The True Cost of Giving Promotional Discounts
by Stephen Lett
Free Shipping! $10 Off! 10% Offer! Free Gift with Order! Promotions like these are common place today. They are a growing part of any print and online marketing program. These promos are being used to increase revenue especially in a lagging economy. They are also being used to drive traffic to the web. Are you top-line focused and/or do you know the true cost of these promotions and their impact on your bottom line? This is the subject of my column this month. The four most popular offers are free (or flat) shipping, a free gift with order, a dollar amount off and a percentage off. Free shipping is always #1 followed by a dollar amount off, then a percentage off and lastly, a free gift with purchase. I have included the chart below which details summary results that you might expect from these various offers. Also shown is a control column with no promo to serve as a baseline.
| DESCRIPTION |
NO PROMO |
FREE SHIPPING |
FREE GIFT |
$5.00 OFF |
10% OFF |
|---|---|---|---|---|---|
| Quantity Mailed |
50,000 |
50,000 |
50,000 |
50,000 |
50,000 |
| Response Rate |
3.00% |
3.60% |
3.15% |
3.36% |
3.30% |
| Average Order Size |
$60.00 |
$60.00 |
$60.00 |
$60.00 |
$60.00 |
| Orders |
1,500 |
1,800 |
1,575 |
1,680 |
1,650 |
| Gross Sales |
$90,000 |
$108,000 |
$94,500 |
$100,800 |
$99,000 |
| Less: Refunds (5%) |
$4,500 |
$5,400 |
$4,725 |
$5,040 |
$4,950 |
| Net Sales |
$85,500 |
$102,600 |
$89,775 |
$95,760 |
$94,050 |
| Less: Promotional Cost |
$0 |
$0 |
$0 |
$7,980 |
$9,405 |
| Adjusted Net |
$85,500 |
$102,600 |
$89,775 |
$87,780 |
$84,645 |
| Cost of Goods (45%) |
$38,475 |
$46,170 |
$40,399 |
$43,092 |
$42,323 |
| Gross Profit (55%) |
$47,025 |
$56,430 |
$49,376 |
$44,688 |
$42,323 |
| Less: Selling Expenses ($.60) |
$30,000 |
$30,000 |
$30,000 |
$30,000 |
$30,000 |
| Less: Promotional Cost |
$0 |
$13,680 |
$8,978 |
0 |
0 |
| Contribution |
$17,025 |
$12,750 |
$10,399 |
$14,688 |
$12,323 |
| Contribution Percent |
19.91% |
12.43% |
11.58% |
15.34% |
13.10% |
All of these promos increased sales. Free shipping increased sales $17,100 or 20% which is pretty typical (for a free shipping offer). Even the weakest promo, free gift, increased revenue 5%. However, in all cases, the contribution dollars and percent contribution were less than the control when all costs were considered. Note that the promotional costs for the $5.00 off and 10% off promotions affected net sales, i.e., adjusted net. The free shipping and free gift are shown as a line item expense. It is the amount of the incremental lift or increase from the promotion that matters. For example, the control group had a response rate of 3.0% with no promo. The response rate from free shipping was 3.6%. Therefore, the offer increased the response rate by .6% i.e., the incremental lift. Consider that the promo had to be given to the customers who would have ordered without the promo. This impacts the bottom line and true cost of the promotion. In order to maximize the contribution from an offer, consider no minimum order requirement (if you do insist on a minimum, set it at no more than 80% of your average order size). With regard to prospects, I often see an increase in both the response rate and average order size when there is no minimum dollar order requirement. When there is a minimum, consumers try to get to that order threshold and once they do, they stop buying. With no minimum, they tend to shop/spend more. Follow these basic rules when making offers to customers and prospects. They will help you increase revenue while maximizing contribution to profit & overhead.
TEN SIMPLE RULES WHEN USING OFFERS
- Know why you are making the offer. Use offers strategically.
- Prepare a pro-forma; do your financial analysis. Know your true cost.
- Test the offer against another offer.
- Don’t over test offers within a drop.
- Don’t make the offer during peak season (if you don’t need to).
- Don’t over use an offer; Re-test against a control or another offer.
- Know what your competition is doing. You might have to use offers just to stay competitive.
- Make sure your sample size gives you statistically valid results.
- Expect some decline in the impact of the offer over the control if the offer is repeated.
- Read the results and act on what you see!
When planning a promotion, do your homework by doing a P&L analysis. Know the true cost of giving the promo. Consider the top line results but know the affect on contribution and bottom line. Promotions work. They are an important part of the marketing toolbox. Use them wisely.