Discount Containment in Software Sales
By Jim Geisman & John Maruskin, Marketshare, Inc.However, MarketShare has developed a method that can affect revenues very quickly — within 3 months or sooner. Our method for helping clients get this near-immediate revenue boost is to systematically exploit a source of untapped revenue -- negotiated discounts.
To be sure, companies will always negotiate discounts to get orders from large customers. And today’s softer economy is causing many companies to negotiate discounts with their smaller accounts as well. However, we have found that companies can make more money faster de-spite the current economic climate — if they actively seek to understand, quantify, and control revenues being “lost” to discounts.
In many cases, one-fourth to one-third of the negotiated discount can be recovered and con-verted into revenue. Any money recovered from these discounts increases the top line and drops directly to the pre-tax line of the P & L. Recovering some or all of these "discount dollars" can increase pre-tax profitability by 20 percent or more (see example in Table I).
In one client engagement, for example, we estimated earnings per share would increase by $0.02 for every 1% decrease in large deal discounts. This technical software company was let-ting their sales force give up $0.10 or $0.20 per share in order to do business with their large customers. By recovering just 20% of all the discounts the company went from a significant loss to a breakeven financial position.
While this paper focuses on software companies, the method we describe can be used in prac-tically any industry. Every company that negotiates with its customers is likely to leave some money needlessly “on the table” – money that can be recovered though effective discount moni-toring and control.
Profits Slip Away in the Typical “Big Deal” Process with Large Customers.
Profitability often suffers during “Big Deal” negotiations with customers in a process that looks something like this:
Bundle prices
Volume discounts
Corporate discounts
Promotional discounts
Prompt-payment discounts
... giving the customer more discount for same products & services
... “throwing in” more products & services keeping price the same, or
... giving up more discount and throwing in more product & services
The results: The customer gets better price; the sales rep gets a commission; and the company loses revenue and margin. These results are amplified the closer the deal is to the end of the quarter or fiscal year. The customer gets an even sweeter deal, the company loses even more revenue and margin — and sometimes the rep even gets additional money as an end-of-quarter bonus.
To make matters worse in this economic climate, many smaller customers are now responding to what they sense is a buyer’s market and are making demands like the “big boys” when they sit at the negotiating table.
Why Discount Dollars Are Given Away
There are many reasons why sales reps give away discount dollars. The most common stated reason is: "That's what it took to do the deal." Sometimes this is correct because the product is simply too expensive for the value delivered. Or maybe the standard discount, for the volume of purchases, really is too low.
But the real reason is almost always more complicated than that. Sometimes the sales rep is outgunned by a purchasing agent or experienced negotiator. Or the customer is using time pressure to get end of quarter price concessions. Perhaps there is a mismatch between cus-tomer needs and product price. Or perhaps the economic value delivered to the customer is not communicated properly by the sales rep — or understood by the customer.
Maybe it is sales management. Maybe it is the rep. Maybe it is the pricing structure or product functionality. Maybe the customer senses from his read of the economy — that lower prices and deeper discounts are available to every buyer for every sale.
Whatever the cause, a company needs to understand the flow of these revenue-decreasing, profit-eating discount dollars in order to control them — and regain control of revenues and profits.
Keys to Effective Discount Management
What can management do to improve the way discounts are meted out?
Senior management can control discounting by fiat. They can establish broad scale policies for controlling the range of discounts. They can terminate sales reps that negotiate "bad deals" or miss their numbers because the deals weren't good enough. But these are reactions and they may cause more harm than good.
Successful management action requires a proactive, systematic approach based on information and knowledge. Without a system and without solid information, any positive results are short-lived and can cause even more significant problems in the future.
Managers that want to be effective when they "do something" about discounting behavior need to be armed with the proper information. Management that has information about how discounts are given up or invested can anticipate and manage their net revenues on a proactive ba-sis.
Insights Leading to Effective Actions
While every company knows the invoiced amount of the deal, in an informal survey of more than 100 software companies, less than one-third of the sales and marketing executives said their companies tracked negotiated discounts — the spread between invoiced amount and the amount net of standard discounts. This is important when the sales rep gives up additional product or additional discount — sometimes both — to get the sale.
Companies that track this spread — “give ups” (as in how much the sales rep “gives up” to get the deal) — will know how much money was left on the table and know how much revenue can be recovered.
The key to effective action is understanding the what, where, when, and who of these “give ups”.
… specific products?
… specific bundles?
... industry focused packages?
… customer segment?
… individual customers?
… certain deals or size?
… links to quota periods?
… disturbing trends?
… which sales reps?
… which sales managers?
Management needs to dig into the details, to understand where the problems are focused and where the opportunities lie. Empowered with this information, management can choose a suit-able course of action:
The degree of discount and revenue management can be applied flexibly — from specific ac-counts or sales reps at specific times, all the way to across-the-board implementation. Dis-counts can be tightened when a company needs the revenue and profitability and loosened when they do not.
Empowering Sales Rep Success
Information that marketing and sales management uses to better understand and control dis-counts can help individual sales reps too — helping them to know when and how to “push back,” and potentially strengthening their bargaining position in difficult customer situa-tions.
Adding discount management to the radar screen of performance measures gives individual reps a chance to establish and achieve their own goals while watching their progress relative to the goals.
