When we hear of “volume discounts” it often sounds like just another sales pitch and often that’s the case. Someone offers a slight reduction in price and you get more stuff than you need. It is technically a volume discount but not very useful in most cases.
However, volume discounts have real powerful for both the producer and the savvy consumer when well understood and properly used by both parties.
For the producer it is all about hedging costs. Often volume discounts are explained as savings being passed along by a seller who has made a large purchase himself. This is a “middleman effect” and doesn’t really do anything to explain where the savings come from. The real savings in production come from two areas. The first is being able to predict volume and make better decisions with regard labor, capital expenditure, and other cost drivers. The second is the allocation of fixed or sunk costs. These are costs you are going to pay regardless of your sales volume or anything else and you divide them by your unit sales forecast to get a cost per unit (it’s usually more complicated than this but we don’t want to get to far into the weeds here). Once you surpass that forecast number those costs are no longer deducted from the sales price of each unit, meaning you have greater profit and/or pricing flexibility from that point onward. This is the sort of calculation at the root of virtually every sale you see. Even clearance sales at retailers which are designed to recapture those sunk costs work on this principle at their core. Volume discounting is just another type of sale designed to leverage the finite nature of fixed costs.
Typically, a volume discount program hinges on some combination of two ideas. The first is that low volume (essentially retail) sales will generate the revenue needed to cover fixed costs so that volume sales only have to cover variable costs (material and additional labor costs for instance). The other idea about volume pricing is that all items are volume priced but sold at such volume that the fixed costs are reduced to a very small portion of total cost that is easily absorbed. This second mechanism is
most like the idea behind volume retailers. It can be very successful, as with Wal-Mart, or very risky, as with K-Mart. Of course these companies have many other factors at play with regard to their success but it is a handy way to think about how the discounting of an entire product line would work.
If the seller can reasonably project a volume of unit sales and then spread their fixed costs across those units it becomes a powerful determinant in the final price of a unit, especially in a competitive marketplace. The volume discount, no matter how it is applied, can be a critical tool in hitting projected volumes and even allowing a firm to increase the volume of those projections.
For instance if a firm sells at retail 100 widgets this year at a fixed cost of 1 and they expect to sell 100 next year, their fixed cost will remain the same at best. However if that same firm can sell 20 more units and their fixed cost goes up 10%, their fixed cost actually drops over 8%. Therefore, it is in their best interest to sell those 20 items at a volume price to ensure the savings across all 120 widgets. In other words a greatly reduced or even loss-leading price on some items makes all others more profitable. Understanding this is important for both the producer and the sharp consumer that is buying in sufficient volume to affect the producer’s fixed cost calculations. The producer has to know what volume matters to his fixed costs and the consumer needs to understand that if they are one of these large volume buyers, their low price sale increases the profitability of other high priced sales. A caveat for both, sufficiently high volume can actually flip the balance of the producer’s business costs and lead to real losses on high volume transactions. No matter how big the dollar amount is, it is critical that the producer understand his cost equations and the underlying reasoning of his projections and that she be willing to walk away when the numbers don’t add up in her favor. The buyer needs to also be aware that there is a point where the deal is too big (or the discount too deep) to work and that they could see a valued supplier walk away if they bargain too hard or if they push for deeper discounts on very low margin goods or services.
For the purchaser the price savings are the obvious objective, but if the product goes to waste that’s another cost they’re paying. It’s important when you buy in volume to make sure that what you’re buying isn’t going to lose its value as it sits, waiting for you to use it. If you buy five heads of lettuce for the price of four but two turn brown in the crisper, you’re a head of lettuce worse off than you would have been buying them as needed. This is also true of things like electronics which become obsolete over time. To hedge against this, buyers can often agree to buy a set quantity of an item or category of items and have them delivered over time, in lots or as needed. The logistics costs may cut into the savings some but if you’ve worked a good deal you’ll still come out ahead. An example would be Hackworth’s High Volume Printing Program.
Many of our clients’ work is, in a way, perishable because the designs and messages they need to convey aren’t consistent over long periods. They may use 10,000 square feet of printing over a year but no more than a few hundred feet of any one message. If they had to buy all 10,000 with the same message it would be a huge waste and they would lose money. However, thanks to the digital, on-demand world which printing now occupies, we can change the out put on the fly without principally affecting our costs. As long as we know the client is going to purchase 10,000 square feet over a given period, the content is immaterial to our cost. We can enter the appropriate cost variables into the spreadsheet algebra and generate a price that reflects the volume of the purchase.
When looking for a discount program or selling one it is important to look for a win-win. A good volume arrangement is a partnership with two equal partners. In such a partnership the client gets a great deal but no so great that their valued supplier goes under, or worse, limps along unable to give the client the best service, product, or new innovations because they have given away their future just to bring in a check. From the producer side, the goal should be not just to cut a good deal today but to offer a coherent volume program that enhances your overall business. You should remain competitive in service, technology, and quality as well as price in order to be a valued partner in the long term and still be around for your other customers, your employees, and everyone who counts on you. If a competitor is “giving it away”, check your math and make sure he doesn’t know something you don’t. If you’re sure you are on the right track then be patient and the other guy’s rush into the price gutter will sort him out over time as his quality, service, and ability to adapt to changing conditions suffer.
For more information on Hackworth’s volume discount program contact Drew at 757-284-6856 or dlittle@hackworthrepro.com.