Price promotions and discounts are often times a customer's most favorite times as well as the businesses most profitable time.
Stores such as Nordstrom have their half-yearly sales in an effort to drive higher demand and higher sales during their sales events. However, a price promotion gone wrong can have a catastrophic effect on your business.
The key thing in any price promotion is to measure its success. Too many small business owners take price promotions for granted and tend to promote price reductions when sales are down, but do little to track the performance of their program. Comparing the difference in average profits prior to the price promotion with the profits earned during the price promotion and the average profit after the price promotion will help you determine the success or failure of your price promotion.
Why compare profits after a price promotion with before the promotion? The goal of any price promotion is to drive new customers to your business by incentivizing them with lower prices in hopes that you convert them to long-time customers. If your promotion worked, you should see greater demand for your goods after you have run the price promotion which should directly increase your profits.
Price promotions can be effective when managed properly, but you need to understand the economics and underlying demand of your products and services before just running a price promotion. There is a movie cinema in Europe that offers its movie goers, a big discount if they come back for a second movie within 30 days. The idea here is to incentivize movie goers to increase their frequency of movies watched at a cinema by lowering the cost of the second movie.
This is a result of the "law of diminishing return" which states that as you consume more of a good, the value you extract from the good lowers with each one consumed. For example, imagine eating 5 ice cream cones in a single day. You might be willing to pay $5 for the first one, but probably only $3 for the second, $1 for the third, and by the 4th, you may not be willing to pay anything.
Another key factor in determining a successful price promotion is to understand that your customer base is heterogeneous. This is to say, every one of your customers has a different willingness to pay for your different products and services. The ideal price promotion will only allow price-sensitive customers to buy your discounted goods while your regular non price-sensitive customers continue to pay full price.
In practice this is quite difficult to pull off. However, if we use Nordstrom as an example, if you've ever been to their half-yearly sale you know that the stores get extremely crowded and the clothing racks are a mess. A customer who is not price-sensitive may not choose to shop at Nordstrom during this "peak" period in hopes of avoiding the crowds and stress associated with shopping at this time.
Next time you think about having a sale or price promotion, think of the simple ways that you can measure its success and determine how you can reach your most price-sensitive and new customers first so that you are not simply letting your regular customers buy today at half off.