The Bottom Line: Managing Profitability, Increasing Net Worth
By judiciously controlling and managing discount dollar amounts, management can more finely control their revenue and profitability. Here are some examples:
Situation: A large order comes in sooner than expected.
Response: Use the extra revenue to increase negotiated discounts on selected accounts to get added sales in the next quarter
Situation: A large order may slip by a quarter.
Response: Provide higher levels of discounts to other accounts whose total revenues equal the revenues of the large order thereby making the quarter. (This may also decrease the pressure for added discounts to get the single large order in the next quarter.)
Situation: One product group is consistently discounted at above av-erage rates.
Response: Adjust the value by bundling products; develop an ROI / value proposition to bolster the price. Do a competitive benchmark pricing study.
Situation: A development program is running over budget in a quar-ter, or there are one-time costs associated with an acquisition.
Response: Decrease negotiated discounts in three new accounts and one existing account this quarter to offset these expenses
Managing negotiated discounts gives senior management another dimension of control over company revenue and profitability. By doing so, the financial performance of the company can be more predictable, which leads to higher earnings and (in public companies) improved stock prices.
For privately held companies, the benefits are even greater as the bulk of the increased valua-tion flows to a limited number of shareholders.
The impact of leaving less money on a company's P&L statement is shown in the attached ta-ble. The data uses as an example a typical software company's financial performance.
Is Discount Management Right for Your Company?
In deciding whether a program of discount management is likely to have a significant payback for your company, we offer the following key indicators for CEOs, CFOs, and senior marketing & sales executives:
Discounts are significant relative to sales
Discount details are not reviewed or analyzed
Causes of discounts are accepted without challenge
Where to Begin and How to Proceed
Once it has been decided that a program of discount management is likely to have a significant payback for your company, we recommend the following three step process for recovering the revenues:
Discovery is the initial assessment of the amount of discount dollars at stake. Identify current discounts by source, and approximate discount amount and variance within each source. Also identify additional data required for making detailed assessments in the Assessment phase that follows.
The most important aspect of the Discovery phase is the preliminary identifica-tion of high potential areas for discount reduction and a “first-pass” identifica-tion of programs for controlling discounts such as, category-based discount guidelines, discount allocation techniques, sales rep feedback mechanisms, discount-linked compensation schemes, and negotiation training.
Assessment involves drilling into the details of discount composition and completely itemizing the set of activities that will reduce discount-dollar outflow. This is where a discount reduction team is formed – a team with rep-resentatives from Sales, Marketing, and Finance that works to evaluate and fine-tune “first-pass” recommendations. The discount reduction team also works to identify steps necessary to integrate agreed-upon programs with ex-isting systems and procedures. Mechanisms to monitor the effect of these pro-grams are also identified.
Remedy & Reporting is the actual program development and imple-mentation. To ensure a lasting improvement, an ongoing program must be put in place that includes metrics and performance reporting mechanisms. Stan-dardized report formats (e.g., scatter diagrams indicating discount perform-ance by sales rep, territory, product, etc.) should be produced with linkages to the company's financial reporting systems. This phase should also include training, compensation alignment (if desired), action plans, and 6 – 12 months of ongoing program refinement.
Summary
We’ve described a method that can boost revenues and bottom line profits by managing the level of discounts negotiated with customers. Although this methodology has been applied to technology companies, it can be successfully applied to any company that negotiates prices with their customers or key channel partners.
Underlying the method is a view that negotiated discounts represent an investment in a cus-tomer relationship. That investment can be used by sales, pricing executives, and senior man-agement as a tool to reward specific customer behavior. But like any major investment, it must be carefully managed to deliver a maximum return.
The methodology leads to more predictable financial performance as measured by higher valuations, improved cashflow and higher margins. And in the end, customers are treated more uniformly.
About the Authors
Jim Geisman jgeis@moreshare.com, and John Maruskin johnm@moreshare.com, are both with MarketShare, Inc. in Wayland MA (508-647-0330). MarketShare helps technology companies realize greater returns from the products they sell and the sales professionals that sell them. The company specializes in Discount Management, Value Based Pricing and ROI Communica-tion. Additional information about the firm is available at www.softwarepricing.com.
Table I: Revenue and Valuation Impact
Of Leaving Less Money on the Table
(Example of a Typical Software Company)
Of Leaving Less Money on the Table
(Example of a Typical Software Company)
| Total Revenue | 100% | |
| Net income | 6.5% | |
| Product revenue only | 60% | % Totale revenues |
| Big deal revenues | 30% | 50% of product revenues |
| Negotiated discounts | 12% | Big deals get 40% discounts |
| Amount recovered | 3 - 6% | Recover 25-50% of negotiated discount |
| Percentage improvement | ||
| Revenues | 3 - 6% | Revenues and pre-taxincrease by 3 - 6 percentage points |
| Pre-tax income | 46 - 92% | Pre-tax rises by 3 - 6 percentage points to 9.5 - 12.5% |
| Impact on valuation/market cap(% increase) | ||
| Based on X Revenues | 5 - 10% | Market Cap=1.5 X Sales rise |
| Based on X Earnings | > 5 - 10% | Market Cap=15-20 X Earnings |