Academic journal article International Journal of Purchasing and Materials Management

Business Volume Discount: A New Perspective on Discount Pricing Strategy

Academic journal article International Journal of Purchasing and Materials Management

Business Volume Discount: A New Perspective on Discount Pricing Strategy

Article excerpt

This article the emergence of a new strategy for developing discount pricing schedules called Business Volume Discount. Several advantages are discussed from both the buyer's and the supplier's point of view.

INTRODUCTION

In the traditional mass production or batch production environments, a supplier's cost structure can be classified into two categories: (1) fixed costs, which are independent of the quantity produced (rent, equipment, set-up cost, etc.), and (2) variable costs, which are directly proportional to the quantity produced (primarily labor and materials costs). Some components of fixed costs, such as rent, are common to all the products manufactured, whereas other components, such as set-up costs, are product-specific. The production of a large quantity of a product dilutes the effect of set-up cost over the entire lot and results in a lower production cost per item. This is a major reason the traditional manufacturing approach has fostered standardized high-volume production and provided economies of scale based on quantity.[1]

The rationale behind quantity discount models is derived from the economic advantages of larger customer orders. With larger orders, both the buyer and the supplier should be able to reduce their order processing costs. The major benefits, however, come from the supplier's manufacturing cost savings. Larger orders result in fewer manufacturing set-ups and larger production runs. These savings are especially important if the supplier experiences high product-specific set-up costs. On the other hand, increased order size results in higher inventory holding costs for the buyer. Therefore, a supplier should compensate the buyer for this extra cost with an attractive quantity discount pricing schedule as an inducement to increase the order size.

In recent years, however, this traditional manufacturing cost structure has begun to change. The continuing development of flexible manufacturing systems (FMS), which has been triggered by increasing customer demand for diversified products, often causes the product-specific set-up cost to become negligible in comparison with other costs. These flexible systems, all arrange tools, machines and connecting transport systems, all under the control of a central computer, in a manner that allows processing of several workpieces simultaneously. This blurs the previous distinction between what constitutes fixed set-up costs and variable costs. FMS's ability to switch production quickly among products expedites the delivery of customized products to the market as the customer's preference changes. The introduction of office automation also assists in reducing the individual order processing cost, a component of the fixed cost. Therefore, if the quantity discount concept is viewed from the standpoint of product-specific set-up and order processing costs, there is little incentive for a supplier to offer a quantity discount pricing schedule.

Nevertheless, larger orders may still be quite lucrative to a supplier simply because of the potential for increased gross revenue and market share. So a supplier should be willing to offer a discount for large volume orders to offset a buyer's extra holding costs and to be competitive in the market. These discounts, of course, do not have to be a form of the traditional quantity discount. It is more meaningful for suppliers to offer discounts based on the total dollar amount of multi-product orders sold to a given buyer. The following section discusses a new discount pricing model that makes sense for both the buyer and the supplier.

EMERGENCE OF THE

BUSINESS VOLUME DISCOUNT

As a more general case of the discount model, a new approach called business volume discounts has emerged. In this approach, the amount of the discount is based on the total dollar volume of business awarded to a given supplier, not on the quantity of each individual product purchased. …

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