What Is a Quantity Discount?
A quantity discount is an incentive offered to a buyer that results in a decreased cost per unit of goods or materials when purchased in greater numbers. A quantitydiscountis often offered by sellers to entice customers to purchase in larger quantities.
Theselleris able to move more goods or materials, and the buyer receives a more favorable price for them. At the consumer level, a quantity discount can appear as a BOGO (buy one, get one discount) or other incentives, such as buy two, get one free.
Key Takeaways
- A quantity discount is an incentive offered to buyers that results in a decreased cost per unit of goods or materials when purchased in greater numbers.
- Enticing buyers to purchase in bulk enables sellers to increase their units per transaction (UPT), lower their inventories, and potentially reduce per-unit costs.
- Discounts canhave an adverse impact on profit per unit, also known as the marginal profit.
- An alternative to quantity discount is linear pricing: charging the same price regardless of how many items the customer buys.
How a Quantity Discount Works
Retailers often get better deals if they order more of the same item. For example, the cost per unit for t-shirts might be $7.50 per unit if fewer than 48 pieces are ordered; $7.25 per unit if 49-72 pieces are ordered; or $7per unit if 73 or more pieces are ordered.
Depending on the quantity discount, all pieces ordered must be delivered and paid for by a certain date. Alternatively, the purchases and payments can be spread out over a specified period of time.
By selling inlarger quantities, the seller can increase their revenues per transaction (RPT). The vendor can also scale quantity discounts in "steps," with lower per-unit prices at higher quantities to encourage bulk buyers.For instance, a coatmaker that employs "steps" in its pricing strategycouldoffer coats at $20 each, fivefor $90,and 10 for $160.
Advantages and Disadvantages of Quantity Discounts
Advantages
Quantity discounting can be fruitful. The principal benefit is to increase total sales volume in order to realize economies of scale. Quantity discounts boost units per transaction (UPT). The resulting increased sales volume can lead to economies of scale in the form of purchasing goods and materials in bulk at a quantity discount from suppliers, and the ability to combine incidental per-order costs, such as shipping and packaging, into one sale. These economies of scale have the potential to reduce per-unit costs to the seller.
Quantity discounting can also come in handy when a seller is keen to lower its inventory. Taking such action can be particularly useful when the product in question risks going out of fashion or becoming obsolete, due to a technological breakthrough.
Disadvantages
There are several caveats to this strategy, though. The main drawbackof quantity discounts is that the discountsqueezes profit per unit, also known as the marginal profit, unless sufficient economies of scale are realized to at least offset the discount offer.
So, if the per-unit cost for the coatcompany is $10, the company makes a $10 profit on every single $20 sale. However, if the company offers quantity discounts of $2 per coat for orders of five coats and $4 per coat for orders of 10 coats, then it makes only $8 in marginal profit on an order of five and $6 in marginal profit on an order of 10. That would of course change if the coat company is able to save money by, for example, buying in bulk from its suppliers.
Quantity Discount vs. Linear Pricing
When companies price their goods and services, they generally have two options: quantity discounting or linear pricing. Alinear pricing strategyis simpler to manage for business owners than quantity discount pricing and makes it easier for them tomaintain the marginal profit on each item.
For instance, aT-shirt company that employslinear pricingwould sell a single shirt for $20, five shirts for $100, and 10 for $200. If each shirt costs $10 to make, each shirt will bring in $10 in marginal profit, regardless of how many are sold in an order.
The primary drawbackof linear pricing is that it does not provide an incentiveto buyin larger quantities. When customers order only single items, the price per transaction stays the same. Linear pricing also denies the business owner the opportunity to take advantage of economies of scale.
What Is an Example of a Quantity Discount?
If a company sells a product that costs $5, buying 100 of those units would cost $500. To entice buyers to purchase its product, a company may offer a quantity discount, selling 100 units for $450, which would make the per unit cost $4.50 instead of $5; a 10% discount.
What Is the Purpose of Quantity Discounts?
The purpose of quantity discounts is purely to sell more products. By offering lower per-unit costs through quantity discounts, a seller entices a buyer to purchase its products since it's a better deal for the buyer.
How Is Quantity Discount Calculated?
To calculate the quantity discount, divide the total cost by the number of items at each quantity level to determine the per-unit cost. For example, if you are getting 100 items for $300, the per-unit cost is $3 (300/100). If you are getting 200 items for $400, the per-unit cost is $2 (400/200). You can then compare these per-unit costs to the cost of buying the unit individually without a quantity discount.
The Bottom Line
Quantity discounts mean a buyer is buying in bulk and receiving a lower cost per item than they would if they bought the items individually. Quantity discounts are cost-effective for people or companies who know they need a product consistently. For example, buying toilet paper in bulk helps save costs for a household. Similarly, if a company knows it needs timber to make houses, it can buy in bulk to save on raw material costs.
