Giving Away to Create a Gain: Discounting Strategy

Discounting and promotions when done well, will yield incremental sales revenue and provide either incremental cash flow or net profits or both.

Discounts accomplish this by either the sale of additional goods and services to an existing order/sale –or- by lowering the entry price point they would induce sales transactions that would have either occurred at a different point in time or would not have occurred. It is important to note that in some industries it is easier to create narrow discounts than in others. A narrow discount, is a discount which applies to a narrow slice of the total product offering. The number of seats sold at a certain fare and the items featured on the dollar menu are examples of narrowing. In the case discussed below, prices were publically released with a quarterly catalog with a six month sales window and we were forced to live with our published rates for a large percentage of sales for better or for worse.

I was tasked with both developing a discounting strategy and forecasting the resulting sales and revenue into our P&L and Balance Sheet which projected the resulting cash flow and net profit. This data is from a hotel-conference center that hosted events, professional training and served as a destination as well.

The key issues in developing a discounting strategy are:
1: Understanding the market in terms of demand, price points and what represents a “fair” price.
2: Having sufficient or excess capacity to meet the full response to your discount or promotion.
3: Understanding the variable costs and net cash contributions of incremental sales.
4: Understanding the burden of fixed and overhead costs on a sales unit basis.

Key Question 1:

What is the burden of your fixed and overhead costs on a unit basis?

In this case, our unit burden was about $117 (at 0%) and a 10% growth in unit sales reduced this burden by 8.8%, whereas a 10% shrinkage increased the burden by 11.1%. Notice the steepness of the curve as unit sales drop and quickly over-burden the remaining units.

There is a cost of being in business regardless of sales level, businesses need to understand the slope of the this curve as they change prices and and unit sales. Notice that once sales are reduced to a certain point the rise in steepness in the curve.

Key Question 2:

What are the relative direct costs and margins associated with each product or service offering?

In this case, the highest variable margins were associated with our amenities plan and our housing. The amenities plan was essentially a fee for access to our facilities and a number of classes offered by our staff.

The Price minus the variable direct cost is the cash impact of an incremental unit of sales and the potential profit from the incremental sale.

Key Question 3:

When your customer is making a purchase decision, what components are included in the decision itself and what other products or services are ancillary sales?

In this case, the five typical package purchases involved a combination of; the underlying purpose of the visit (event, professional training or destination visit), the housing and the meal plan.

Ancillary potential and probable sales were spa services and gift shop items.

Strategy Development:
With the answers to the questions above and an understanding of the key issues, it is possible to develop a discount strategy that optimizes financial performance. An optimized discount strategy should:
1. Increase the likelihood of a purchase decision.
2. Satisfy the resulting incremental sale from excess capacity with a minimal amount of variable-direct cost and maximum net cash contribution.

In our modeling we were able to test discounting of various components and various levels of applied discounts. The strategies tested included:
1. Across the board flat-rate discount of 5-10%
2. Blended discounts of the deluxe and standard housing from 5-20%
3. Steeper discounts of only the standard housing packages ranging from 15-35%

The sales impact of the three discounting strategies looked as follows. The steep discounts of the standard product combined with the amount of excess capacity led to the largest unit growth.

The impact on net profit of the three strategies looked as follows. Here the lack of leverage in flat-rate discounting (strategy 1) is even more apparent and nuances of the housing demand and price elasticity show their significance.




With appropriate statistical tools, we were able to examine a multitude of discounting options within each strategy to search for optimal levels of discounting and the roll-up of sales of all products and services, whether discounted or not.

In this chart, the response mapped is the expected net profitability of the enterprise at a given % of unit sales growth and average level of discounting.

The dark green in the upper left is the current net profit. The darkest green at roughly 5% discount and 11% percent growth shows an even higher potential net profit.

The discount level on the graph is not discount offered but the degree to which we are actually discounting the revenue generated from sales, which is the effect of the discount on sales revenue.

The key learning in this graph is that one of the strategies and levels of discounting actually increased net profit through a combination of a steep but leveraged discounts that could be fully captured with excess capacity.

The percent net profit of the enterprise would, in general, always go downward as sales were stimulated by discounted prices; however there are always anomalies that can be exploited.

The current profitability of approximately 7% is shown at the bottom left, the strategy that is most profitable on a percentage basis is at $26MM in revenue and 11% growth. This occurs as the result of a significant change in the product mix as the net result of the strategy.

