than one in five deal customers came back at full price.
A two-slider widget shows your own break-even
A lean calculator sits beside Exhibit 2 with two sliders, one for the contribution margin from 20% to 80% and one for the discount from 5% to 40%, and one result written as a sentence: "You would need X% more visits to earn the same amount." When the discount equals or exceeds the margin, the result reads "Every discounted visit loses money."
How you compare
- Your margin: add up the costs that rise with one visit, divide by your average ticket and subtract from 100%; that is the margin to use in Exhibit 1.
- Your last promotion: count the visits it brought, how many were regulars and how many of the new customers booked again at full price, then compare with the Rice figure of 19.9%.
- Your break-even: find your margin and discount in Exhibit 1 and ask whether last year's sale brought that many extra visits.
Before the next sale, write your margin and the planned discount into the formula, and run the promotion only if you can reasonably expect the extra visits it says you need.
About this research: The break-even formula is standard margin arithmetic, computed by osNOVA. The pricing figure comes from McKinsey's analysis of the average S&P 1500 income statement, and the deal figures come from a Rice University survey of 324 businesses that ran daily deals between 2009 and 2011. The worked example is illustrative.
Sources
- Marn, M. V., Roegner, E. V. and Zawada, C. C. The Power of Pricing. McKinsey Quarterly, 2003.
- Dholakia, U. M. How Businesses Fare with Daily Deals: A Multi-Site Analysis of Groupon, LivingSocial, OpenTable, Travelzoo, and BuyWithMe Promotions. Rice University, SSRN, 2011. 324 businesses.
Related reading: How to Stay Booked in the Slow Season Without Discounting · How to Raise Prices Without Losing Customers, Based on the Research · Gross Margin vs. Net Profit, Explained for Owners · How to Calculate Profit Per Service in Five Minutes
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