Effect of Discount Pricing on Profits

Abstract:

The purpose of this study to investigate the impact of discount pricing strategy on organizational profit and the importance of planning for a discount; the study was conducted depending on unreal numbers, and it clarify that discounts increase sales volume, but not always increase the profits.

KEYWORDS: Pricing Policy, Discount, Organization, Profits, SMEs, Sales Volume

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Introduction

Pricing decision is a decision that must be taken carefully, because of its nature and its effect on the overall goals and objectives of the organization, which is mainly profit maximization. Hilton (2005:633)

Generally, to run any business develop a pricing strategy for a product after performing a marketing analysis is necessary. A pricing strategy is formulated taking into consideration factors of cost, competition, and profit objectives. Possible pricing strategies include a full-price strategy, competitive pricing, discount pricing or a mix of these. In this research paper, we are focusing on discounts pricing strategy. Retailers uses discount strategy as a way of increasing demand, poling share of business away from competitors, and to increase total sales.

Objectives of Study

The aim of this study is to study the impact of discount pricing strategy on organizational profit and the importance of discount planning.

Research Problem

Due to people preference to buy things on sale, discounts play an important role in attracting people to buy and this lead to increase sales volume and thus profits, but the issue that some managers miss-planning which leads them to lose profit rather than to gain.

Research Importance

Discount can help organizations to enhance their sales; however, most organizations usually don’t take into consideration the impact of discount on the long term because they miss planning and testing the discount. This study aims to explain the impact of discount on organizational profit, when the organization must discontinue discounting and the importance of planning for discount.

Research Hypotheses

Ho1: there is no impact difference at (α = 0.05) of discount pricing strategy on organizational profits.

Research Model

An overview of the research model is presented in Figure 1. The model articulates the independent and dependent variables.

Independent variable Dependent variable

(Organizational Profits) (Discounts pricing strategy)(Figure1: Research Model)

The diagram above shows the relationship between variables. It shows Discounts pricing strategy the independent variable. Organizational profits are the dependent variable, which is directly affected by Discounts.

Sources of Information

We have used books, journals, personnel meeting, and various websites to gather information and gain knowledge in order to help us expand prospects in writing this study.

Literature Review

Generally price is defined as amount to be paid for any goods or service.

Different scholars defined price such as Prof. William J. Stanton's, “Price is the amount of money and/or other items with utility needed to acquire a product.” Prof. Philip Kotler, “Price is the only element in the marketing mix that produces revenue, the other elements produce cost.” Last David J. Schwartz, “Price is the exchanged value of the product or service expressed in terms of money.

According to Agwu and Carter (2014), ‘among the four Ps, price is the only income generator and it is the value attached to a product. It is the sum of all the values that customers give up in order to gain the benefits of having or using a product (Kotler et al 2010).

Pricing is the process of setting the price for products and services at which it will be sold and it may be part of the business's marketing plan, which is a report that outlines your marketing strategy for the coming year, quarter or month.

Pricing has always been an integral component of marketing (Borden, 1964); of the traditional marketing elements, only pricing creates revenue (LaPlaca, 1997; Shipley & Jobber, 2001). As Morris (1987, p. 79) notes, “one of the more basic, yet critical decisions facing a business is what price to charge customers for products and services.”

Pricing strategy is the policy a firm adopts to determine what it will charge for its products and services. There are several different pricing strategies, such as penetration pricing, price skimming, discount pricing, product life cycle pricing, and even competitive pricing.

A discount sale consists in selling a given set of items at a reduced price for a limited period. Some examples are proposed in (Bolton, 1989), (Blattberg and Neslin, 1990), (Bemmaor and Mouchoux, 1991). This reduction should generate enough supplementary sales to compensate the reduction in income. However, this is rarely the case. Few companies realize the true discount cost. When a product discount is offered for a given period, it applies to all sales, which often leads to disastrous consequences.

One of the pricing policy is discount-pricing strategy, which is defined by most of the researchers that it is selling products in low priced to increase sales volume and thus profit, and it has different type:

1. Quantity discounts: which is offering quantity discounts to customers who purchase in bulk.
2. Seasonal discounts: which is offering discounts to customers who purchase during off-peak time.
3. Promotional discounts: which is offering discounts to customers to drive sales and it is short-term.
4. Loss-leaders: which is offering discounts to customers by selling products at price below its market cost in the hope that they will purchase more profitable goods and services.

Profit is the revenue remaining after all costs are paid. There are three types of profits: Gross Profit, Operating Profits and Net Profits.

Important definitions of Profit according to different authors are as follows:

• Prof. Marshall – “Profit is the earning of management”
• Walker – “Profit is the rent of ability”.
• Croome – “Profit is the reward for uninsured risks”.
• Ely – “Profit is a surplus over and above the expenses of production”.

Also according to economist profit is defined as:

• Profit = Gross Profit – (Rent + Wages + Interest)

According to different studies there is no standard relation between profits and discount it varies according to the case of each organization, but we have concluded that when an organization do a discount it has to increase its sales and production to gain the same margin of profit it used to gain before the discount or it will lose profits.

(Figure1: Relation Between Discount & Profit)

Research Method and Data Collection

Data was collected after conducting interviews with different organizations from their financial and marketing departments, however due to confidential reasons companies refused to provide us with their actual numbers. Table (1) was built with approximate figures.

Most of the organizations’ answers upon purpose of applying discount were matching as follow:

1. Encouraging and attracting customer to buy their products.
2. Incresaing their sales volume and profits.
3. Increase their market shares.
4. High competition.

Data Interpretation

The table below briefly explain how discount impact sales volume and profit which can be adapted as a reference for planning and testing discount ratio.