The real world application of the strategy covered here led to incremental sales representing less than 10% of revenue but which generated 25% of overall profits.

For more information contact us at Metamorphosis Management Group. http://www.metamg.com/

Mapping Your Customers Demand For Your Products

I am deviating from the format I have followed so far as it is leading to a pile-up of work that I could share with you all but which does not fit the format that I have been using.


During a pricing and revenue project, I was faced with determining the strategy for raising prices across the universe of published prices, shown in figure 1, to achieve a specific result in terms of both sales revenue generation and net profit.

There were nearly 1,000 published prices for the various offerings including combinations and packaged quantities. Although indexed in the graph, the dollar values associated with this graph range from about $50 on the low end to several thousand dollars on the high end. Although there were thousands of published prices, most of the revenues were generated in the regions enclosed in the boxes. From this complexity I worked to identify the points of leverage and underlying patterns. This analysis eventually led me to see the pattern shown in figure 2.

Note: In the pricing universe above, each published price contains between 1 and 30 of the base units and may or may not include additional elements.


The statistical name for what you are viewing below in figure 2, is a response surface. Its presentation is the same as a topographic map with contour lines reflecting values and peaks of demand looking similar to mountain peaks. When the lines are close together, you are approaching a cliff face where demand suddenly drops for a variety of reasons. It contains concentrated information regarding the demand for this company’s product offering (Economy – Standard – Deluxe) across the price range at which the base products are sold.

Since this company’s assets are relatively fixed over short periods of time and the addition of significant new assets is capital intensive, I have chosen to reflect demand as a percentage of the capacity available with the current assets.
The dark green area is the area where capacity is close to selling out at the current pricing. The dark gray area is a mix of low demand –and- what is essentially unknown as it also contains areas where there is no data.
The area I am most interested in is, using topographic map language, the ridge line of the mountains running from the bottom left diagonally to the top right. It is along this ridge line that opportunities and problems to be addressed are found.

Of note are the following:

1. The demand for the Economy product (1.0) is low regardless of pricing. The capacity of this product offering far exceeds demand but is unlikely to be remedied by discounting.

2. The demand for ST3 (2.6), the upgraded Standard product, is weak compared to both the Standard and Deluxe products. Notice the saddle in the ridgeline at 2.5. This product is relatively over-priced as it lacks key features of the deluxe product yet is priced just below Deluxe. This product could be sold out at the right price mark-up over the standard product, ST1.

3. The Deluxe product line (3.0 to 3.6) has areas of strong demand and could support price increases during the cyclical periods of stronger demand.

4. The Standard (ST1) product also has strong demand and can support price increases.

5. There appears to be strong demand (1.5) for a value-based version of the ST1 product as this product satisfies needs that are not met by the Economy product and taps a segment of the market that is very price sensitive.

The solution successfully implemented over time included:

1. A strong relative price increases for the ST1 and Deluxe products.

2. The mark-up of ST3 over ST1 being reduced over time.

3. The development of a Value ST1 product offering which met the needs of a segment of the market.

4. The reduction of Economy product capacity by reconfiguring assets and modest price adjustments.

Within two years of this strategy being deployed and refined, the company had increased revenues by >40% primarily by selling more of what had been excess capacity and commanding on average 14% higher prices.

On Wings: Revenue Optimization through Pricing Strategy

Rather than being driven from a strategic perspective, the basis for most price increases is an internally driven response to cost increases and a subsequent attempt to pass those costs on to customers in hopes of maintaining profit margins.

The Opportunity or Threat:

I was invited to a meeting with the CEO, CFO and finance department of an organization to examine the budget assumptions and cost-revenue projections. As the result of increased spending on marketing and investment into upgrading product quality and key managers, the budget was projected to run an unacceptable deficit unless a series of price increases could be designed and effectively passed on to our customers. (In other words, expenses were already up with the hopes that sales would increase. However, the current price structure did not sufficiently cover expenses on a unit basis and could not provide a return on this investment.)
I was asked to examine the sales forecast, operational capacity and capability, price structure and the revenue forecast –and- develop a pricing structure and revised revenue forecast.

The Insight:
My insights and strategy came from understanding dynamic models for predicting the interrelationships between price, units sold and total net revenue. You are probably familiar with the first dynamic model which is the basic price elasticity curve from micro-economics. In essence, I needed to develop pricing that walked the prices upward pushing downward on demand to approximately the sweet spot on the curve where net revenue (profit) is optimized.


