The secret to maximizing sales and margins? Volume-based pricing strategies. In this article, Israel Rodrigo, Business Consultant at Vendavo highlights the benefits, challenges, and best practices for implementing volume discounts and pricing strategies that captivate customers and boost your bottom line.
My kids recently discovered that second-hand thrift stores are a paradise for finding treasures at a good price. Whether it’s hunting for well-priced items, negotiating with salespeople, or going to wholesale centers to buy products in bulk, we all love getting a good deal.
As buyers, we define for ourselves the implicit fairness or perceived balance between value and price.
As sellers, that line is much more difficult to understand, set, and execute. This is where customer price sensitivity and willingness to pay interjects with the sellers long awaited ability to maximize their price realization opportunity. Needless to say, in B2B commercial settings, this is a romanticized, oversimplified concept.
Understanding Volume Discounts
There are a few different approaches you can take to architect your company’s commercial strategy, deal discounts, and negotiations. Sometimes deals are streamlined, with approvals based on a complex set of business rules and signoffs. Other times, companies’ deals are based on a sales request and do not reflect similarly across all deals or even all sales executives.
This is where understanding your volume discount, and how this affects segmentation, is crucial to long-term success. With powerful AI-enabled pricing segmentation, companies can create pricing guidance on a more granular level and better act on a particular customer or set of customers’ willingness-to-pay. By establishing more specific pricing guidance, sales teams have what they need at their fingertips, and with floors, target, and stretch prices they can approve immediately.
When Should You Consider Segmentation as a Method to Optimize Pricing?
Always at the highest level. Why should you apply it? If a company has hundreds or thousands of SKUs, deals are very competitive, and/or pricing guidance across the company is a priority, to name only a few.
Also read: Price Segmentation to Optimize Profitability: Exploring Types, Benefits, and Strategies
The Benefits of Volume-Based Pricing or Tiered Pricing Policies
Incorporating volume-based pricing or tiered-pricing policies helps maximize sales and margin opportunities, and balances price realization and risk between the buyer and the seller. Whatever your business objectives, effectively implementing volume-based pricing policies has substantial benefits including:
- Enacting and reinforcing value selling arguments: Isolate volume discounts from negotiated ones, fostering customer relationships and safeguarding long-term margins.
- Decreasing marginal utility: Discover how customer willingness to pay can diminish with additional volume, enabling strategic pricing adjustments.
- Leveraging price sensitivity: Larger customers exhibit heightened price sensitivity, while volume buyers often display greater price elasticity—tap into their potential.
- A competitive edge: Safeguard your market share through a robust pricing strategy that entices customers and keeps rivals at bay.
- Rewarding loyalty: Nurture relationships with your largest and most profitable customers, ensuring they receive the best price and reinforcing their commitment.
- Business consolidation: Incentivize customers to consolidate their purchases, fostering loyalty and long-term partnerships while streamlining your operations.
- Streamlined pricing structure: Simplify pricing by decoupling list price management from volume-based negotiations, enhancing clarity and efficiency.
Common Volume Discount Structures
Most purchase incentives fall under the category of volume-based pricing discounts policies where the allure of lower prices per unit encourages customers to embrace larger quantities. Typical volume discount structures are:
Discount off list or regional prices:
- 3% off on Product Family A
- 5 % off on Northwest customers
Tiered based or Scale list pricing:
- Tier 1: 1-100 units – $10 per unit
- Tier 2: 101-500 units – $8 per unit
- Tier 3: 501+ units – $6 per unit
Up-front based upon customer’s commitment to buy certain volume:
- Tier 1: 1-100 units – 3% off list per unit
- Tier 2: 101-500 units – 5% off list per unit
- Tier 3: 501+ units – 7% off list per unit
Defined upfront but paid out after achieving certain volume:
- Tier 1: 1-100 units – 3% off list per unit
- Tier 2: 101-500 units – 5% off list per unit
- Tier 3: 501+ units – 7% off list per unit
In most cases, it’s difficult to understand your customer’s willingness to pay and ascertain how the different tiers, volume breaks, and associated discount curves are defined. The challenge becomes even more complex when we start cross-referencing products, channels, customers, and the aspects of the negotiation process.
Managing all these potential options manually is unsustainable, if not impossible, in the long run. Industries including manufacturing, high tech, distribution, and chemicals are evolving in volume-based price discounting maturity.
