Throughout ecommerce, discounts are widely used as a method of engaging shoppers and driving purchases.
Whether in the form of new customer discounts, seasonal sales, BOGO deals, or loyalty rewards, discounts are everywhere. And they're often a primary tool for marketers.
Our goal was to cover the typical benefits and consequences of discounting, and outline how you can quantify the impact of discounts on the customer lifetime value of your Shopify business.
Before we get too far along, let's cover some basics. Firstly, how to calculate percentage discount. This provides some context for our later analyses.
Now, let's go through the typical benefits and consequences of discounting.
Discounts can be a very powerful tool in ecommerce. Let's walk through some of the common advantages and constructive uses of discounting.
When used properly, discounts can be a highly effective way to acquire new shoppers.
In fact, for one women's fashion brand, just over 44% of shoppers had a discount in their first purchase. This means that almost half of their customers have been acquired at a discount.
Customer retention is absolutely crucial throughout most of ecommerce.
And a key to retention is repeated activity - getting shoppers to keep visiting your site and interacting with your brand.
The greatest hurdle in retention is often driving repeat purchases from first-time buyers. When used discerningly, discounts can be a very efficient way to drive repeat purchases from existing customers.
Discounts can prove to be valuable for reaching intermediate goals, such as reducing excess inventory.
Inventory can make or break a merchant in ecommerce.
In addition to implementing an inventory management software, retailers often hold end-of-season sales to help reduce the inventory that's left.
While heavy discounts aren't exactly ideal, they are far preferable to a pile of excess inventory at the end of a season.
Beyond smaller objectives, you can leverage discounts to achieve long-term strategic goals within your business.
Discounted customer acquisition can be effective for growing your overall customer base, testing out a new market, or gaining share in specific market segments.
But as we will explore, it is important to monitor and evaluate the profit potential of customer acquisition.
Nothing in life is free. While discounts can be a highly impactful tool, they certainly do not come without costs.
At the most basic level, discounts inherently eat into your profit margin.
Retailers in many verticals can afford to offer a 10% to 20% discount and still retain a reasonable margin on the purchase.
However, this must be considered in conjunction with other costs related to the transaction.
Costs of fulfillment and shipping, though typically not too high, still account for about $5 to $10 per purchase.
And, of course, roughly 10% to 30% of items sold online are returned. Not only do returns negate the sales revenue, but they also generate additional costs of shipping and processing.
Be sure to incorporate all costs and expenses related to purchases, so you can more precisely understand your profit margins and discount campaigns.
Offering discounts to new customers can prove to be risky, since it may attract shoppers who will be less valuable over time.
Paul van Loon highlighted opportunists, who solely purchase because of a pricing offer.
These opportunists are never truly your customers. The concept of CAC goes out the window - you will likely have to reinvest to see them again since brand loyalty isn't establish.
They are, quite reasonably, looking for a good deal.
While opportunists are prime candidates for end-of-season sales, they embody a central risk of using discounts to acquire customers. They may not be the customers you want.
As with any marketing tactic, discounts are likely to condition shoppers in some way.
Especially in the case of new customers, discounting runs the risk of training shoppers to look for discounts or even expect them.
The key here is using discounts to reinforce positive, profitable behaviors. Customer loyalty isn't simply bought, it's earned. Discounts can be a helpful tool to ease shoppers along the journey.
Common and widespread discounts can even devalue your brand and diminish your customer lifetime value.
While discounting can be a useful stepping stone to drive additional activity, we need to be sure that we do not develop a dependency among shoppers.
We shouldn't offer discounts to our loyal customers if we don't have to. If there is a reasonable chance a shopper was going to purchase with or without a discount, then discounting simply diminishes the profit margin.
Used improperly, discounts can have a spiraling effect on customer behavior.
When shoppers are repeatedly conditioned with discounted pricing, they are likely to become highly price sensitive and may only respond to lower prices.
This can eventually lead to smaller margins in the future and long-term revenue loss.
We must be careful to not convert potential loyal shoppers into opportunists.
So how are discounts impacting your profits and your customer lifetime value?
We must find ways to measure the short-term effect, while also considering more long-term outcomes.
In the most immediate scope, you always want to examine the effect that your campaigns have on sales.
Uplift modeling serves to quantify the observable impact of a treatment, such as a discount offer, by comparing those who received it to those who did not.
Let's say we are considering an on-page discount offer. We randomly assign a portion of visitors to receive the offer, and others would not see the offer.
The outcome may look something like this: 9% of shoppers who are offered a discount made a purchase, whereas only 4% of those who were not offered a discount made a purchase. Therefore, the uplift of this offer was 5%.
This is a highly simplified example. Nonetheless, it demonstrates the fact that quantification, perhaps by uplift, is necessary to truly understand the impact of your campaigns.
We could then expand the case to test different levels of discounts (such as 5% versus 10%), types of discounts (such as percentage discount versus BOGO deal), or even customer segments (such as new shoppers versus repeat customers).
Clearly, we want to minimize discounts within reason. So if you see that a 5% has roughly the same uplift of a 10% discount, 5% is the way to go.
Discounts can have some substantial and unexpected consequences on returns.
Let's check out the returns data of the same women's fashion brand from earlier.
For this brand, it's clear that discounted purchases have a return rate far greater than other purchases.
This makes sense - the purpose of discounting is to drive conversions. And some of, if not most of, those incremental conversions are bound to be impulse purchases.
As a result, discounted purchases are likely to cause more returns.
While lift should be the primary focus when evaluating discounts, it's important to consider larger, more long-term effects of campaigns, as well.
There is a major question you'll want to answer: is there a difference in the lifetime value and profitability between customers who were acquired at a discount and those who were not?
This will certainly vary by brand and vertical, but let's look at the purchase data of the same women's fashion brand, as an example.
We will start by looking at the retention rates of shoppers acquired at discount, and those acquired at full price.
For this brand, it seems as though the presence of a discount in a shopper's first purchase has no substantial impact on the likelihood of additional purchases.
If anything, customers who had a discount in their first transaction repurchased at a slightly higher rate.
We should also consider discounts in repeat purchases, however. Additional purchases will only provide a marginal source of profit if they are made at a discount, as well.
For this case, we will visualize the average percentage discount in repeat purchases by a categorical indicator of the percentage discount in the first purchase.
We see that, for this brand, the greater the discount in a customer's first purchase, the greater discounts there will be in her repeat purchases.
In fact, shoppers whose first purchase had a percentage discount between 20% and 30% exhibited a repeat purchase percentage discount almost double that of shoppers whose first purchase had a discount of less than 10%.
This supports the notions of opportunists and conditioning - those who first purchase at a discount are more likely to purchase again at a discount.
As a result, the future customer lifetime value of these shoppers is reduced. This could severely limit the brand's ability to profit from repeat purchases.
It is crucial to consider the long-term effects of discount campaigns, even though they are much more complex to quantify than short-term impacts.
Discounts have a variety of impacts on the customer lifetime value of your Shopify business.
We cannot simply assume the discount campaigns are profitable - you must test, measure, and learn in order to drive optimal results.
Discounts should drive profitable activity, or behaviors such as signing up for a newsletter, joining and engaging on social media, or writing reviews.
A deep look into the use of discounts enables you to implement more profitable discount campaigns and encourage customer activities that will drive growth both now and in the future.