In response to the recession many small to mid-sized companies are discounting their prices to attract or maintain customers. Although this may make sense from a sales perspective, financially this could be the decision that destroys the company.

Many business owners follow this thought process: offer lower prices to get the customer in the door and the discount will be “made-up” on the ensuing sales. If you are reducing the profit margin to gain market share this can be an effective short-term strategy. However, if you are discounting below the company’s cost structure the financial loss on each transaction can lead a company to insolvency. Therefore, prior to deploying a discount strategy a true assessment of the cost structure must be considered.

Here is where companies miscalculate:

Large corporations follow similar strategies but they differ in their financial understanding of the cost structure, which considers ALL expenses involved in the production of the product or service. Less financially sophisticated companies, which are indicative of smaller companies, make the mistake of only considering the obvious cost, leaving out overhead items such as rent, marketing efforts, sales commissions, administration and insurance. Whereas the large companies are discounting the amount of profit, the smaller companies are unknowingly losing money on every transaction. Eventually this becomes evident in the cash flow, as the amount of cash slowly diminishes every month in spite of an up-tick in sales.

So what is a small company to do?

In response to the recession most companies have seen a decrease in sales. Many small companies simply do not have the cash reserves to cover the overhead during a prolonged sales decline. Additionally, the profit margins may have been slim prior to the recession and therefore they do not have much “wiggle” room to decrease prices. In the case of decreasing sales a company may be better off reducing the overhead expenses to respond to the new sales numbers thereby protecting the profit margins. A profitable company with revenues of 2 million is much better off than a company discounting prices in an attempt to maintain 5 million in top line revenue, while losing money every month.