The best pricing strategy is useless without consistent price enforcement.
Discount management is a massively underestimated lever for increasing profits. In fact, many companies do not necessarily have a price problem but a price enforcement problem on an individual level, which leads to a considerable discrepancy between list and transaction prices – or, if list prices do not exist, between customers’ actual price acceptance and the finally negotiated transaction price. This sustainably destroys margins companies need desperately.
Strategy and enforcement are the two inseparable sides of professional pricing. Especially in industries where list and transaction prices are typically far apart, such as in many B2B or negotiation-intense B2C businesses (e.g., insurance or automotive), the key approach to quickly and directly improving a company’s earnings is not necessarily to redesign the pricing strategy but to improve price enforcement.
The bigger the gross-net gap, the bigger the potential for well-thought-out discount management. Every percentage point of discount given unnecessarily is a lost margin that cannot be re-gained by an alternative increase in sales in the future (more on this later).
At the same time, the individual negotiation and discounting strategy of individual sales employees in the last mile (“in front of the customer”) represents a black box for many companies. It is often unclear what actually happens there. However, all the sources for unnecessary and margin-killing discounts center around this often routinized sales behavior and its influencing factors.
Unnecessary Discounts Kill the Margin Twice
Over the past 25 years, our price and sales optimization projects have repeatedly shown that up to 50-80% of the individually given discounts are granted unnecessarily. Companies thus give away considerable margin potential.
Unnecessary discounts do not only waste margins and cost money in the short term but also have fatal consequences in the long term. The reason is that if a discount is unnecessarily awarded today, it will become the new reference price of the negotiation tomorrow, making it a margin killer in the long run. The short-term focus on quickly increasing sales by discounting typically neglects this expensive consequence.
Figure 1:
Discount iceberg
When and How to Give Discounts
Not all discounting is unnecessary or harmful in the long run. A discount can actually be an essential sales tool if:
· The discount triggers a purchase decision that the customer would not otherwise have made, i. e., either helps the customer cross the “Rubicon” if that final spark has not yet been ignited or serves as an individual price differentiation to open up new customer segments that otherwise could not be won.
· The discount draws customers into higher-value options or promotes cross-selling, increasing the wallet share.
The most important rule is that discounts must be used selectively. They are not merely a price reduction but a reward for better customer behavior, and long-term consequences must be analyzed. We always need to ask ourselves whether the customer would not have made the purchase without the discount. Define what the customer must do to qualify for the extra rebate and quantify whether the short-term gain is worth the long-term costs.
Why Are the Most Important Rules So Difficult to Follow?
Two of the most common reasons for disregarding these rules are the following vicious circles that reinforce each other:
1st vicious circle: Companies often assume that customers are primarily bargain hunters. Any inquiry about the price is quickly misunderstood as a demand for more discount. However, customers do not always inquire about the price because they would not buy without a discount. They often only do so because they want to understand the calculation or to fulfill their obligation to have at least asked.
If the company grants discounts because of the chronic “customer = bargain hunter” assumption, it quickly becomes a self-fulfilling prophecy: Even customers who were not bargain hunters were raised to be bargain hunters as they were rewarded with unexpected discounts whenever the issue arose.
2nd vicious circle: The second vicious circle is the orientation towards competition and is also a self-fulfilling prophecy:
The most common internal justification for giving discounts is to keep pricing “in line with the market” to remain “competitive.” And if we ask a company that started price wars, the answer is a reference to the competition.
This leads to undercutting and discounting competition, which is not the customers’ but the companies’ fault.
These vicious circles underline that the core issues center around assumptions, perception, routines, and behavior. This is why all measures to minimize unnecessary discounts must start with challenging and systematically improving sales behavior, and this is why “Behavioral Discount Management” is the key to a sustainable profit increase.
Figure 2:
The self-fulfilling prophecies in discount management
Reasons & solutions for unnecessarily granted discounts
Individual negotiating and discounting behavior is always determined by many influencing factors. This is why we have divided the root causes of unnecessary discounts into the dimensions “Knowledge,” “Motivation,” “Necessity,” and “Ability” below and provided suitable solution proposals.
