I have a favorite client who always eggs me on to tell the “7-Eleven Big Gulp story” in meetings. “C’mon, tell it,” he nudges. Often, I do.
My friend’s fascination with the story is well-founded. 7-Eleven does a fantastic job of employing volume discounts. Fountain drink sizes at the convenience store’s Cambridge, MA location range from 16 to 32 ounces (priced from 99 cents to $1.39). While 16 ounces of soda – a Gulp – will satisfy my thirst, I inevitably purchase the 24-ounce Big Gulp because it’s only 20 cents more. By lowering the price-per-ounce on larger sizes in a manner that mirrors my reduced willingness to pay for more soda, 7-Eleven entices me to purchase a bigger size.
Squeezing me for an extra two dimes may not seem like much, but remember, fountain soda drinks are notorious cash cows. 7-Eleven reports that after introducing the Big Gulp line – which has included sizes as large as 128 ounces (Team Gulp) – profits from fountain drinks increased by close to 100%. Some 7-Eleven operators report that Big Gulp fountain drinks account for almost 10% of their stores’ revenues.
The moral of this story is clear: when properly implemented, volume discounts can unleash generous new profits and growth.
That assumes the volume discounts are implemented properly. This happens too rarely; many companies play this strategy incorrectly. As I highlight in my previous article on this topic, the key reason for employing a volume discount is rooted in the law of diminishing marginal utility. This “law” posits that the more we consume of a product, the less we value an additional unit of it. (Think of how much more you appreciate your first slice of pizza at dinner, compared to each additional slice.) The purpose of volume discounts is to use price reductions to incentivize customers to purchase more than planned.
In my experience, companies in the B2B sector are especially prone to misunderstanding volume discounts. That’s partly because business customers are especially likely to buy goods in high volumes, so conversations about volume discounts are common.
When I work with B2B customers on pricing, I remind them of two insights when it comes to volume discounts:
Never forget: the key goal of volume discounting is to incentivize additional purchases. Most managers don’t understand the purpose of a volume discount. A classic mistake is to blindly subscribe to the “if you buy more, I have no choice but to give you a break” mentality. That’s incorrect. A discount is only necessary when it leads to a sale that will deliver additional profit that wouldn’t have otherwise been earned.
Through my consulting work, I’ve discovered another misunderstanding: many B2B managers view volume discounts as a reward to their biggest customers. While it’s important to show appreciation to kingpin clients, providing discounts shouldn’t be the lead gesture. There are less expensive ways to express gratitude. And remember, in many situations, a big purchase simply means the customer loves (or needs) the product–a reason to hold the line on pricing.
When possible, tailor volume discounts to each customer. A key challenge of designing any volume discount strategy is that each customer has a different level of what they consider to be a “large purchase.” Revisiting Big Gulps, 16 ounces of soda may be a large buy for me, but others will have different thresholds of what constitutes a large purchase.
Since B2C companies like 7-Eleven can’t customize volume discounts for each customer, they compromise to target an average customer with a one-size-applies-to-all strategy. Because of this averaging, customers who make smaller purchases are often ignored and bigger customers enjoy larger-than-necessary discounts.
Many B2B companies also offer one-size-applies-to-all volume discounts. Ask a salesperson for their volume discounting plan and it’s likely that they’ll hand you a single page table that lists discount bands along the lines of: A client who buys 10,000 to 19,999 units will receive 15% off, 20,000 to 30,000 units means 20% off, purchases of more than 30,000 units yields 25% off, etc.
The drawback of using a one-size-applies-to-all discounting table is that small customers (e.g., the less-than-9,999 units buyers in the above example) are neglected. Also, the biggest customers are likely enjoying a sweetheart deal, because they would have likely purchased a large amount without a discount. Despite these imperfections, this is the best that a company can do if it doesn’t have a salesforce to negotiate deals.
Using a one-size-fits-all volume discount is a mistake if a salesforce individually negotiates deals with customers. (That’s true in B2B as well as B2C). Sales personnel should tailor volume discounts to each situation. After it’s clear how much a client will realistically purchase, a custom incentive can be extended to incentivize them to buy even more. Whenever possible, customized volume discounts should be offered to every customer regardless of how much they are purchasing. Small, medium, and large customers can all be coaxed into buying more if the discount resonates with them. Discounts should be structured to profitably achieve the highest percentage of potential sales to each client.
It should now be clear why my client is fanatical over the Big Gulp story: selling more for a small price increase can reap a financial windfall.