Decoded: Volume Based Discounts

How often have you strolled in a store and found yourself saying “If I take the large packet, it’ll be much cheaper, family pack here I come!”

Such a type of price discrimination wherein your price per unit declines as you purchase a bigger pack is called a volume or quantity-based discount. It’s used pretty much everywhere: FMCG products, Insurance(Family Policies), Hotel bookings, etc

But have you ever considered why a company would offer a volume discount in the first place? From a theoretical microeconomics perspective, it’s a dumb move.

Suppose you have weekly demand for a product and there is a company supplying the same. You eventually reach a mutual price point where you both would keep transacting provided external factors like brand, quality, etc are kept constant.

Then why would the company reduce its selling price per unit when you’re perfectly willing to pay higher?

That’s not the case though. Corporations are actually smarter than you think.

There are many reasons why a company would offer volume-based discounts. I’ll stick to relatable consumer goods but a lot of this can be applied to other industries too. 

Higher Margin because Cost to Serve is less

The cost that a company incurs while providing you a product or service is not limited to the cost of raw material and processing costs. It includes distribution, marketing, and countless different cost heads, even the cost of you wasting time strolling around in a retail outlet.

If you purchase in a higher volume the company saves on the cost of invoicing, distribution, time spent by employees servicing you, and acquisition cost for a repeat purchase. All of this trickles down to give greater net profit margins to the corporation.

Consumption Expansion due to larger volume

It’s a psychological tool. If you have more of a commodity, especially a consumable good, you’d most likely be careless in its consumption like not making portions, letting some of it go to waste, consuming more, etc.

This phenomenon arises because the part of our brain that “budgets” resources no longer does that when we have a considerable amount at hand. How many times have you gobbled up that big pack of chocolates just because it … existed?

The math here is simple. You price the bigger pack low enough to make people switch to it, but high enough to make more sales and margin on it considering the expansion in consumption.

Customer Loyalty

Leave two people on an island long enough and eventually, they’ll become friends.

The same goes for brands. Once you start using/consuming a product for some time you become accustomed to it and the human brain in general resists change once it has become comfortable with something. Purchasing in volume ensures that you will consume the product for quite some time and are not looking for a “hookup experiment” elsewhere. If a lower selling price means the company can solve your commitment issues, then why not?

Loyal customers generate significant lifetime sales for a company and are to be retained. The more loyal customers you have the more you can retain.

Reduced Risk

When selling a greater volume, you get the surety of cash flow upfront, thus reducing your credit risk. You’d be able to fulfill your debt obligations faster and raise more debt to take on further expansion projects. It also solidifies investors' faith in the company.

So it should be pretty clear by now why a company would offer volume discounts. 

Then why not offer just large volume products?

There are majorly two reasons for this:

A limited purchasing power of many people

People falling in a lower income group cannot afford bulk purchases because of the limited disposable income at hand. They don't have enough capital to enjoy quantity-based discounts.

Real Estate Constraints

Brands might be manufacturing a product but in the end, it’s the retailer (a small departmental store, your local superstore, Big Bazaar) who pushes the product to the general public. And if there is one thing retailers hate it's wasted shelf space.

Sales per Square foot is a metric used by retailers to benchmark their performance. If all the small-ticket items (which add up to a higher total sales amount) are replaced with large packets then this metric falls thus incentivizing them to not continue with the product. This would just hurt the company

Interestingly though Volume Based discounts are not so significant in a lot of Indian products.

Amul Butter

• 20gm pack - Rs. 10, 2gm/rupee
• 100gm pack - Rs. 48, 2.08gm/rupee
• 1kg pack - Rs. 430, 2.32gm/rupee

Oreo

• 46gm pack - Rs. 10, 4.63gm/rupee
• 120gm pack- Rs. 30, 4gm/rupee
• 300gm pack- Rs. 75, 4gm/rupee

Maggi - Roundabout 12rs per pack of noodles, no matter what size you purchase.

Wonder why? Its because in India the purchase decision is made with the purpose to ration products. Unless you like shopping for consumer goods a lot you probably make a visit to the store once every 2-3 weeks or more. We are always planning ahead, it's just how our purchase decisions are made. Companies take advantage of it.

Will we see a change in pricing practices if we as consumers become more aware?