Dimension #1: “Knowledge”: Biased assumptions, misleading and missing information
15-25% of all discounts are granted unnecessarily because of biased, misleading, or missing knowledge. Firstly, sales beliefs about customer decision strategies are often strongly biased. On average, they overestimate the percentage of bargain hunters in their customer base by factor two. At the same time, the ratio of price accepters in the same range is underestimated (see GRIPS-Types). It is often assumed that customers need “a good deal” to buy, and every question about the price is immediately interpreted as a call for a discount.
It is often assumed that customers need “a good deal” to buy, and every question about the price is immediately interpreted as a call for a discount.
Secondly, what they know pretty well are their costs, which is not only unnecessary as sales are supposed to be a value, not a cost expert, but it is misleadingly anchoring everybody in the sales team on the wrong numbers when setting the expectation level for the negotiation.
Finally, the relevant data is not provided systematically, although potentially available: How many discounts have customers received in the past? Does this make sense from a CLTV point of view (see Figure 3 for a typical example)? Which sales representatives were able to sell with less discounts than the average? What is their secret? Collecting and exchanging these insights internally is easily possible. It would be highly insightful and motivating, but it is rarely done in practice. If you want to see what such information can trigger, start by providing information as shown in Figure 3, and then (announce) publish the ranking of sales reps by their average discount granted. You will see miracles happening to your average discount in the next quarter!
Figure 3: Customer example – erratic discount allocation
Dimension #2: “Motivation”: Misaligned and nontransparent incentives
15-30% of discounts are given unnecessarily due to sub-optimal incentive systems. No matter how well the sales training, tools, and tactics are designed, if the sales team is incentivized primarily by sales quotas and revenue targets while at the same time being able to grant discounts according to their discretion, the result is an explosive mix that continuously and reliably erodes margins. The problem is not the employees but the design of the incentive system, which promotes this self-optimization to the detriment of the company’s profitability because of misaligned personal and company goals.
However, even if the goals are aligned, an additional issue is that incentive systems are often too complex and nontransparent to effectively and efficiently steer sales behavior. Often, too many elements of the incentive and benefits plan have been added over the years, some of which contradict themselves. Moreover, the individual status is unclear daily, or the feedback provided to reach a specific target is not given properly.
An incentive system is intended to steer behavior. Two things are essential for this.
Firstly, the targets need to be aligned with the company strategy and across teams and departments. Secondly, the incentive systems, their requirements, and consequences must be transparent at any time, not only once a quarter or at the end of the year. However, an incentive system is often historically grown and hard to change.
When changing the incentive system, it is not possible nor necessary to adjust everything at once. It is more about developing a target image and successfully migrating from the current status to this target. It is helpful to take a three-step approach:
1. A quick win is often to improve the sales team’s transparency and understanding of discounts’ monetary impact on individual incentives. A lot can be achieved with simple means and intelligent, preferably immediate feedback, e.g., the feedback on peer performance concerning discounting can be a very effective intrinsic motivation without any additional monetary incentive needed as the competitive aspect often triggers more commitment than any extrinsic incentive.
2. The next pragmatic step is to gradually evolve the existing incentive systems by eliminating inconsistencies and misleading incentives in the current system. In some cases, it is also possible to include a more profitability-related component in addition to the revenue-related incentive components, e.g., an incentive based on deviation from the target price.
3. To conceptually align corporate goals, desired behaviors, and incentives, developing a long-term vision based on a greenfield approach is necessary rather than an evolutionary perspective on the existing incentive system. With such a vision, negotiations on how, in which stages, and when this target incentive program will be achieved can begin immediately with the internal stakeholders involved.
Read more about Incentives and the factors which need to be considered when optimizing incentive models here: https://www.vocatus.de/behavioral-incentives-higher-sales-growth-through-effective-incentive-models/
Dimension #3: “Necessity”: Confusion of price setting vs. execution and suboptimal escalation
Two issues are essential when creating the structural necessity to avoid unnecessary discounts.
