Issue No. #7 19 April 2001 ISSN: 1532-1886

The Injustice of Volume Discounting by Carl Wright

Volume discounting appears in different forms. The most common involves the buyer receiving a discount if they purchase more than or equal to a defined amount of product. The defined product amount is measured either in dollars spent or in a unit of measure representing the product/service consumption.

The Injustice of a Volume Discount is in the Overhang

Assume that we give your customer a ten percent discount if they spend more than or equal to $100.00 of services in a billing period. They get no benefit if they spend less than $100.00, but if they spend between $90.00 and $100.00 they pay more than the customer who buys $100.00 of services.

"I bought $94.00 of stuff, but I'm paying $4.00 more than I would have spent when buying exactly$100.00. How can you do this to me? - The unlucky customer

The following graph shows this "overhang" caused by the discount schedule. This problem exists in the tariffs for freight carriage in the United States, but trucking carriers solved the problem by "over-charging" their customers. If you ship a 480 pound item and the cost of shipping a 500 pound item is lower because of volume discounts, the trucking company increases your billed-for weight and gives you the lower price.

Figure 1. Charging results of the 10% off volume discount

 

The Importance of Clarity

Even though there is an inherent injustice in the simple volume discount offer, there is a significant value in the clarity of the offer. Customers recognize the logic behind the offer. It's a familiar buying situation. Vendors use volume discounting to encourage you spending all your budget with them. Here's how I'd rewrite the offer to eliminate the injustice.

We offer you a 10% discount on accounts spending more than $100.00. If you spend from $90.00 to $100.00, you get a discount that lowers your cost to $90.00.

This isn't very clear. Perhaps you can retain the clarity of the offer, but eliminate the injustice by creating the "free zone". In this scenario, I'd even consider advertising the "free zone" as a benefit. Tell your customers that if they spend $90.00, the next $10.00 are on you. It gives them a handle for your offering. When they can remember your offering as the one with the "free zone", they are more likely to buy from you.

How did it Happen?

Volume discounts are an attractive approach to sharing cost savings with your customers when their shopping behavior lowers your wholesale costs. For example, if a customer buys product in the same wholesale unit as you (i.e. by the case), you eliminate the cost of opening and displaying the products as well as other handling costs. In this situation, the customer makes a purchasing commitment for the required volume at one time. With most telecommunications purchases, the purchasing decision consists of many different smaller decisions and your customer has no ability to gauge whether they should purchase more to earn the volume discount.

The volume discount might also make sense when you can tell your customer that they can reap the benefit if they were to purchase just a little more. Sales staff use inducements such as these to encourage customers to buy more during a target selling period (like before the close of the quarter).

Volume discounts traveled from other industries where they avoid the overhang situation. A better solution is the tapered discount because no overhang exists.

Tapered Discounts

The tapered discount is a rating method where the discount for each new unit of consumption (dollar, minute, megabyte, etc.) may change. Typically, the discount goes up as you buy more units. This eliminates the overhang of volume discounts. You reward increasing spending by lowering prices.

Our example of "10% off if you spend more than $100.00" can be recast as the following:

Zero discount for the first $100.00 of spending.
10% discount for each additional dollar of spending in excess of $100.00.

This technique actually delivers less savings than the volume discount, but nobody ends up feeling cheated. You can adjust the percentage to give similar benefits to the previous offer.

Figure 2. Charging results with tapered 10% discount. No overhang!

Summary

Volume discounts have the potential to create angry customers. These are customers who almost purchased enough services to be rewarded. You can use volume discounts, but implement a discount method that insulates this customer from the overhang by creating a free zone (from $90.00 to $100.00 in the example above). Alternatively, you can implement tapered discounting to eliminate the overhang of volume discounts.

Rating Matters Definitions

Iíve left out the other meanings for these words that donít relate to the billing industry. Below Iíve added additional meanings.

volume discount n. 1. the discount offered when a specific quantity of a product or service is purchased v. 1. to apply a discount based on the quantity of product or service purchased

tapered discount n. 1. a discount that reduces the cost of a product or service as the quantity used increases

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