This week’s guest article is from Daniel Murphy, Co-Founder and Managing Principal of Strategic Choice Partners. Dan has over 30 years of experience holding senior finance and operating roles at TJX, Pepsico, Panera Bread, Princess House and Immunotec. For the last 15 years Dan has served as both a CEO, CFO and COO for two party plans and network marketing company respectively. Currently Dan is a consultant specializing in the direct selling industry. Dan also served as the Treasurer of the Direct Selling Educational Foundation and previously served as the Treasurer for the US Direct Selling Association.
Guest Post by Dan Murphy
Striking the Proper Promotional Balance: How Much Discounting Is Too Much?
As we enter a new year, I thought it wise to discuss a key driver of performance in any direct selling business: The mix of promotional offers. As executives and stakeholders in the industry, we know that what moves our business is excitement and enthusiasm.
This energy can come in many different forms: New products, a national convention, a travel incentive trip and most recently, via social media and public relations. I am reminded of a time in the history of one business I was running that it came from the arrest of a consultant for indecency – a charge which was later dropped. The surprisingly positive outcome came thanks to the national public attention and led to the largest increase in sponsoring in the history of the Company! It’s the best example of the adage “There is no such thing as bad press” I’ve ever personally experienced.
One area of great caution when it comes to generating excitement in a direct selling business is the implementation of promotions. Promotions, of course, have an important place in our tool kit of options to generate excitement and enthusiasm. The proper mix of promotions designed to motivate leadership development, sponsoring and sales to either customers or hostesses are crucial to success.
But if this tool is overused, there is the risk of building a reputation as a High/Low seller with customers and consultants waiting for the next big sale to make purchases, creating successive cycles of “boom” followed by “splat.”
A Formula for Proper Discounting
A good rule of thumb when finding your promotional balance is to start with the blended times cost multiple for the business (meaning the relationship between the retail price of the products and their fully loaded landed costs). For example, if the times cost multiple is 7x (meaning I buy an item for a cost of $10.00 and sell it at full price at $70.00), then I can afford to have between 25% to 30% of the business in a period be sold at a discount of between 10% to 30% off.
However, if my times cost multiple is only 5x or 6x, then I must only have 15% to 20% of my total revenue be sold at a discount of 10% to 20% off.
Generally, if your compensation plan pays in the range of 40% to 45%, a mix of 25% of the revenue being sold at a discount of, say, 25% off will yield an after-commission margin of 40% assuming a 7 times cost multiple, which is adequate to cover the overhead and produce a solid profit in most businesses.
Here’s how that works:
- Full Retail $70
- Total Units Sold 20
- Units sold at a discount = 25%, or 5 at $52.50
- Discount offered = 25%, so the discount is $17.50 x %, or 87.50
- Total revenue from this item is 15 x $70, or $1,050 (from full retail price), plus 5 x $52.50, or $262.50, so Total Revenue is $1,050 + $262.50, or $1,312.50
- Total Cost of goods sold at $10 per unit is $200
- Total Commissions and Over-rides (assuming a 45% plan payout) is $1,312.50 x 45% = $590
- Margin after commission and Cost of Goods is $1,312.50 (Total Revenue) – $200 (Total COGS) -$590 (Commissions) = $522.50
- Margin Rate equals $522.50/ $1312.50, or 39.8%
Don’t Forget About the Impact Discounts Have on the Field
Whenever you are making a decision to offer discounts off of normal pricing as a means to generate excitement and revenue, keep in mind that you are also essentially asking your field sales force to CO-OP the price discount with you. This is a fact that is often overlooked.
Here’s an example of what I mean: An item that would normally sell for $70 full price would generate commissions and overrides of $31.50 assuming a 45% total payout. That same item sold at a 25% discount would generate commissions and over-rides of only $23.63, a decrease of 27% in total payout. The Company, on the other hand, gets to discount a product by 25% or in this example $17.50 but the true cost is only $8.77 as the other half is offset by lower commission payout, making the effective cost to the company of 16.7%.
Here’s what it looks like when you work through the assumptions above:
- Full Retail $70
- Discount Retail $52.50
- Commission paid on full retail $70 x 45% = $31.5
- Commission paid on discounted products $52.5 x 45% = $23.63
- Commission if 20 sold at full price = $630
- Commission paid if 15 sold at full price and 5 sold at a discount = $590.50
- Savings in commissions to the company due to discount is $630-$590.50 = $39.50
- Total price off to the Company of offering 5 at a discount is $17.50 x 5= 87.50
- Total price off after accounting for reduced commission $87.50 – $39.50 = $48
This may sound confusing, but these details are what your internal team (especially those in marketing and finance) should be reviewing on an ongoing basis. Usually this occurs on the front-end in a period promotion planning session and on the back end by a post-period debrief.