I licked my chops over this blog post. "Rafi's Ribs" is my take on Rafi Mohammed's recent purchase of 30 pounds of ribs for a Korean barbecue -- and then, asking for, and getting a generous volume discount from the butcher. ("Without giving it a second thought, the butcher chopped the per pound price from $8 to $6"). After receiving this volume discount, Rafi reflected, "As a consumer I appreciated the $60 savings—but as a consultant who helps businesses optimize their pricing, I wondered if the butcher realized how much of the store’s operating profit margin disappeared due to his hastily-considered discount." Not to mention the fact that the butcher had worked long and hard to slice the ribs thinly as Rafi had requested.
Rafi, a highly respected pricing strategy expert and regular contributor on pricing issues to the Harvard Business Review, among others, uses this experience as an object lesson for When it's wise to offer volume discounts -- and when it's not.
Rafi's point is, while there are sound reasons to provide volume discounts, most companies overuse them and offer them with too little thought.
First, some mistaken ideas about offering volume discounts:
1. Don't follow the mantra: “The more you buy, the lower the per-unit price.”
2. Don't misdirect your intent to express gratitude via volume discounts. Rafi: There are many less costly alternatives such as a handwritten thank you card.
3. Don't assume that every customer is seeking a discount. Rafi: Providing a volume discount may be costly, unappreciated, and, most of all, unnecessary.
4. Don't feel compelled to oblige customers with a lower price just because customers may believe it's cheaper to sell larger quantities. Rafi: The specifics of your company's cost structure are not the business of your customer.
When is it ok to offer a volume discount?
1. To compete with rivals. If your close competition provides volume discounts and you believe that by not granting similar price breaks you’ll lose the sale to a rival…trim away.
2. To lock in customers. In highly competitive markets, volume discounts nudge customers to commit. If a competitor is entering a market, locking-in customers preserves market share as well as thwarts the new entrant.
3. To encourage the efficiency of a large order instead of a series of small ones. Pharmacies often offer a discount if you purchase a yearlong supply of a prescription. This price break yields higher profits through the efficiency of filling a prescription once, instead of twelve different time.
4. To capitalize on the law of diminishing utility. The concept, “the more one person consumes within a period, the less they value a product” (i.e. the more you have in a short time, the less you appreciate its specialness). Convenience stores and movie theaters do it with drinks and popcorn. Customers fill up on the first, expensive order, so refills are less frequent, and, ultimately, less costly to the theater, but the customer has already paid the premium price.
When You Can Increase Prices For Volume Or Value:
The idea of perceived quality, i.e. with wine or champagne -- is that more of a good thing should cost more. Magnums of champagne (1.5 liters) are often sold at more than double the price of individual 750ml bottles. Why? One reason is because it’s more festive and impressive to show up at a party with a magnum compared to two regular bottles.
Bottom Line For A Retailer's Bottom Line:
The next time you contemplate offering a volume discount, ask yourself, “Do I really have to do this?
Also remember, as in recent blog post, 10 Reasons A Retailer Would Be Crazy To Lead With Price, you don't want to give away the price too early.
Meanwhile, back at the gourmet store, Rafi says, "Remember, I’d already committed to buying 30 pounds of Korean ribs, discount or no discount. So it was a case of the manager extending a discount "that took a wholly unnecessary slice out of profits."
Finally, businesses need to give more thought to how they price their offerings: As a business owner you need to track your customers’ habits and calculate exactly how much of your products they can typically consume at a single time -- and from there price your gradual volume discount accordingly, i.e. competitive eCommerce pricing.
Rafi Mohammed is author of The 1% Windfall: How Successful Companies Use Price to Profit and Grow.