“The more you buy, the lower your price.” It’s a familiar pricing mantra, but should it be? When trying to increase sales volume, the knee-jerk reaction can often be to lower prices for the most voluminous buyers. However, the impact of volume discounts can be more complex than you might realize. In fact, discounting may do a business more harm than good.
Here, we explore the rationales for – and risks of – volume discounts.
The Psychology Behind Volume Discounts
The pyschology behind volume discounts can easily be illustrated in the B2C world by walking into any McDonald’s restaurant. In the right circumstances, lowering the incremental price of a product can encourage customers to purchase larger orders than they normally would. After all, who wouldn’t want to double the size of their fries for just $0.50 more?
From a B2B perspective, volume discounts allow businesses to show appreciation to important customers and (hopefully) encourage customer loyalty. Sales bonus structures may also play a role; when bonuses are tied to topline sales numbers, sales staff is automatically incentivized to use discounts to increase their sales.
The Dangers of Volume Discounts
Unfortunately, the real danger of volume discounts is that on the surface, they may seem to do a good job of increasing sales. But dig deeper, and these discounts can also expose businesses to serious risks.
Volume discounts lower the reference price for the customer. Every time a business offers a discount, the lowered price becomes the new standard for the customer. Try to raise the price – even if the customer stops making the large orders on which the discount is predicated – and the customer will balk.
- The Solution: Communicate with the customer about price frequently so customers understand the rationale behind price changes.
Volume discounts risk loss of profits. We recently helped a manufacturer re-evaluate its pricing strategy; our analysis showed that for every 5 percent reduction in price, this business needed to sell 38 percent more product just to remain at the same profitability level as before. Viewed in this light, a business would understandably hesitate before making any reduction in price!
- The Solution: Carefully review your cost structure so you can set a discount ceiling that provides customers with incentives to buy but still allows a profitability level your company can realistically live with.
Volume discounts often lack accountability. In many businesses, sales representatives are authorized to provide discounts on the spot to customers in order to close a sale. However, what happens if the customer places an order that’s smaller than anticipated? What if the company’s cost structure changes? What if the discount is so big the sale is not profitable?
- The Solution: There must be a central pricing authority and a documented process in place for discounts. It’s vital that there be a company-wide understanding of the expected price a customer should pay based on your discount structure. Any discount over a certain limit should be analyzed and to determine whether the discount is in the best interest of the business.
Ultimately, volume discounts can either improve profits– or cost you profits. To ensure the former and avoid the latter, be crystal clear on the reasons why volume discounting is the right strategy for your company. Make your pricing decisions with eyes wide open, and your profitability will be right where you need it to be.