Volume Premiums

Not every volume buyer is only interested in the total volume. Smart pricing recognizes what each type of buyer values and adjusts accordingly.

In traditional cost plus pricing volume discounts are generally assumed.

It makes perfect sense. The cost plus formula starts with the cost so, since larger quantities typically mean greater efficiencies and lower costs, the final price will generally be lower as well. This is particularly true with larger package sizes where there are efficiencies in the form of less packaging, handling, etc.

We see this everywhere and are conditioned to expect it. The medium size offers a lower per-unit price than the small size. The large size offers a lower per-unit price than the medium size.

Consider a liquor store for example. The small airplane/minibar size carries the highest per unit cost. Each additional increase in size (first to a pint, then a fifth, then a quart) offers a cheaper per unit price. This makes sense under the cost plus model because there is clearly less packaging and handling involved in filling, shipping, stocking and cashing out a single quart bottle compared to 30+ tiny travel bottles.

Is this always the case? Does a larger pack size always offer greater value?

Take a look at these photos from a duty-free store and compare the options and prices – 3 liters of alcohol in the form of one 3 liter bottle, or 3.5 liters of alcohol in the form of two 1.75 liter bottles.

Belvedere_Vodka_pricing_large.jpg60% Premium For Buying in Quantity
Here we see that the largest pack size, which we typically expect to offer the lowest per-unit cost, is actually far more expensive. The unit price in the smaller pack size is $0.78, while the unit price in the larger pack size is 60% more expensive at $1.26.
Jack_Daniels_side_by_side.jpgInstead of a Volume Discount a 50% Premium

Here again we see that the largest pack size is much more expensive. The unit price in the smaller pack size is $0.65, while the unit price in the larger pack size is 50% more expensive at $0.98.

On one level the versions offer the same thing (a whole lot of alcohol) but at very different prices. The larger size, which we would normally assume to offer the greatest value and lowest per-unit price, is significantly more expensive. In the case of the Jack Daniels it is just over 50% more expensive while in the case of the Belvedere vodka it is just over 60% more expensive. Instead of the small discount we might expect we get hit with a huge premium. Why?

The vendor has chosen to price these products based on the value people place on specific attributes (in this case packaging) instead of a cost plus formula. Instead of offering a volume discount on the larger size the vendor is using versioning and value pricing to maximize profit.

The vendor has realized that some customer place a high value on a specific attribute – the larger bottle. Maybe it is intended as a gift and, while they could instead just give two large bottles, one huge bottle has a much greater “wow” factor. Price is not the primary consideration for this customer – presentation is. Knowing that there is no point sticking to the cost plus model - if the customer is prepared to pay a significant premium for a packaging attribute (the novelty bottle) the vendor is happy to take it.

The vendor also recognizes that another group of customers are concerned primarily with price. If all they want is the largest amount of alcohol at the lowest possible price then the smaller bottle is perfect for them. They don’t value the packaging attribute, they care only about what is inside the bottle.

The vendor tries to maximize revenue from these customers in a different way. You can’t see it in the pictures but throughout the store there are posters promoting a special deal: If you buy two of the smaller bottles the vendor will give you a $6 discount. Here they are using another tactic – recognizing the diminishing marginal utility of their product to this type of customer – and using price to overcome that obstacle and increase profit rather than sticking to a cost-plus formula that focusses on margin.

This is an opportunity for almost all retailers. The key is recognizing that some customers are simply interested in more units of the product (in the duty free example this is the customer that gravitates towards multiple smaller bottles) while others are drawn to a specific attribute(s) of the larger pack size (in the duty free example the customer that chooses to pay a premium for the larger bottle) and offer versions and prices tailored to each.