Discounts and allowances
are reductions to a basic price
of goods or services. They can occur anywhere in the distribution channel
, modifying either the manufacturer's list price (determined by the manufacturer and often printed on the package), the retail price (set by the retailer and often attached to the product
with a sticker), or the list price (which is quoted to a potential buyer, usually in written form). The market price (also called effective price) is the amount actually paid. The purpose of discounts is to increase short-term sales, move out-of-date stock, reward valuable customers, encourage distribution channel
members to perform a function, or otherwise reward behaviors that benefit the discount issuer. Some discounts and allowances are forms of sales promotion
Types of discounts and allowances
The most common types of discounts and allowances are:
- Cash discounts for prompt payment - These are intended to speed payment and thereby provide liquidity to the firm. They are sometimes used as a promotional device. Examples are:
- 2/10 net 30 - this means the buyer must pay within 30 days of the invoice date, but will receive a 2% discount if they pay within 10 days of the invoice date.
- 3/7 EOM - this means the buyer will receive a cash discount of 3% if the bill is paid within 7 days after the end of the month indicated on the invoice date. It should be noted that if an invoice is received on or before the 25th day of the month, payment is due on the 7th day of the next calendar month. If a proper invoice is received after the 25th day of the month, payment is due on the 7th day of the second calendar month.
- 3/7 EOM net 30 - this means the buyer must pay within 30 days of the invoice date, but will receive a 3% discount if they pay within 7 days after the end of the month indicated on the invoice date. It should be noted that if an invoice is received on or before the 25th day of the month, payment is due on the 7th day of the next calendar month. If a proper invoice is received after the 25th day of the month, payment is due on the 7th day of the second calendar month.
- 2/15 net 40 ROG - this means the buyer must pay within 40 days of receipt of goods, but will receive a 2% discount if paid in 15 days of the receipt of goods by the purchaser. (ROG is short for "Receipt of goods.")
- Cash discounts for preferred payment method - Some retailers (particularly small retailers with low margins) offer discounts to customers paying with cash, to avoid paying fees on credit card transactions.
- Quantity discounts - These are price reductions given for large purchases. The rationale behind them is to obtain economies of scale and pass some (or all) of these savings on to the customer. In some industries, buyer groups and co-ops have formed to take advantage of these discounts. Generally there are two types:
- Cumulative quantity discounts (also called accumulation discounts). These are price reductions based on the quantity purchased over a set period of time. The expectation is that they will impose an implied switching cost and thereby bond the purchaser to the seller.
- Non-cumulative quantity discounts. These are price reductions based on the quantity of a single order. The expectation is that they will encourage larger orders, thus reducing billing, order filling, shipping, and sales personal expenses.
- Trade discounts (also called functional discounts) - These are payments to distribution channel members for performing some function. Examples of these functions are warehousing and shelf stocking. Trade discounts are often combined to include a series of functions, for example 20/12/5 could indicate a 20% discount for warehousing the product, an additional 12% discount for shipping the product, and an additional 5% discount for keeping the shelves stocked. Trade discounts are most frequent in industries where retailers hold the majority of the power in the distribution channel (referred to as channel captains).
- Partial payment discounts - Similar to the Trade discount, this is used when the seller wishes to improve cash flow or liquidity, but finds that the buyer typically is unable to meet the desired discount deadline. A partial discount for whatever payment the buyer makes helps the seller's cash flow partially.
- Seasonal discounts - These are price reductions given when an order is placed in a slack period (example: purchasing skis in April in the northern hemisphere, or in September in the southern hemisphere). On a shorter time scale, a happy hour may fall in this category. Generally, this discount is referred to as "X-Dating" or "Ex-Dating". An example of X-Dating would be:
- 3/7 net 30 extra 10 - this means the buyer must pay within 30 days of the invoice date, but will receive a 3% discount if they pay within 7 days after the end of the month indicated on the invoice date plus an extra 10 days.
- Forward dating - This is where the purchaser doesn’t pay for the goods until well after they arrive. The date on the invoice is moved forward - example: purchase goods in November for sale during the December holiday season, but the payment date on the invoice is January 7th.
- Promotional allowances - These are price reductions given to the buyer for performing some promotional activity. These include an allowance for creating and maintaining an in-store display or a co-op advertising allowance.
- Brokerage allowance - From the point of view of the manufacturer, any brokerage fee paid is similar to a promotional allowance. It is usually based on a percentage of the sales generated by the broker.
- Trade-ins - This can be a way of reducing the price. By offering more for a trade-in than it is actually worth, the net effect is to reduce the effective price earned by the seller. The advantage of this is it encourages replacement sales without altering the list price or the perceived value.
Dependence of price on quantity
An extreme form of quantity discount is when, within a quantity range, the price does not depend on quantity:
- if one wants less than the minimum amount one has to be pay for the minimum amount anyway
- if one wants an amount between two of the fixed amounts on offer, one has to pay for the higher amount
These also apply in the case of a service with "quantity" referring to time. For example, an entrance ticket for a zoo is usually for a day; if one stays shorter, the price is the same. It is a kind of pass for unlimited use of a service during a day, where one can distinguish whether or not, when leaving and returning, one has to pay again. Similarly a pass can be for another period. In the case of long periods, it is obvious that one can leave and return without paying again.
If one has to buy more than one wants, we can distinguish between the surplus just not being used, or the surplus being a nuisance, e.g. because of having to carry a large container.