Volume Discount Pricing Theory

Volume discount pricing theory states that a firm can generate more net income by selling more items at a lower price than it can selling less items at a higher price. With the exponential boom of Wal-Mart, dollar concept stores and other discount stores in the 1970s and 1980s, small businesses are facing increased pressure from those who put this theory into practice. To adequately compete with these giants as a small business owner, it may be helpful to understand how discounters have positioned themselves within this theory.

One of the catalysts driving a volume discount pricing scheme is the availability of inexpensive goods. The NAFTA and other free trade agreements in the last generation have facilitated the promulgation of inexpensive goods to the United States from Mexico and other countries. The positive effect of these agreements was lower costs and increased competition and higher profit margins. In time, with costs low and the thirst for new and improved products high, planned obsolescence has become the norm in manufacturing. An item is produced with a higher margin, sold for a short time until a version release to replace it is created, then is liquidated at a volume discount price.

An informed and thrifty customer also leads to volume discount pricing. The rise of "extreme couponing," or buying in bulk using a host of coupons that drive a customers price to near zero, has increased the push for a volume discount pricing theory. A manufacturer and merchant, knowing the variety of coupons available, augmented with coupons from the manufacturer's website, accept a lower potential profit margin in exchange for a high turnover. This works in retail food especially well since most food is high turnover and low margin to begin with.

Logistics, once a vague concept describing generally how a company sends and receives goods, is now a popular college degree because of volume pricing discount strategies. "Just in time" delivery, requiring low inventory and quick product replenishment, has replaced the "just in case" system of stocking large quantities of merchandise that may become obsolete and require deep liquidation pricing. Products are quickly introduced, a high volume is sold at a lower margin, and the product is liquidated and replaced with a new version release. Products do not stay shelved until liquidation requires even deeper price reduction.

Economies of scale, meaning a large company having a reduced price of production caused by a greatly increased resource availability and buying power, has helped drive volume discount pricing. Discount stores, with hundreds or thousands of stores, can sell at a relatively low profit margin because they buy at such a high volume that they get the best price. They can even sell below cost, as competition dictates, until they win the price war and the other store either relents on the price or closes due to increased competition. They can negotiate with wholesalers easier, promising enormous purchasing in exchange for a lower margin.