By Steve Walter, Vice President, Global Partners at Aspen Technology, Inc.
According to a study published in the Harvard Business Review, more than 30 percent of companies that frequently granted unmanaged discounts reported a decline in average sales price after only three months. Channel sales and strategy veteran Steve Walter knows firsthand the economic impact that ad hoc discounting can have on software vendors – he once worked for a software firm that was providing $15 million annually in extra discount requests granted to channel partners. You can read more about how he led the charge to get discounting under control in the June 2018 issue of Software Executive magazine. In the meantime, Walter explains why this is a problem for software companies in the first place, why discounting conditions your customers to change their buying behavior, and what you can do to solve this.
In many cases, software companies do not have the infrastructure or systems to understand or determine the impact that unmanaged or ad-hoc discount requests are having on the business. Yet it’s easy to see why software vendors allow discounting to get out of hand. When one of my previous companies announced a plan to get discounting under control, the initial reaction by our internal sales team and channel partners was the new discount policy would freeze the transaction flow and would likely result in the loss of valued install base customers.
This did not occur. Based on interviews and supporting operational research we found that customers demanded discounts due to their long-standing relationships with the company. For example, when a customer demanded an incremental discount due to their established relationship, providing the discount had the potential to condition the customer to ask for the same or a larger discount in the following year.
Discounting also has the potential to change the buying patterns of customers. For example, in some instances customers would hold orders to create end-of-quarter sales pressure. However, we knew these tactics did not increase deal velocity or increase the speed of closing the deal. It was a point of negotiation or leverage the customer was trying to exercise.
As the reasoning for extra discounts became more frequently the subject of competitive price pressures, the sales team may not have verified the competing quote with the partner or customer to justify the discount. Finally, the fear of a customer threatening to go to a competitor typically did not materialize. This is because the entanglement cost of software for mature customers is very high and technological platform shifts are very expensive. The costs of retraining a labor force, changing of design work flows, and/or converting literally thousands of historic electronic designs into a new file format meant it was not economical for a customer to move to a competitor because of the price of a lost 10 percent extra discount.
Acceptable Discounting Programs
Extra discounts are sometimes required for highly competitive situations, or to obtain a new customer/account logo, or to establish a reference account in a new market vertical. In these cases, the company adjusted the extra discount policy to create a hunting incentive for channel partners. The “new logo discount” was structured in a manner that required the channel partner to “share” in the customer’s extra discount request. For example, if a customer requested an additional 20 percent discount, the software company and partner would split the request in a 50/50 basis (e.g. each entity contributes 10 percentage points to cover the customer request).
The extra discount policy that was created to manage the mainstream business essentially applied to new logo opportunities. In order for a discount to be approved, the following operational measures were required:
The Benefits Of Disciplined Discounting
The changes implemented by this new discounting policy helped to increase and maintain visibility on performance trends within the business. Additionally, operational improvements helped to accelerate the related work flow process for extra discount requests. In addition, the company’s sales team and partner sales reps received additional training in sales best practices to better address customer objections.
The program was implemented over a 6 month period. We were excited to see an immediate reduction of 70 percent in orders that required an extra discount request. On average, the decrease in extra discount requests generated an additional $1.5 to $2.5 million in “saved” quarterly revenue, or approximately $8 million over a four-quarter period. Even if your software company’s discounting problem isn’t at the same scale as this example, it’s still worth taking the time to examine why you discount, and how much those discounts are impacting your average sales price.