The Right Discount Turns Inventory Into Cash
When running a discount, how much should one discount? It’s a great question, one that is frequently debated and seldom has a consistent conclusion.
Before I answer, the first thing to consider is why are you discounting in the first place? Is it to bring in new customers? Is it to eliminate excess inventory or change seasonal goods? Are you getting rid of scratches and dents? What’s the goal? Once you know this, then the answer is easier to figure out.
Excess inventory is always a problem. For reasons that escape me, manufacturers, wholesalers, even retailers love inventory. I believe they feel it represents wealth and it brings them comfort to be able to have a dozen of everything in case there is a demand. It provides a feeling of security, the perfect way to satisfy the customer. (Heaven forbid you should lose a sale over an out-of-stock!) So, over time, inventory is over-bought and over-stocked until there is no place to store it all.
I had a client who carefully built over two million dollars worth of inventory at wholesale cost for his own manufacturing needs. It was a gross of every nut, screw, bolt and fabricated custom part for his entire process. It served him well, he said, as he always had the part on hand if he had to service a machine and he reduced his costs by doing this, presumably a smart investment. However, upon analysis, it became clear that he only frequently used 20% of the parts and even then, his turn of inventory was pathetically low. He sometimes stocked a gross of an item when only two or three pieces were used per year.
When I reached this client, he was deeply in debt and barely able to remain in business, fighting for payroll every week (let alone all the other necessary things to support growth and development). When I saw the inventory and did the analysis, I immediately suggested we liquidate it all to raise cash and then purchase as needed, even despite the additional cost and time delays that would be incurred in following such a plan. Not surprisingly, I was met with huge resistance as if I was recommending we sell the company secrets. It was a hard-fought battle but I prevailed as need is sometimes one’s best ally in making difficult survival decisions. We liquidated the parts inventory for approximately $200,000 and with tears in the owner’s eyes as he packed it up and watched it move to a competitor’s warehouse. (I will probably be doing a workout for them soon.) Replacement cost would be significantly higher and turnaround time significantly longer, but now he had some very important cash on hand.
The good news is that the $200,000 saved his company. It was enough liquidity for the owner to manage his way back to profitability and emerge to a successful growth and development path.
In this instance, 10% on the dollar was a great decision. Had he discounted a whopping 50% he would never have raised the $200,000 and may have only sold $10,000 worth, perhaps even less, which would not have done anything substantive for this business. A long story to make a crucial point – depending upon the goal, the discount must accomplish the desired results, otherwise there is no point.
When liquidating inventory in times of extreme need, I have found that it’s all about how low you dare to go. At some price point, junk turns into gold… to someone. So, if the sale is about recapturing a sunk investment and will raise cash that you need very much to either reverse a problem or support a huge leap to greater profitability or revenue, then lower the price to whatever level it must be to make the inventory turn to gold and fly out the door, even if it’s 10% on the dollar. You are not losing 90% but gaining 10%. In this case, the 10% was life changing.
In a sale to create new customers, maybe the issue is the same. Why bother to spend cash to run the ad and get an insignificant return? Consider the discount a cost of marketing and bring in the new customers with a deal they cannot refuse. It’s one thing to be competitive, it’s another to buy a share of the market, which can be a reasonable and effective plan.
Changing seasons, scratch and dents… move the inventory. These things are an unproductive lock-up of valuable cash. Remember, it’s not the original cost you need to consider – that’s already gone – it’s the return of usable cash to try again that is the objective.
Cash is king. Use old or new inventory to create more usable cash and then invest the newly available cash into more profitable activity. That’s my rule. Discount deep, very deep, below cost, and witness the results. One man’s junk becomes another man’s gold. Buy your share of the market with bold and stunning offers that bring your customers in and successfully produce a significant amount of cash to inject in your mission.
Consider the philosophy of a yard sale. Twenty-five cents for an item that originally cost $25, but it makes sense. The crowds line up to purchase chipped and broken glassware, old clothes and old records, old books, etc., turning your junk into another’s treasure at prices massively below the original purchase price. At the end of the day, there is a worthwhile pile of cash earned from converting your inventory to usable cash. It’s all profit from a conceptual point of view, as it is unlocking already spent dollars so you can spend them again. It’s like “profit recycling.”
Forget a 10% sale, or 20% or 30%. How about 90%? Wouldn’t that bring customers in?