The other model I used is similar to the basics of powered flight in an airplane. We had made improvements which were beginning to show up as increased demand but were projecting even greater increased demand, which is similar to fuel for the engines.

Figures below from a slideshow I've published on Cost and Revenue at SlideShare.

When we were able to convert demand into a sale it converted fuel into engine thrust and pushed the plane forward. Although we had excess capacity most of the time, we were losing sales at peak demand periods due to lack of capacity.

So as long as we captured sufficient sales, we had achieved lift and had a net gross profit (Gross Sales – Gross Expenses). Given lift and altitude, the plane is in flight. When the plane is in flight, it can use an

 increase in demand to either speed up (increase sales), increase altitude (increase profit margins) or a combination of the two. However, too much of a price increase will quickly lead to a loss in demand and the plane will stall.

Just as a pilot, adjusts the flaps to optimize while flying, I developed a series of price increases that took into account the product mix available for sale, past demand patterns and current capacities.

The optimal flap adjustments will vary across the product-mix segments. Essentially there are three important segments to understand when pricing:

1) What is Vanilla? What is the highest volume or typical product offering? This will be the bar as it is not possible to successfully raise prices if you can not maintain price and volume in this segment simply due to the proportional size of this segment. In this case, the Vanilla was about 55-60% of the volume in both capacity and revenue.

2) What is your entry-point product or Economy Offer? Unless demand outstrips capacity, there will be little room for price increases here that do not reduce sales volume. A smaller price increase combined with off-peak pricing to shift demand away from cyclical peeks can be most effective here in maintaining volume.

3) What is your deluxe product or Premium Offer? This segment of your market is least sensitive to price but may be very sensitive to quality and performance. If there is strong demand relative to capacity for this segment already, it can absorb significant price increase without a loss in sales volume.

The Action:

Our goal was to grow sales volume by 8% and increase prices by 10% with an understanding that there would be some trade-off between the two.

My description here is simplified for examples purposes. The percentages quoted are on an annualized average basis and represent a weighted average of units expected to be sold at each price. The actual number of distinct product offerings was eleven and the total number of offerings by price was 44 based upon two types of peak and off-peak demand.

Based upon the analysis, we increased the Economy product price by 4% on average but in-fact lowered the price by 4% during our strongest off-peak periods where we had excess capacity.
The Vanilla product price was increase by 10% on average with a 5% increase during off-peak periods. We also began to lay the groundwork to further segment vanilla with both an upgraded and a value option that took two years to fully implement due to needed upgrades to our enterprise software.
The Premium product line was historically the most segmented from a product offering perspective. It also had a generally healthy demand with periods of over-capacity demand due to our limited capacity. Here we engineered a price increase that averaged 16% but ranged between 10% and 22% and planned future expansion.

We were successful in our efforts to simultaneously grow demand which we did by 14% and revenue by 26% year over year. In essence we maintained our 10% price increase on top of 14% unit sales growth. Given our strong growth in demand and the modeling we did, we were able to engineer an even more aggressive strategic price increase the following year as we filled to capacity and achieved a record for net operating income.

In an upcoming article, I will go into greater detail as to how to build a revenue projection model and cover the use of Bayesian probability or analysis. This method allows you to estimate the sum total of a sequence of events, if you can estimate the probability of individual future events. (This is the same branch of statistics that Google uses to determine what you likely to be looking for when you enter a specific key word sequence.)

To see how our work benefitted a client related to this method, visit our case studies at Metamorphosis Management Group (http://www.metamg.com/).

Constraint Management: Optimizing Revenues by Keeping the Net in the Water

A commercial fisherman spends a lot of money to be in business between the boat and equipment, the crew, the fuel and the licenses. However, a fisherman is only making money when the fishing nets are in the water. Since it costs so much to just get out to sea, a successful fisherman works to get to the fish and keep the nets in the water either until the nets are full or until the fish are done feeding.

The Opportunity or Threat:
I was working as the Director of Operations for a financially weakened organization with just above skeleton level staffing as we worked ourselves back from the brink of bankruptcy. Due to the hard work of our staff, we were able to get a celebrity to speak at one of our scheduled events. Our expectation for demand for the event tripled overnight without any supporting changes to our assets or resources.

The past behavior would have been to cap the event size, in this circumstance somewhere around 300 people but it was clear that if we did that, we would be squandering an opportunity. The same as a captain heading back to shore while the fish were feeding.

