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What are volume discounts?

The Deal EconomyNovember 7, 2019

Introduction

A volume discount is a change to the cost of a product based on the quantity of that product traded with your trading partner. Typically, volume discounts are paid retrospectively so sit under the wider banner of rebate, although sometimes these volume discounts can be up front.

This potential retrospectivity often depends on whether different discounts apply to incremental tiers of volumes traded with a specific trading partner throughout the course of the year, meaning that you are unsure of the value of the discount until the year end.

Volume discounts are often used by suppliers to incentivize greater purchase volumes and are available due to the advantages brought about by economies of scale. This has the side effect of increasing the suppliers market share and presence in the marketplace because increasing quantities of their products are being traded.

Merchants on the other hand benefit from the cheaper prices, which increase their profit margins on the specific products included. However, merchants may choose to pass this discount on to the end customer while still maintaining their usual profit margin meaning that end customers benefit from cheaper prices. This is why big-name supermarkets can often offer well-known brands cheaper than their competitors.

However, the reality is normally somewhere between the two, where the end customer gets a slightly cheaper price and the merchant still gets an improved profit margin, but this differs depending on the scale of the business involved and the industry.

What does a volume discount look like?

There are a few different flavours to volume discount deals, the most basic would be a deal where a stringent minimum volume is enforced before a discount becomes applicable. For example, a volume discount (which can be a certain percentage or a fixed monetary amount) may only take effect for a given time period if you meet or exceed a baseline of the same purchase volume you achieved in a prior period referenced in the agreement. Typically, these time periods would be annual, but it is also common for them to be monthly.

For example, an annual agreement for the current year could yield a discount of 10% off of all purchases if the current year’s total order volume exceeds the previous year’s order volume of 100,000 SKUs.

It’s worth noting that rather than simply just basing these volumes on individual SKUs, some deals can be based on the volume of packages of units which can include multiple SKUs!

In general, volume discounts are often based on individual SKUs and are tiered to incentivize greater purchase volumes. This means that better discounts are achieved when volumes increase. For example, you may get a 1% discount if you buy over 1000 products, but a 2% discount if you buy over 2000 products and so on. Obviously, this is a simplistic example.

A further complexity can be that some discount deals are retrospective, and some are not, meaning that the discount achieved when hitting a new tier applies back to the entire purchase volume or only applies to the purchase volume for that specific tier.

For example, if you had an agreement with volume discounts of 1% on 0-1000 SKUs, 2% on 1001-2000 SKUs and 3% on 2001-3000 SKUs and you had traded 2500 SKUs over the course of this agreements period, this could be calculated in the following two ways based on the deals retrospectivity:

Retrospective:
2500*0.03 = $75

Non-retrospective:
(1000*0.01) + (1000*0.02) + (500*0.03) = $45

Further still, various other considerations need to be accounted for to accurately describe a volume discount deal. For example:

  • Are there any sorts of purchases that may not be eligible for the discount? Some trading partners may exclude transactions where they have delivered or collected the items at their own expense or transactions that will be held in stock and not immediately sold, at their own discretion.
  • Can the same product or transaction be part of two separate discount deals? If not, does the transaction belong in the calculations for the highest earning deal, the lowest earning deal, the most recent deal or the oldest deal?
  • Does the discount apply to all locations or only a specific subset? Some volume discount deals may be targeted to push transactions in one region of the country or to help support a specific branch.

Why do volume discounts exist?

As mentioned earlier, volume discounts allow merchants to increase their profit margins or pass on discounts to the end customer in order to win more custom and out compete their competitors. With more customers in stores they also indirectly have an increased opportunity to upsell other related products.

Additionally, suppliers benefit from being able to push more of their products out into the marketplace which increases presence and awareness of their brand without having to spend their own resources on dedicated marketing campaigns.

This also works for promotions, perhaps for new or seasonal products. Suppliers may decide to offer greater discounts on these products for a short period of time to push volumes ahead of demand, for example manufacturers of car windscreen de-icer may want to offer discounts to push volumes into stores before winter ahead of the perceived increase in demand. In this way, volume discounts can be a valuable tool when used strategically.

However, it is difficult to use them strategically when resources are wasted on tracking, calculating and managing volume discount claims and payments. Most businesses simply do not have the resources to focus on both.

Another benefit to the supplier is that they can clear stock if they have over manufactured a certain product expecting a certain level of demand that was never realized.

Related to this is the concept of ‘locking in’ customers. Volume incentive deals help to improve loyalty of trading partners by incentivizing them to commit their trade to you for the year for certain SKUs with the reward of an increased discount when higher volumes are reached, rather than shopping around for a cheaper price from your competitors each time. This helps to forge stronger relationships with your trading partners and allows your business to be more secure and have more faith in accruals, whilst also giving you the confidence that your trading partners won’t abandon you during the year for your competitors.

Conclusion

Volume discounts can be applied to most industries and are beneficial to both parties involved in the agreement, with the potential to pass this benefit on to end customers.

On the surface, a volume discount is a way of rewarding a merchant for buying large quantities from a specific supplier, but when you look more closely you see that there are abundant benefits to the supplier also.

Your business can benefit greatly from having a system which can provide analysis of the volumes traded with your trading partners while seamlessly referencing all deals to accurately calculate the discounts owed when certain volumes are reached. When the system also contains the ability to evaluate the impact of these deals on margins and compare the potential benefit of proposed deals, you can have complete control over the volume discount process and can consistently evaluate your pricing strategies to ensure that your business is gaining the maximum benefit possible from the volume discount deals you are involved in.

When managed properly, volume discounts can be invaluable. An automated system will allow your company to have confidence managing volume discounts, allowing resources to be spent on using these agreements strategically and maximizing benefits.

You can enter negotiations and get the best rates for specific key products which may have high margin accessories or other relevant items which can be upsold along with the rebatable product, but in order to get to this point you need transparency at every level to identify these SKUs and to model potential agreements and their benefits.

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