Figure 4: Separation of price setting and price execution
Secondly, besides the structural separation of price setting and execution, pricing governance must also define the escalation process in individual cases. Escalating the discount decision to the next hierarchical level is too easy, creating an enormous margin drain as any escalation separates customer expertise from discount authority and leaves the subordinate with a decision dilemma. If he does not grant the discount, the sales representative will argue that he cannot reach his sales targets. If he grants the discount, he has taken over the responsibility, and the sales employee with the actual customer contact is “off the hook.”
This leads to notoriously excessive discounts and an enormously high burden on managers handling these requests repeatedly. Experience shows that 10-25% of all unnecessarily granted discounts in companies fall into this category, sometimes with strong aberrations, as the following real-life example illustrates.
Client example
One of our clients had an internally defined maximum discount of 25%. However, customers were granted an average of more than 32% discount. How could this happen?
This discrepancy arose because over 90% of the negotiations were escalated to the next level, and 85% were waved through as the regional managers did neither know the customers nor did they want to have internal fights with their sales representatives. This whole routine induced enormous internal efforts to manage this process and a considerable margin loss for which no one felt responsible. Moreover, the customers learned to disrespect their direct counterparts and always trigger an escalation to the next level. So, one rule companies should embrace more when it comes to price execution is: “Keep the boss out!”
If a sales representative requests a higher discount for their customer, the decision must be pushed back to the sales rep level by pointing to the sales increase they must achieve to make up for the additionally granted discount (see Figure 5).
Figure 5: Transparency on the trade-off between discounts and sales
All these measures – the increase in transparency (knowledge), the improved incentive system (motivation), and the more transparent governance (necessity) – eventually help to evolve an internal negotiation between manager and sales representative to an external negotiation between the sales rep and the customer, and this is where it should take place. Once we make this shift, we must ensure that the sales team is well-equipped to negotiate successfully. This brings us to the last dimension.
Dimension #4: “Ability”: Ingrained routines instead of negotiation excellence
When it comes to the actual negotiation with the customer, inadequate preparation, poor negotiation skills, and a lack of self-confidence to counter requests for discounts account for another 10-40% of unnecessary discounts. Most of these issues trace back to implicit yet ingrained sales routines.
The first issue is typically the missing preparation. Firstly, the sales staff is unprepared with ways to defend discount requests. Secondly, they are not equipped with strategies to divert monetary discount requests into other currencies like more value or service, which is often more attractive for the selling company. And finally, they mostly forget to demand a counterpart from the customer, although this is the “golden rule” of discounting: never ever grant a discount without requesting the customer to give something in return. A discount is not a price reduction but should always and only be a reward for better customer behavior!
The second issue is that salespeople often believe they are simply selling a product and its features. If possible, they have to explain all of them and then hope the customers understand them and buy. If they do not, they explain the advantages of the product again. If the customers still do not buy, they give a discounts. This classic sales approach only focuses on the product’s “value,” i.e., WHAT the customer presumably wants. It entirely neglects the customer’s decision-making strategy, i.e., HOW he decides. However, selling is ultimately about influencing purchasing decisions. That is why we need to stop selling products and start managing decisions. If the sales employees do not know the decision-making strategy of the customers and cannot read them on this dimension, they risk using the wrong tactics and may be too quick to offer discounts.
The GRIPS-Typology (see Figure 6) describes this second dimension of sales excellence and helps to better prepare for and run negotiations to systematically avoid unnecessary discounts by training sales representatives on two tasks: identifying the decision strategy of the customer and negotiating accordingly. Leveraging this second dimension significantly improves profitability and conversion at the same time.
If we focus more on managing these four dimensions of price execution, we will minimize the unnecessarily given discounts and increase margin beyond any expectation. However, we must realize that managing behavioral change and bringing more light into the “black box” of individual sales routines is not a sprint but a marathon. Yet, engaging in it pays off exceptionally well and can be started immediately with the small measures outlined above.