The table was calculated as follow:

• Fixed Cost = Given Number
• % Profit From Variable Cost = Given Number
• Profit rate from sales (CM) = % Profit From Variable Cost – (% Profit From Variable Cost * Discount Rate + Discount Rate) / % Profit From Variable Cost – (% Profit From Variable Cost * Discount Rate + Discount Rate) +1
• Breakeven Point = Fixed Cost / Profit Rate From Sales (CM)
• The % Of Change In The Break-Even Point = (Breakeven Point x+1 - Breakeven Point x) / Breakeven Point x
• Expected Sales = Given Number
• The % Of Change In Expected Sales = (Expected Sales x+1 / Expected Sales x) / Expected Sales x
• Difference Between Expected Sales & Breakeven Point = Expected Sales – Breakeven Point
• Expected Net Profit = Difference Between Expected Sales & Breakeven Point * Profit rate from sales (CM)
• Net Profit Ratio = Expected Net Profit / Expected Sales
• Expenses Ratio = Fixed Cost / Expected Sales
• Total Expense Ratio And Net Profit Ratio = Net Profit Ratio + Expenses Ratio

(Table 1: Impact Of Discount On Profits)

Case No.

Fixed Cost

Profit % From Variable Cost

Profit Rate From Sales

Discount Rate

• Break-even Point
• The % Of Change In The Break-Even Point
• Expected Sales
• The % Of Change In Expected Sales
• Difference Between Expected Sales & Breakeven Point
• Expected Net Profit
• Net Profit Ratio
• Expense Ratio
• Total Expense Ratio And Net Profit Ratio
• 1
• 1,500,000
• 70%
• 41.18%
• 0%
• 3,642,545
• 0.00%
• 4,000,000
• 0.00%
• 357,455
• 147,200
• 3.68%
• 37.50%
• 41.18%
• 2
• 1,500,000
• 70%
• 38.73%
• 4%
• 3,872,967
• 6.33%
• 6,000,000
• 50.00%
• 2,127,033
• 823,800
• 13.73%
• 25.00%
• 38.73%
• 3
• 1,500,000
• 70%
• 36.34%
• 8%
• 4,127,683
• 6.58%
• 8,000,000
• 33.33%
• 3,872,317
• 1,407,200
• 17.59%
• 18.75%
• 36.34%
• 4
• 1,500,000
• 70%
• 33.23%
• 12%
• 4,513,993
• 9.36%
• 10,000,000
• 25.00%
• 5,486,007
• 1,823,000
• 18.23%
• 15.00%
• 33.23%
• 5
• 1,500,000
• 70%
• 29.97%
• 16%
• 5,005,005
• 10.88%
• 12,000,000
• 20.00%
• 6,994,995
• 2,096,400
• 17.47%
• 12.50%
• 29.97%
• 6
• 1,500,000
• 70%
• 26.93%
• 20%
• 5,569,996
• 11.29%
• 14,000,000
• 16.67%
• 8,430,004
• 2,270,200
• 16.22%
• 10.71%
• 26.93%
• 7
• 1,500,000
• 70%
• 22.29%
• 24%
• 6,729,475
• 20.82%
• 16,000,000
• 14.29%
• 9,270,525
• 2,066,400
• 12.92%
• 9.38%
• 22.29%
• 8
• 1,500,000
• 70%
• 18.86%
• 28%
• 7,953,340
• 18.19%
• 18,000,000
• 12.50%
• 10,046,660
• 1,894,800
• 10.53%
• 8.33%
• 18.86%

(Table 1: Impact of discount on profit)

Case number one:

• Discount Rate: 0%
• Expected sales: 4,000,000 JD
• Expected Net profit: 147,200 JD

Case number two:

• Discount Rate: 4%
• Expected sales: 6,000,000 JD
• Expected Net profit: 823,800 JD

Case number three:

• Discount Rate: 8%
• Expected sales: 8,000,000. JD
• Expected Net profit: 1,407,200 JD

Case number four:

• Discount Rate: 12%
• Expected sales: 10,000,000 JD
• Expected Net profit: 1,823,000 JD

Case number five:

• Discount Rate: 16%
• Expected sales : 12,000,000 JD
• Expected Net profit : 2,096,400 JD

Case number six:

• Discount Rate: 20%
• Expected sales : 14,000,000 JD
• Expected Net profit : 2,270,200 JD

Case number seven:

• Discount Rate: 24%
• Expected sales : 16,000,000 JD
• Expected Net profit : 2,066,400 JD

Case number eight:

• Discount Rate: 28%
• Expected sales : 18,000,000 JD
• Expected Net profit : 1,894,800 JD

As shown, sales volume increased by increasing discount rate, on the other hand expected profit continually increased until case number six. This means the organization must not apply discount more than 20% to prevent loses.

The graph below simply explains how expected profits increases and decrease due to discount rate.

(Graph 1: Impact of discount on profit)

Limitations

1. Time we have to write the study.
2. Non-cooperation of companies to provide us with desired data.
3. Lack of available research paper discussing this topic.

Conclusion and Recommendations

Discount effect organizations by increasing sales volume, but not always increases the profits due to that each organization should do discount planning strategies as well to test discount before implementing it to avoid loses.

During process it was noticed that small-medium enterprise do not take planning in a serious matter which led them to lose. We recommend that all organization should specify departments to do such a plans in detailed.

Future Research

This research was conducted based on unrealistic numbers, in order to get better result real numbers must be used in the future, also we have noticed that most of the research papers were discussing discount as a part of pricing and marketing strategies and few discussed discount strategies individually. We suggest to increase number of research papers discussing this kind of topic, moreover to take in consideration factors affecting the discount effect such as seasons.

References

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