How much does a discount really cost a small business?

Why does a 10% discount cost so much more than 10%?

Most owners think of a discount as a small cut to the price. The problem is that your costs don't get a discount. Every dollar you take off the price comes straight out of your gross profit.

Say you sell something for $100 and it costs you $70 to make or buy. Your gross profit is $30, a 30% gross margin. Take 10% off and you sell it for $90. Your cost is still $70, so your gross profit drops to $20.

That's not a 10% drop in profit. It's a 33% drop. To earn the same $30 you used to, you now need to sell 1.5 units for every one you sold before. That's 50% more sales, plus 50% more stock, labour, delivery and customer service to handle them.

The lower your margin, the worse this gets. A business on a 20% margin that offers 10% off needs to double its sales just to stand still.

Discounts can still have a place, for example to clear old stock. Just do the maths first so you know what you're really giving away.

What is gross margin and how do you work it out?

Gross margin is the share of each sale left over after paying the direct costs of what you sold. Direct costs are things like materials, stock, and labour that goes into the job. It doesn't include rent, insurance or your accounting software. Those come out later.

The formula is simple:

• Gross profit = Sales minus direct costs
• Gross margin = Gross profit ÷ Sales × 100

If you sold $50,000 this month and direct costs were $32,000, your gross profit is $18,000 and your gross margin is 36%.

Most owners can't quote their margin without looking it up, and that's normal. But it's one of the most useful numbers to carry in your head, because it tells you instantly how much room you have to discount, and how much a discount will hurt.

A good habit is to know three numbers every week: this month's sales, your gross margin, and how much money customers owe you. If you can't find them in a few minutes, fixing that is the first job.

What can you offer instead of a discount?

Customers who ask for a discount often want to feel they're getting a good deal. You can give them that without cutting the price.

Try adding value instead:

• A bonus item or service that costs you little but feels valuable to them
• Faster turnaround or priority booking
• A longer warranty or a free follow-up check
• Free delivery or setup above a certain order size
• A bundle that lifts the total sale while protecting your margin

The trick is to offer things with a high perceived value and a low cost to you.

It also helps to accept that not every customer is the right one. Saying yes to a customer who only buys on price costs you time, margin and energy, and often leads to more haggling next time. Being clear about who you serve, and what you're good at, often makes you more attractive to the customers who value it. Politely saying no to a heavy discount request is a legitimate business decision, not a failure.

Which of your products actually makes the most money?

Your quietest product might be your most profitable. Many owners push the thing that sells easily or the thing they enjoy most, without checking what it actually earns.

Here's a pattern I see often. An owner lists everything they sell with its price, direct cost and gross margin. The best seller turns out to have the thinnest margin, often because it's been discounted to stay competitive. Meanwhile a service they barely mention earns twice the margin.

To check your own range:

1. List your products or services in a spreadsheet.
2. Add the price and direct cost for each.
3. Work out gross profit in dollars and gross margin as a percentage.
4. Sort by margin, then by total gross profit for the year.

Then ask: what would happen if we sold more of the high margin items? Could they go on the front page of the website, into your quotes as a standard option, or into staff conversations with customers?

Shifting your sales mix towards what pays is usually far more profitable than discounting what doesn't.

How do supplier costs quietly shrink your margin?

Margin isn't only lost through discounts. It also leaks when costs creep up and nobody notices.

Take a small manufacturer making outdoor furniture with a team of six. Orders are healthy, but margins have been shrinking as material costs rise a little each year. He lists his top ten purchases by spend and realises most have never been re-quoted since he started.

He spends one afternoon on the phone, gets two competing quotes for timber and fixings, and gives his existing suppliers the chance to match. Two of them do. In this example, the changes save around $1,500 a month on materials, which goes straight to gross profit.

Loyalty to suppliers is good, and good relationships matter. But it's reasonable to check every year or so that prices are still fair. Start with your biggest spends, because a small percentage saving there is worth more than a big saving on something minor.

Every dollar saved on direct costs lifts your margin and gives you more room to hold your price.

Worked example: what does 10% off really cost?

Here's a simple example for a business with a 30% gross margin.

Before the discount

• Price: $100
• Direct cost: $70
• Gross profit per sale: $30
• Sell 100 units a month: gross profit of $3,000

After a 10% discount

• Price: $90
• Direct cost: still $70
• Gross profit per sale: $20

How many sales to earn the same $3,000?

$3,000 ÷ $20 = 150 units. That's 50 more units, or 50% more sales, just to stay where you were.

The shortcut formula

Required sales increase = Discount ÷ (Gross margin minus Discount)

10 ÷ (30 minus 10) = 10 ÷ 20 = 50%

Now flip it: what about a 5% price rise?

At $105, gross profit per sale is $35. To earn $3,000 you need only about 86 units. You could lose around 14% of your sales and still make the same gross profit, with less work.

Key numbers

Steps to take this week

1. Work out your overall gross margin for last month using sales and direct costs from your accounts.
2. List your products or services with the gross margin on each, and sort them from highest to lowest.
3. Before your next discount, use the formula to calculate how many extra sales you'd need, and decide if that's realistic.
4. Write down three value adds you could offer instead of a discount, such as faster service, a bonus or a longer warranty.
5. List your top ten supplier purchases by spend and request a fresh quote on the two biggest.

Frequently asked questions

Is it ever worth offering a discount?

Yes, sometimes. Clearing old or slow stock, rewarding a large upfront order, or filling genuinely spare capacity can make sense. The key is to calculate the extra sales you need first, and set a clear end date so the discount doesn't become the new normal price.

What is the difference between margin and markup?

Markup is profit as a percentage of cost, while margin is profit as a percentage of the selling price. An item costing $70 and selling for $100 has a 43% markup but a 30% margin. Mixing them up is a common reason owners think they have more room to discount than they do.

What is a good gross margin for a small business?

It depends heavily on your industry, so there's no single right number. Retail and wholesale often run lower margins, while service businesses can run much higher. The more useful question is whether your margin covers your overheads and leaves a profit, and whether it's rising or falling over time.

How do I say no to a customer asking for a discount?

Be polite and confident, and explain what's included in your price. You can offer a value add instead, like faster delivery or a small bonus, so they still feel looked after. If they only want the lowest price, they may not be the right fit for your business.

Should I work out margins including or excluding GST?

If you're registered for GST, work out your margins using figures excluding GST, because the GST you collect isn't your money. It's passed on to the ATO through your BAS. Check with your accountant or BAS agent if you're unsure how this applies to your situation.