How to measure the true impact of discounting on margins

Discounting costs more than you think

When you offer 20% off, you might think you’re giving up 20% of revenue. The actual margin impact is much larger. A 20% discount on a 40% margin product cuts your profit per unit in half, not by 20%.

Understanding the true cost of discounting helps you make better promotion decisions and avoid accidentally destroying profitability.

The margin math of discounting

Discounts come directly out of margin, not revenue.

Example calculation:

Product price: $100. Product cost: $60. Margin: $40 (40%). With 20% discount: Price becomes $80. Cost stays $60. Margin becomes $20 (25%).

The discount was 20% of price, but it eliminated 50% of your margin. This is the leverage effect that makes discounting so dangerous.

The general principle:

Discount impact on margin = Discount percentage / Margin percentage. A 20% discount with 40% margin = 50% margin reduction. A 30% discount with 40% margin = 75% margin reduction.

Volume required to offset discounts

To maintain the same profit with lower margin, you need higher volume.

The breakeven volume increase:

If margin drops 50%, you need 100% more volume (2x) to maintain the same total profit. If margin drops 75%, you need 300% more volume (4x).

Realistic assessment:

Will a 20% off sale actually double your sales? For most products, the answer is no. This means the promotion reduces total profit even if it increases revenue.

Calculating required lift:

Before running a promotion, calculate the volume lift required to maintain profit. If that lift seems unrealistic, the promotion will hurt profitability.

The full cost of promotions

Beyond margin reduction, promotions have additional costs.

Operational costs:

Higher volume means more orders to fulfill. If fulfillment capacity is constrained, you might pay overtime or expedited costs. Volume spikes have operational costs that reduce the profit you thought you’d keep.

Customer service costs:

Promotions often bring more customer service contacts. Questions about the promotion, order issues from volume spikes, and returns all cost money.

Marketing costs to promote the promotion:

You might spend on ads, emails, or other marketing to drive awareness of your sale. These costs further reduce the net benefit.

The return rate impact

Promotional purchases often have higher return rates.

Why returns increase:

Discount buyers are sometimes less committed. They buy because the deal seems good, not because they truly need the product. Buyer’s remorse and impulsive purchasing lead to more returns.

Return cost compounding:

Returns on discounted items hurt twice. You sold at lower margin, and now you’re absorbing return costs. The effective margin on a returned promotional item might be deeply negative.

What to track:

Compare return rates for promotional versus full-price purchases. Factor higher return rates into promotion profitability calculations.

The customer quality question

Discounts attract different customer types.

Deal-seekers:

Some customers only buy on discount. They wait for sales, buy at reduced prices, and never purchase at full price. Their lifetime value is lower than full-price customers.

Lifetime value comparison:

Track LTV of customers acquired during promotions versus customers acquired at full price. If promotional customers have significantly lower LTV, the promotion’s true acquisition cost is higher than it appears.

Training customers:

Frequent promotions train customers to wait for discounts. Full-price conversion drops because customers expect sales. This erodes long-term pricing power.

Cannibalization effects

Some promotional sales would have happened anyway at full price.

The timing question:

A customer who would have bought next week at full price buys this week at a discount. You didn’t create a new sale; you discounted an existing one.

Estimating cannibalization:

Compare sales during and after promotions. If post-promotion sales dip below baseline, some promotional sales were pulled forward rather than created.

True incremental sales:

Only truly incremental sales should be credited to the promotion. If 30% of promotional sales were cannibalized, the promotion’s effectiveness is 30% lower than raw numbers suggest.

Measuring promotional profitability

How to actually calculate whether a promotion was profitable.

The calculation:

Promotional revenue minus promotional COGS equals promotional gross margin. Subtract incremental fulfillment costs. Subtract incremental marketing costs. Subtract return cost estimates. Compare to what you would have earned at full price on cannibalized sales.

Net promotional impact:

The result shows whether the promotion actually made money or lost money compared to doing nothing.

Many promotions lose money:

When fully calculated, many promotions that looked successful on revenue actually reduced profit. This is why detailed analysis matters.

When discounting makes sense

Discounting isn’t always bad. Some situations justify it.

Clearing inventory:

End-of-season or overstock inventory needs to move. The alternative is write-offs or storage costs. Discounting that clears problematic inventory can make sense.

Customer acquisition:

If a discount acquires a customer with high lifetime value, it might be justified. But only if you’ve calculated that the LTV truly exceeds the promotional acquisition cost.

Competitive response:

Sometimes you must respond to competitor promotions. But do so knowing the cost and don’t assume it’s a good strategy just because competitors do it.

Tracking discount impact over time

Build ongoing visibility into discounting effects.

Track discount depth:

What’s your average discount rate across all orders? Is it increasing over time? Rising average discount is a warning sign.

Full-price revenue percentage:

What percentage of revenue comes from full-price sales? Track this over time. Declining full-price percentage indicates growing discount dependency.

Margin trend:

Track overall margin trend. If margins are declining while revenue is stable or growing, discounting might be the cause.

Metrics to track for discounting impact

Focus on these discounting metrics:

Margin per unit at full price versus discounted. Volume lift versus required lift to break even. Return rate by promotional versus full-price orders. Customer lifetime value by acquisition type. Cannibalization estimate (post-promotion sales dip). Full-price revenue percentage over time. Average discount rate over time. Blended margin trend.

Discounting seems simple but has complex profit implications. Measure the full impact before assuming promotions are helping your business.