Designing Effective Discount Structures

The Purpose of Discounts

Discounts exist to change behavior—yours or the customer's. Every discount should have a clear purpose; otherwise, you're simply giving away margin. Before designing any discount structure, ask: what behavior am I trying to encourage, and is the discount the most efficient way to encourage it?

Common discount purposes include

• Volume consolidation: Encouraging customers to buy more from you instead of splitting across suppliers
• Customer retention: Rewarding loyalty to reduce switching
• Cash flow acceleration: Incentivizing faster payment to improve working capital
• Channel enablement: Providing margin for distributors and resellers to support your product
• Trial stimulation: Reducing barriers for first-time buyers
• Inventory management: Moving slow or excess inventory before it loses value Discount Types and Applications

Discount Type

Purpose

Typical Structure

Key Consideration

Volume

Consolidation; scale

Tiered % based on quantity or $

Set thresholds above natural purchase levels

Loyalty/Tenure

Retention; relationship

% based on years or cumulative purchases

Reward continued behavior, not past behavior

Early Payment

Cash flow; reduce risk

% for payment within X days (e.g., 2/10 Net 30)

Calculate annualized cost

Trade/Channel

Enable resellers

Fixed % off list for channel partners

Ensure channel economics work

Promotional

Trial; awareness

Temporary % or $ off

Time-limit strictly; avoid expectation

Competitive

Win specific deal

Match or beat competitor price

Document justification; don't set precedent

Volume Discount Design

Volume discounts are among the most common—and most frequently misdesigned—discount structures. Effective volume discount design follows several principles:

Set Thresholds Strategically

Place tier breaks just above natural purchase quantities. If customers typically buy 100 units, set Tier 2 at 125, not at 100. This encourages stretch behavior without giving discounts for purchases customers would have made anyway.

Analyze purchase history to identify natural clusters. If you see purchases grouping at 50, 100, and 250 units, set thresholds at 75, 150, and 300—requiring customers to increase volume to earn discounts.

Ensure Economic Justification

Each discount tier should reflect real cost savings from serving larger orders. These might include production efficiency (longer runs, fewer changeovers), shipping efficiency (fuller trucks, better rates), transaction efficiency (fewer orders to process), and demand planning benefits (predictable volume reduces uncertainty costs).

If you can't identify real cost savings, the discount is simply margin transfer to customers—you're paying them to buy what they would have bought anyway.

Case Study: Volume Discount Economics A manufacturer sets volume tiers at 75, 150, and 300 units with 5%, 10%, and 15% discounts. Analysis shows: Moving from 50 to 75 units reduces per-unit production cost by $3.20 (longer runs). Moving from 100 to 150 reduces shipping cost by $1.80/unit (full pallet). Moving from 200 to 300 enables dedicated production slot saving $2.50/unit. At a $40 base price, the 5% Tier 2 discount costs $2.00/unit but saves $3.20—economically justified. The 10% Tier 3 discount costs $4.00/unit but saves $5.00 (cumulative)—justified. The 15% Tier 4 discount costs $6.00/unit but saves $7.50 (cumulative)—justified. Each tier passes the economic test: the discount is smaller than the cost savings.

Choose Cumulative vs. Incremental

Cumulative (retroactive) discounts apply the higher discount rate to all units once a threshold is reached. Incremental (marginal) discounts apply higher rates only to units above each threshold.

Cumulative discounts create stronger incentives to reach each tier—every unit benefits from reaching the next level. But they create cliff effects where customers near a threshold have incentive to over-order.

Incremental discounts are smoother but provide weaker tier-reaching incentives. Each additional unit earns only its incremental discount, not improved pricing on prior units.

Key Takeaways

• Every discount should have a clear behavioral purpose—don't give away margin without reason
• Set volume thresholds above natural purchase levels to encourage stretch behavior
• Ensure discounts are economically justified by real cost savings
• Choose cumulative vs. incremental structure based on incentive strength needed