You’ve been there: the snack bar at the movie theater. A small popcorn is really all you know your stomach can handle, and it’s $7. But wait! There’s a medium-sized popcorn for $1.25 more… and the large is only $10, with free refills! Suddenly that small popcorn, the ideal size, has lost its appeal.
(We won’t even get into the estimated 85% profit on movie theater concessions.)
This is a good example of volume pricing.
What is Volume Pricing?
In simple terms, volume pricing is a pricing structure that figures in discounts for large-quantity purchases. The more that is purchased at one time, the larger the discount.
This blog has previously touched on the topic of volume pricing as part of our pricing strategy series. In this post, we’ll take a deeper dive.
Tiered Pricing Versus Volume Pricing
There are two terms that are commonly confused in pricing strategies: tiered pricing and volume pricing. Let’s break down each term.
Let’s say you have discounts for up to a volume of 100 articles.
With tiered pricing, you would segment the quantities into tiers. The customer pays a different price PER TIER. The price per tier also decreases as additional purchases are made along the subsequent tiered segments.
The below example calculates the cost if the 100 items were purchased through a tiered pricing strategy.
At the end of the transaction, they would pay $400 for all the items.
On the other hand, volume pricing gives one defined price for ALL the items purchased. You can take the same pricing structure as above, but you apply one price according to the quantity purchased.
So, say this same customer purchased the same 100 items. Instead of going through the different pricing layers or tiers, to get to the final result, that quantity of 100 items would automatically trigger the pricing to $3 per item for 100 items.
The below table calculates the cost if 100 items were purchased at one time through volume pricing.
|Quantity||Original Price/Article||Volume Discount Price for 100 Articles||Cost|
At the end of the transaction, they would pay $300 for all the items.
As you can see, there is a $100 difference between tiered pricing and volume pricing in this example—a pretty considerable one whether you’re the business or the customer.
Let’s get back to volume pricing though. The obvious benefits of this pricing strategy are that the discounts are easy to understand. And in a SaaS (Software as a Service) and other similar subscription business models, the incremental cost of selling extra units, such as a software license key is almost insignificant, compared to selling physical goods that have to be manufactured, warehoused, and handled.
5 Reasons to Incorporate Volume Pricing
Many other businesses also see the benefit of establishing volume pricing for their customers. There are five main reasons to do so.
- Encouraging larger orders. Simply put, offering volume pricing motivates customers to purchase higher quantities so they can earn a discount. This can help move out old inventory or minimize shipping costs.
- Setting yourself apart from the competition. By offering a discount for larger quantity purchases, a business can create competitive differentiation, while also getting that larger order from the customer.
- Creating a new customer. Instead of offering volume pricing all the time, making it available for a first-time buyer can help close that deal. Then, when they are ready to make that next purchase, they have been using your product and are aware of its value. Now, you can revert to your standardized, higher price.
- Combating the Law of Diminishing Marginal Utility. This principle states that the more someone consumes something within a specific time frame, the less value he will place on that item. Let’s say you go to a restaurant and have the twin lobster special—it doesn’t get any better than that, right? And that first, oh-so-buttery bite is gastronome heaven. As you work your way through the first lobster, and then crack open the second one, that meal starts to lose its appeal. As a business, you can combat that diminished perceived value by offering volume pricing, showing a savings for buying more.
- Freeing up sales rep time. Salespeople are responsible for both the new customer and the recurring customer. Reorders take time for a sales rep when she could be utilizing that time to make new sales. For those established customers, you can give them a volume discount to encourage them to purchase more than they had originally planned.
So now that a business understands the value of volume pricing, how do they start setting up volume pricing?
5 Steps for Establishing Volume Pricing
A business undoubtedly has a lot of data from previous sales. Take a good look at those numbers when you put volume pricing into practice.
- Plan wisely.
Before you start playing with numbers, you need to analyze your data first. Marketer Neil Patel recommends these steps:
– Highlight your current profit margin, as well as markups and your ‘break even’ point.
– Look at your sales calendar—when do you see a dip in sales?
– Confirm that your projected discount price still turns a profit.
– Check out competitors. What are their discounts and how are they promoting their products?
– Brainstorm other ways to drive sales instead of offering discounts or volume pricing.
- Divide your customers into segments.
Customers have different buying habits. Some opt to make smaller, more frequent purchases while others buy larger quantities every time they make a purchase. Offering the volume pricing to the first customer will encourage her to order larger quantities. Conversely, if you offer volume pricing to the customer who is already making large purchases, you’re suddenly giving him an unnecessary discount.
One example of this is a software company that priced their product at $79. Sales were lethargic. The company looked at why and found that the product was priced too high for consumers but too low for professionals. Consequently, that company focused on the professional segment, raised the price to $129 and sales took off.
- Stick to target prices per transaction.
There should be some clear boundaries on pricing. If you are already offering a discount on purchases, and throwing in free shipping, offering volume pricing could cut into your margins even more. At a certain point, offering all these incentives to make the sale is going to be unprofitable.
- Set minimum threshold pricing per product.
It’s critical to analyze the sales margins on each product and price accordingly. Some products might have a much higher margin so a business can give a larger discount than another product that sells with tighter margins. When establishing volume pricing, set a strict minimum price per product as well as by pricing segment.
- Monitor sales and constantly evaluate your pricing strategy.
First, make one person responsible for monitoring invoices and ensuring that sales have not dipped below that minimum pricing threshold. At the same time, keep an eye on transactions to make sure volume pricing is actually working.
Ask these two questions:
1. Is the pricing strategy bringing in volume growth?
2. Are your margins growing instead of shrinking?
Answering these questions by analyzing your data can determine if you need to adjust your pricing. Depending on the product, volume pricing may not even be the most feasible option.
For example, a study through the University of Chicago looked at ‘in-game’ purchases—used to move through the game more quickly. They found that these virtual purchases were not only unaffected by volume discounts, but the large volume discounts could actually discourage gamers who might have otherwise made a small purchase.
Tips for Volume Pricing Success
As you make the move to establish volume pricing, keep in mind that while the idea sounds like a win-win, it’s important to avoid making costly mistakes. Here are a few ways to avoid pricing pitfalls.
- Go easy on the discounts. Making price changes can inadvertently decrease the value of your product. When establishing volume pricing, make the changes small.
Establish the fact that the discount offers a benefit for purchasing a higher quantity, while maintaining the perceived value of your products.
- Have different volume pricing options. Know your customers and understand what pricing package would complement their purchase habits. As mentioned before, if a customer is already making large quantity purchases, there is no reason to give her as deep of a volume discount as a customer that makes smaller purchases and can benefit from a more aggressive pricing package.
- Protect future pricing increases. A customer that is used to getting a discount all the time, every time, is going to balk when you need to raise prices. One way to avoid this is by offering volume pricing to make that first sale, instead of all the time.
Do you remember the Subway $5 footlong? It was introduced to combat the recession several years ago. However, the special pricing ended up devaluing the sandwich. When the prices were raised, customers took their complaints to social media, ripping into the company for raising the prices on a discount item. That was one of several headaches for Subway that contributed to a customer drop of as much as 25 percent.
Volume pricing can be a part of other pricing strategies, including price bundling, in a successful recurring revenue business model. A thorough look at your company’s customer data can determine if this is an effective pricing structure for your business.
When you’re ready, you should look into a comprehensive subscription billing platform that supports volume pricing or other pricing methods you may want to explore.