Where Can Volume-Discount Pricing Go Wrong?
There are many obstacles and pitfalls to executing volume discount programs well. Many organizations still struggle to effectively manage, optimize, tailor, execute and measure the effectiveness of volume-based discount commercial policies for a long list of reasons, including: poor design, lack of understanding of customer price sensitivity, disconnected commercial execution processes, incomplete analysis, loose governance on compliance enforcement, and underinvesting on commercial excellence enabling technology.
Let’s break out a few of the more common, according to Vendavo pricing experts:
Poor Design
Many large organizations still tend to oversimplify the design of volume discount programs. Often customers will put all discounts into one category and provide them based on a specific, rock-bottom net price. Examples of a typical volume-based discount given upfront include:
- Customer’s committed volume
- A promise to direct more or consolidate customer share with specific supplier
- Last year’s volume
Inability to Track and Measure
Without appropriate investment in pricing technology and suboptimal commercial processes, many negotiated discounts are purely based on volume commitments vs volume attained. This is much easier for the product manufacturer or service provider to manage but it comes with a steep price tag and plenty of risk. This approach leaves money on the table and introduces significant risk by not enforcing volume compliance policies early enough. Considerations should be given to both profitability and compliance:
If there is no customer profitability analysis, it’s difficult to know if the customer warrants a discount at all.
- What is the cost to serve?
- How do changes to product mix impact profitability?
- What is their pocket price / pocket margin?
A commitment is easy to make but is it being followed? How do you know?
- Does the customer over-promise and under deliver? (We call this Big Hat, No Cattle. It happens more than you think.)
- What consequences are in place if the commitment is missed? How are they enforced?
Lack of Customer Segmentation
Other volume discount program roadblocks stem from improper customer segmentation and a lack of understanding of the customer’s willingness to pay.
- An understanding of willingness to pay provides leverage for future price increases – eliminating the guesswork.
- Clear customer insight helps prevent customers from exceeding their commitment and requesting a price decrease.
No Sales Guidance
Sometimes, deals get streamlined with discount approvals that are based on a complex set of business rules and signoffs. Other times, deals are based on a single sales request and do not reflect similarly across all deals or even all sales executives. Providing guidance on what volume target discounts should be for a specific deal is one way you can arm your sellers with the right negotiated prices for the right customers for every deal. This maximizes sales effectiveness and your bottom line.
Learn how a Leading Electrical Distributor Improves Sales and Margin with Vendavo
Volume Discount Best Practices
Clarify Negotiated Discounts vs. Volume-Based
One-size-fits-all discounting leaves money on the table. A better discount program starts with differentiating negotiated discounts from volume-based discounts since both impact the bottom line differently. The negotiated discount has a more implicit customer willingness to pay for your products. A volume-based discount incentivizes purchasing patterns and larger quantity orders. Therefore, consider two categories of discounts and focus the sales team on the negotiated discounts.
Work to Align Buyer Behavior with Business Objectives
Pricing software will help you proactively align buyer behavior with business objectives. With it, you can differentiate negotiated discounts from volume discounts, implement tiered pricing policies, and reinforce value selling arguments. Each of these goes a long way toward protecting margins and increasing customer loyalty.
Improving your discount program is a process. Consider these good, better, best execution recommendations for getting you further down the path of profitability:
GOOD – Upfront Sales Negotiated Discounts with Commitments
- Pros: You have the ability to track volume compliance and perform a Deal Lifecycle Analysis.
- Cons: There’s no real stick because the discount is given upfront.
BETTER – Volume-Tiered Contract Pricing
- Pros: The back-end discounts are granted based upon actual volume shipped.
- Pros: You can track specific reason for discount and document it.
- Cons: This can still lead to price erosion – it’s hard to raise prices once reference has been established.
BETTER – Volume-Break List Pricing / Volume Driven Guidelines
- Pros: Volume discounts are set at a strategic level rather than a tactical, deal level.
- Pros: Ability to set volume-adjusted prices/guidelines at any dimension and/or attribute level.
BEST – Volume Based Rebates (Get the eBook, Build a Profitable Rebate Strategy)
- Pros: Discounts are granted based upon actual volume shipped.
- Pros: Eliminates setting a low reference point for product and curbs price erosion.