There has been sudden increase in discounts in India retail especially since the growth of e-commerce. There is a well-defined logic behind these discounts. Getting customers from internet isn’t cheap. It requires companies to spend a lot of money upfront to acquire one customer. The money spent to acquire a customer is called customer acquisition cost. E-commerce businesses hope that customer will make several repeat purchases from them, and so they will be able to recover the money spent to acquire that customer.
Discounting to boost customer acquisition
Let’s take an example of an e-commerce company- This company sells products worth Rs 600-800 per transaction and earns a gross margin of Rs 100 after excluding cost of product, delivery, payment etc. Customer acquisition cost for these companies can be in the range of Rs 1,000- 1,500 so let’s assume its Rs 1,000. What it means that the company requires any customer to do 10 transactions (10 x margin of Rs 100 = 1,000) to recover their acquisition cost. Now, if this company starts giving an average discount of Rs 300 to new customer, it would require them to spend very little in acquisition. They still need to invest in marketing, lead generation but a significant discount of Rs 300 will catch a lot of attention. Let’s assume that only Rs 200 will be spend to acquire a customer with this discount. So, the total acquisition cost is= Rs 300+ Rs 200 = Rs 500. This is half of earlier cost. It makes great sense. So, what can go wrong here?
Are you acquiring customers by discounting?
The underlying assumption of acquisition cost is that you are acquiring a prospective customer who is aligned to your brand, product or services and will make significant transactions in future as well. But is this assumption valid when we are acquiring customers by giving discounts? There can be a lot of first purchases by people who aren’t your customers but doing it only because of the discounts, which means they might not purchase anything from you if it isn’t discounted. They aren’t switching to your brand or platform but simply looking to maximize their short term benefits. Even worse, “discount seekers” are more likely to find your discounted products because that’s what they are looking for. You can’t call all of them your customers because they might not make any purchase after this. So, continuing from our example- if the same company gets 1 customer out 4 (rest 3 are discount seekers) by giving discounts, the true acquisition cost for this customer is Rs 2,000 (500×4), this is double compared to without discounts.
Discounts are good to build momentum, get critical mass, reach out to a new segment, incentivize existing customer to increase purchase frequency, clear inventories etc., but companies should watch out for future behaviour metrics because they are solving for customer’s lifetime, not one transaction. This is easier said than done especially when you have limited data. Hence, it is important to keep experimenting and analysing data continuously. The quality of customers is the strength of a company, which isn’t necessarily reflected in the P&L. Don’t give discounts randomly, and keep doing the math.