Retail discounts and the illusion of success

I came across a blog post for a retail software product (which I will not name here), which said the following: "We have achieved great success with our product implementation at a European online auto parts retailer. Our product was able to deliver a 15% sales lift with an effective discounting of only 2.17%..."

I thought that sounded very good.

But then I indulged myself in a thought experiment: 'What sales lift does a retailer need to breakeven on an initiative which discounts the price by 2.17% below the regular price?'. Stop for a moment and answer that question within 5 seconds without pen and paper....

Now let's look at the math behind a 'successful' promotion

If you are an online retailer with gross margins of 20%, average CPA commission of 1% and net shipping costs (shipping costs less shipping charges to customers) of 6% of revenue, then your 'effective' margin is 13% of revenue.

To breakeven on a 2.17% discount, you would require a sales lift of 20% (!!!).

Here is a What-if scenario table which calculates breakeven sales lift for various levels of effective margin and discount:

Said in another way, to breakeven on a 2.17% discount with a sales lift of 15%, the European retailer would need an 'effective' margin of 16.7%. With 1% average CPA commissions and 6% net shipping costs, they would need a gross margin higher than 23.7%.

I doubt whether the European retailer broke even on the discount, because my thought experiment doesn't even include the cost of the software (which claimed 'great success').

The thought experiment is an eye-opener for eCommerce and retail companies who are willing to spend a lot on discount programs. Remember that even a harmless looking 5% discount requires a sales lift of 63% if your 'effective' margin is 13% (refer to the table above).

So that set off another thought in my mind: "What long-term strategic reasons would merit making an apparent loss on a discount program?"

Here's what I think are potentially valid strategic reasons for any retailer:

1) It is a short life-cycle/ shelf-life product (clothes, shoes, books, mobile phones, cameras, laptops, perishables) which is approaching the end of its season/life-cycle/ shelf life. As a retailer you are taking a strategic call that the cost and the risk of carrying inventory beyond the end of the season/life-cycle/ shelf life would be too high. However it is critical to distinguish long life-cycle products in short-life cycle categories (e.g., plain blue jeans, basic dress shoes, text books, reference books, etc) and ensure that you are not discounting those as much as the short-life cycle products.


2) Competition is discounting the same product heavily and you assess that you will not be able to sell the product at a 'regular price' later. This reason may often play along with reason 1. However it makes sense to use price comparison frequently (at least daily) to ensure that you are not pricing well below competition.

3) By discounting the product and taking a short-term loss, you estimate that you will be able to acquire new customers who will be loyal beyond the short-term. Many eCommerce companies seem to be thinking this way. My good wishes for pulling this strategy off :-)

Would love to hear your thoughts. If you need a copy of the spreadsheet behind the breakeven table (which has a more detailed working based on gross margin, CPA commissions, and shipping costs), please email me at raj AT knowledgefoundry.net

Dell's smartphone strategy.....Are they dialling the wrong number?

The Wall Street Journal reported that Dell has been working for over a year on Android and Windows-based smartphone designs (click here). WSJ claims that Dell has been meeting component manufacturers, software vendors and handset manufacturers for its smartphone project.

CNet's Crave blog (click here) quotes Jeff Kagan, a reputed telecom analyst, saying that the smartphone market is likely growing at 10-15% after growing more than 50% till recently. The folks at Canalys even think that the US smartphone market grew more than 100% till Q3'08 (click here).

RIM, Apple and Nokia dominate the high-end of the smartphone market. Between them they account for 71% of the global smartphone market (Nokia 39%, Apple 17%, RIM 15%). All the other handset manufacturers (Palm, HTC, Motorola, Samsung, Sony Ericsson, etc) make up the remaining 29%. Incidentally the Windows and the Android platform account for less than 15% of the market.

I wonder: Is it a good idea for Dell to launch their own Windows/ Android smartphone?

I think it would be a difficult business case to pull off. Here's why:

• Buyers of an iphone, Blackberry or the Nokia E71 are brand sensitive and are not likely to be seeking the cheapest smartphone available. Dell will have to spend significantly in marketing and product development if it wants to have a serious chance in the high-end of the smartphone market.
• Unlike servers or printers, people who buy PCs are not likely to be buying mobile phones at the same time. Thus having a full product line does not give any strategic advantage. The last time Dell tried to establish a brand in the consumer electronics space (by making MP3 players), it ended up badly (click here).
  
• Dell's traditional strength has been online direct selling of PCs. Mobile phones are already being sold online and Dell brings nothing new to the table on that front. Moreover in the US market, Dell will have to deal with each of the mobile carriers to sell its smartphones (Apple has done that successfully but then they had a hotttt product and they had Steve Jobs).

I would love to hear your thoughts...