The Insight:

Following the principles of constraint management, as outlined in The Goal by Eliyahu Goldratt, we carefully examined each perceived bottleneck to accommodate a larger event. There are several types of constraints and in this case we mostly looked at policy and resource constraints.
Resource constraints exist when you outstrip the capacity of a resource whether that is staffing or asset-based. Policy constraints exist when your method of managing your resources results in their inability to produce the needed capacity.

The Action:
Our initial examination of our constraints showed three potential bottlenecks; the capacity of the auditorium where the celebrity would be speaking, our capacity to feed a group of people with our existing dining room and kitchen staff and finally our existing housing capacity.

With the participation of key people from throughout the organization, we began the work of unraveling the bottlenecks.
Although we were running a three-day themed event, our celebrity was only speaking and participating in one half day of the program. We decided to move the celebrity’s talk off-site and found a suitable venue about ten miles away. We rearranged the schedule, so that we could bus people attending the three day event to the venue and back. This allowed us to sell hundreds of additional tickets to the celebrity’s presentation beyond our other capacity bottlenecks.
The next bottleneck we worked upon was the food service operations. Here our strategy required three coordinated efforts to elevate the capacity of food service above other constraints. First we needed to change our schedule to allow us time to feed more people and remove the load of staff meals from the peak load. Second, we needed to change the menu to a menu that took less labor and allowed more preparation ahead of the events. Third, we needed to both modify the staffing and staff schedule by pulling extra workers from both inside and outside the food service area. This raised our food service capacity to nearly double for the three day event.

The final capacity bottleneck to be addressed was to manage our own housing capacity to fill it as efficiently as possible and then find housing outside our facility for additional customers. We worked out arrangements with several nearby establishments and developed internal rules to ensure that we optimized our own housing.

The net result was that we turned almost no one away from the event, leaving no feeding fish, when we pulled in our nets. We also handled nearly three times our typical capacity and double our normal peak capacity.

The event was so successful, that some of the methods were more broadly applied to our operations, policies and assets over the next two years and contributed to nearly doubling our gross revenues.


To see how our work benefitted a client related to this method, visit our case studies at Metamorphosis Management Group (http://www.metamg.com/).

Building a High Performance Team: Engagement and Respect

I worked for an organization that decided it was imperative that we both modernize and expand our revenue generating facilities. While maintenance and renovation was an ongoing area of expertise for us, the institution had never engaged in any large-scale construction.

The Opportunity or Threat:

Most operating companies and organizations are not normally engaged in the architecture, engineering or construction business. When a company has decided to build new facilities to support the revenue growth of the organization they are faced with challenges in design, permitting, financing and construction along with the complexity of project management. Bad projects with their cost and schedule over-runs have gotten so much attention that many people assume that you can have no faith in a construction budget or schedule.

When you look at the body of expertise required for even a modest project it can be astounding when the architects, engineers of various disciplines, construction cost estimators and construction management people are all assembled.

The Insight:

Seeking engagement and giving respect are essential to optimizing long-term relationships rather than merely optimizing a transaction.

We needed to develop a project management structure where we had the competence and capacity to do the job but also a structure where there was shared success in the optimal execution of the project. In my role as owner, with fiduciary responsibility for the net result of the project, I needed to understand both the factors which provided optimal revenue generation and the costs in both time and money of the realized design.

The objectives of the project and the roles of each team member were reinforced at each major decision point in the project.

The Action:

Engagement has a few interrelated but different meanings and I wish to point out two of those meaning here. Engagement can refer to a contractual relationship between two parties where the "engaged" party has been hired to deliver a specific result. Engagement can also refer to the degree to which one is engaged in their work or a discussion or a relationship.

After building a small internal team of three people to act on behalf of the owner (including one VP-owner and two project manager-construction accountants), we began a process of both engaging emotionally and engaging contractually our design and construction partners. The emotional engagement came from a true two-way dialogue where the goals and objectives of the owners as well as our limitations were shared with the potential team members. On the reciprocating end, we sought proposals and had interviews with small pools of pre-qualified candidates and then selected our first choice partner on a combination of competency and value. In every case, we were able to negotiate the best value with our first choice partner and develop alternative sources for key work if needed in an emergency.

On the contractual engagement end, we entered into collaborative and integrated design build arrangements. The main driver for all became the achievement of a desired design and construction schedule at an acceptable budget. We worked together to price alternatives at several key points in the project. These exercises in developing alternatives allowed us to keep the project moving forward in the face of difficulty.

