The Discount Dilemma: Balancing Sales, Profits, and Variable Costs in Ecommerce

Key Takeaways for Ecommerce Brands:

1. ‍Research shows that 74% of U.S. online shoppers are influenced by discounts, with 67% changing their shopping behavior based on price reductions
2. Discounts should be considered alongside other variable costs – expenses that fluctuate based on how much you sell – like shipping, merchant fees, and advertising. 
3. Successful ecommerce brands don't simply view discounts as profit reducers, but as strategic tools that can potentially lower customer acquisition costs, increase order volume, and attract customers with high lifetime value.  

On the morning of Cyber Monday 2024, Etsy sellers woke up to a surprise: the marketplace was giving shoppers $5 off on any purchase of $25 or more, stacked on top of seller-funded discounts. There was only one problem: while sellers were notified via the community forum a day before, Etsy did not mention it was funding the promotion.

This baffled some sellers, who were worried they would have to cover the costs. “Is Etsy eating these discounts?” asked one of them on Reddit, “It shows up on all my listings.” When the dust settled, many brand operators wished they would have known more details about the discount. “WHY was that not mentioned to sellers?!” asked another operator. “We could have promoted that on our socials!”

The frustration is understandable. Multiple studies have shown that discounts play a significant role in driving sales – and not only during the holiday season. Key findings from the past few years include:

• Discounts are a major factor for 74% of U.S. online shoppers. 

• 67% of shoppers change their shopping behavior based on discounts.

• 87% of consumers reported that a discount would strongly motivate them not to abandon a digital shopping cart; on average, 70% of digital shopping carts are abandoned.

• 30% of shoppers redeem digital coupons within a day of finding them, and 82% redeem them within a week.

The Cautious Approach: Why Some Brands Hesitate to Use Discounts

Digital coupons, in particular, have proved to be an incredibly useful form of discounting. According to research conducted by the Center for Neuroeconomics Studies at Claremont University, this stems from physiological and psychological reasons: people who receive coupons have higher levels of oxytocin, a hormone directly related to love and happiness. In fact, per the study, receiving a coupon is physically more enjoyable than getting a gift.

Despite the clear benefits of discounts, some brands use them sparingly. In many cases, this course of action is supported by ecommerce finance experts. “It is easy to be reactive and increase the discount offered if sales aren't up to forecast,” said Jeff Lowenstein, an ecommerce Fractional CFO. “However, it's crucial to make sure you are dialed into the impact discounts will have on your margins. We've seen this be mismanaged and crush some great brands.”

This approach is particularly prevalent during the promotion-heavy holiday season. “A 50% discount may get sales flying, but that may result in a very low gross margin,” explained CPA Courtney Myers, Founder of Freedom Finance. “We're focusing on pricing goods in a way that makes the company money and not blowing ad spend on heavily discounted items. Don't stop ads, but don't spend all your ad dollars on huge discounted items.”

Embracing Flexibility: Variable Costs and the Strategic Use of Promotions

On the other side of the spectrum, some ecommerce finance preach pragmatism and implore brands to see discounts for what they are: another tool in the toolbox. “Don't fall into the trap of automatically assuming that all discounting will ruin your profits,” writes Jon Blair, founder of Free to Grow CFO, suggesting instead that operators should consider discounts as a variable cost. 

Unlike fixed costs – expenses that remain constant regardless of sales volume – variable costs fluctuate based on how much you sell. The main variable costs for ecommerce brands are: 

• Cost of goods sold (COGS) – the cost of getting a product ready for sale, such as the price of purchasing or manufacturing the product, packaging costs, and shipping-in/freight-in costs to deliver products to your warehouse. 

• Shipping and fulfillment costs – the cost of shipping the product to your customer. This cost varies depending on carrier, product weight, and how quickly it is delivered. In ecommerce accounting, this is usually the largest expense after COGS. 

• Merchant fees – also known as transaction fees or payment processor fees, merchant fees are charged by credit cards and other payment providers for processing transactions. These fees usually include a fixed percent fee and a fixed amount, both charged per transaction. 

In addition to these, variable costs include advertising and promotions/discounts. And while discounts are no exception to the golden rule – as variable costs increase, your gross margin per order decreases – there are, claims Blair, three scenarios that can offset their impact on business profitability:

1. When discounts lead to a higher conversion rate

A high conversion rate reduces customer acquisition costs (CAC), allowing brands to turn a healthy profit despite a lower gross margin per order.

2. When discounts lead to a higher order volume

A significant jump in order volume can overcome the decrease in gross margin per order, resulting in a higher contribution margin. 

3. When discounts lead to acquiring lots of new customers 

If your products have a high lifetime value (LTV), you can earn back the money you "lost" on the first order down the road, as LTV accumulates on repeat purchases.

The lesson is clear: in the complex world of ecommerce accounting, discounts are a nuanced strategic tool that requires careful analysis beyond business profitability.