Volume Discounts - The Good and The Bad

On the surface volume discounts make a lot of sense.  They can be used to gain business with large customers and lock in big chunks of revenue.  Volume discounts should be leveraged to gain profitable demand that otherwise the business would not win. 

The Good – when volume discounts are a profitable option

Volume discounts enable relatively simple price differentiation.  Every customer does not need to pay the same price.  Larger customers have more options and often provide more value to the business.  Smaller customers have fewer options and are typically more expensive to server per unit.  Volume discounts are a relatively simple way to capture additional margin by keeping your base rates higher and discounting for larger customers. 

Large production or distribution businesses can leverage volume discounts profitably especially when faced with a customer base that does not need to be loyal.  If your customers can buy from both you and your competitors without significant additional costs, volume discounts can help you lock in more business with large customers. 

Often in these types of businesses, you experience some economies of scale with larger accounts.  Giving some of the benefit back to your customers for more secured volume is smart.  You will benefit both from the increase’s revenue, but additionally from the decreased cost per unit and the improved visibility into your demand. 

The Bad – when volume discounts just dilute your profits

Volume discounts become unprofitable when the business does not experience economies of scale.  In some businesses additional demand increases production costs after standard capacity is exceeded.  If you need to outsource work or dramatically leverage overtime, that additional volume can severely burden the business.  In these cases, you need to ensure that volume beyond standard capacity is not discounted, instead it should be priced at a premium. 

Volume discounts can dilute profitability even in businesses with economies of scale.  It is important to understand your customers and the value they receive from your product.  If there is no risk of losing the business, then offering volume discounts is just giving away profit.  Volume discounts should be leveraged to gain profitable demand that otherwise the business would not win. 

A key to understanding when and if volume discounts are a good fit to your business is understanding your profitability by product and customer.   You can read more about profitability in this article.

If you would like to speak to me more about volume discounts, e-mail me at stacy@pricingvelocity.com