In addition to proper engagement the tone of the team was one of respect. There were three levels of respect that worked together; personal respect of each person as a human-being, professional respect of each person with regards to their expertise and contractual respect with regards to each person for their area of accountability. We worked hard to work through problem-solving and design-construction-cost detail resolution while holding these aspects of respect.

In a few instances, I gave license to a team member to have there ideas fully vetted even when most team members wanted to move on -and- on other occasions I was able to drive the team to a relatively quick decision with minimal discussion based upon the importance and possible benefits of further exploration versus the impact of delay on the project.

I was charged with responsibility for oversight of $20MM in construction for an organization whose largest previous project was a $2MM renovation. $15MM was spent for the design and construction of a new revenue generating facility and the remainder was spent on associated and required shared infrastructure upgrades.

After 13 months in construction, the building was permitted and opened on the promise date and we were able to return several hundred thousand dollars in unspent contingency from the budget.


To see how our work benefitted a client related to this method, visit a white paper and webcast of this project at Metamorphosis Management Group.

Training and Education: Applying Stadium Pricing Strategy

Training and education is an industry that struggles under a ballooning cost structure and a set of challenging constraints. Amongst the constraints is the perceived value of being physically present with the faculty member in a small student/trainee setting.


While the value of being in the room with a “great” teacher and having a setting that is intimate for dialogue is clear, the cost of doing this has grown steadily at a rate that exceeds inflation across all types of training and education.

Traditional colleges have attempted to lower these costs with broadcasted distance education and large assembly halls that can connect a single faculty member simultaneously with a large number of students. Student feedback indicates that simply facilitating a higher student to teacher ration degrades their experience.

This becomes even more of an issue when the education/training is experiential in nature and the faculty member or presenter is an expert or author.


The Opportunity or Threat:

I was given the assignment of optimizing both the revenue plan and the net revenue generation for an experiential education organization. Although the organization had grown by 40% over the previous five years, its margins had steadily eroded and were now negative.
The Insight:

While a college freshman may have no choice but to sit in a large lecture hall or watch a broadcasted lecture to take a required course, this solution is less than acceptable when the student has discretion over when and where they go for their education or training.

Major league sports (NFL, MLB, etc.) have seen an explosion in their costs due to open market competition for star athletes. This has forced average ticket prices to rise drastically and if these costs were evenly passed on to potential fans, it would greatly limit access to attending games and erode the fan base.

A solution to this problem is the modern sports stadium, where 80,000 people may sit and watch the same event but the spectrum of associated services offered covers a huge range. At the bargain end there are standing room and family sections and at the high end there are private suites where one can host a private party in the midst of the game. The common experience of witnessing the game and being part of the crowd is the single shared experience.

The Action:

As I began my review of revenue for this organization, I looked to achieve two simultaneous objectives:
1) Significantly raise the average total expenditure per student by pricing and offering additional services.
2) Keep the entry pricing as low as possible, so that students who were price sensitive would still purchase and those with limited income would not be turned away.

In addition to experiential education the organization had the following to offer, housing of various qualities, a meal plan, open additional activities, spa services and a retail shop.

Each of these areas can be optimized according to the same basic strategy. For simplicity, I will discuss the primary change made to optimize revenue which was the handling of housing.

The attributes which determined the value of a specific housing option were examined in both space (privacy, view, amenities) and time (peak season, weekends and holidays). A pricing strategy was laid out in both space and time that:
1) Increased the step-up differences as a student upgraded their housing type based upon desire and ability to pay.
2) Facilitated up-selling of limited amenities within a housing type.
3) Maintained higher pricing during periods of higher demand and offered lower pricing during periods of lower demand to facilitate revenue capture during peak demand and shift price sensitive demand to off-peak periods.

The initial year, we rolled out a housing price increase which averaged 10% but ranged from -4% to + 24% when each basic pricing configuration was looked at. The impact on net revenue was huge and the net margins swung from -2% to + 8%.

The total strategy took two years to fully implement as we needed to upgrade the software we used to book and bill students to accommodate the complete pricing strategy. We also used the strategy to selectively upgrade housing within the housing portfolio.


To see how other clients have benefitted from our work, visit Metamorphosis Management Group (http://www.metamg.com/).

Check Out: Upcoming Solutions and Innovations

We've added a page to give you an idea of the topics and scope of upcoming articles. The link for this page sits just below our main page header.

To go directly to Upcoming Solutions and Innovations.

To see additional work in a case study format, you can go directly to the case study page at Metamorphosis Management Group.