Commentary

Discount Management Syndome

Discount management is returning to the center stage of commercial management in enterprise software, reports McKinsey, enabled by Walter Baker, Michael Kiermaier, Paul Roche, and Veronika Vyushina. Traditional software players face increasing discount pressure as they compete with disruptive next-generation players, while vendors migrating to subscription models or to software as a service (SaaS,) find that discounts in initial deals are the main determinant of future customer lifetime value. 

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However, loose discounting practices are hard to rein in: sales representatives are often motivated purely on bookings, the low marginal cost of software drives an “every dollar is a good dollar” mentality. And, the common and myopic quarterly management approach of closing deals at any price at the end of the quarter all drive average software discounts to levels not seen in the past.

Sales reps often argue that higher discounts are necessary to win deals, but McKinsey research across companies consistently shows the opposite to be true: successful deals almost always have lower average discounts than deals that were lost, says the report.

Management usually responds in one of two ways to counter excessive discounting, says the report:

  • The first is by tightening the approval process. However, this slows the system down without significantly changing behavior. Typically, more than 90% of deals that get escalated for more scrutiny get approved anyway, and the discounting continues 
  • The second is by increasing list prices. But this tends to perpetuate the spiral of higher and higher discounts, leading to the 60 to 80% average discounts that we often see for perpetual licenses for on-premises software today

The right discount often depends on many different factors, says the report, such as customer segment, product mix, size, and geography. But these factors do not account for all of the pricing variability we see in the field.

The root of the problem is a lack of insight into objective comparison points, says the report. Although sales reps have a good feel for the market, they don’t have much information about how their colleaguesprice similar deals. And, to managers, every deal can look unique, forcing them to make approvals based more on gut, or accept the sales reps’ argument that the proposed discount is what it takes to win the deal. The pricing challenge is not so much how to deal with big data, it’s how to get valuable insights out of limited data sets, says the report.

The report concludes by noting that sales leaders can address these challenges head on with new advanced-analytics techniques to gain quantitative deal-structure insights in a B2B setting. It changes the sales conversation fundamentally by moving the focus away from margins and discounts and instead putting it on objective deal scores, says the report. 

Embedding insights deep into the commercial process, including quote configuration, compensation, streamlined approval levels, and a new approach to sales performance management, can create significant improvements in return on sales: 4 to 10% and sometimes even better.

For additional information from McKinsey, please visit here.

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