In this article, learn about:
What are trade discounts?
Different types of trade discounts
How different retailers calculate trade discounts
What are Trade Discounts?
Trade discounts are reductions in the listed price of goods or services offered by sellers to buyers, resulting in a lower price for the buyer. These discounts are typically based on purchase volume or specific business arrangements.
Trade discounts are a common practice in the business world, allowing manufacturers and wholesalers to incentivize bulk purchases, promote products, and strengthen relationships with retailers. These discounts can vary in form and purpose, but they all aim to benefit both the seller and buyer.
What are the Benefits of Trade Discounts?
They are usually not recorded separately in accounting books. Instead, the sale is recorded at the net price after the discount. The main objectives of trade discounts are to:
Encourage bulk purchases: Offering discounts on large orders encourages buyers to purchase more at once, reducing sales transaction frequency and lowering administrative costs. Bulk purchases can also lead to more stable and predictable demand for the seller.
Reward loyal customers: Long-term or frequent buyers can receive trade discounts as a reward for their loyalty. This strengthens business relationships and encourages repeat business by making customers feel valued.
Move inventory quickly: Trade discounts can help move excess or outdated stock by offering a price reduction. This clears out inventory faster, making room for new products and reducing storage costs.
Promote new products: Introducing new products can be challenging, but trade discounts make it easier. Offering discounts on new items entices retailers to stock these products, increasing market penetration and visibility.
Related Reading: Demographics: Understanding Your Target Market
How are Trade Discounts Calculated?
The trade discount formula is used to calculate the discount amount that a buyer receives on the list price of a product or service based on the agreed discount rate.
Trade discounts are calculated with the following formula:
Trade discount = list price x discount rate
The list price is the original price of the goods or services prior to any discounting.
The discount rate is the percentage discount offered by the seller.
Additionally, the product net price is the list price minus the trade discount amount.
For example, if a retailer purchased products with a list price of $1,000 and received a 15% trade discount, it would mean that the retailer would receive a trade discount of $150. The formula would look like this: $1000 x 15% = $150.
The net price would be $850, with the formula being: $1000 - $150 = $850.
Trade discounts are applied to the list price, not the discounted price resulting from other discounts.
Understanding these formulas is important for:
Setting competitive prices
Managing costs
Maintaining accurate accounting records
Aiding in informed pricing
Budgeting
Financial planning
Types of Trade Discounts
Trade discounts come in various forms, each serving different purposes. Here are the main types of trade discounts:
Cash Discounts
Cash discounts are discounts typically offered to buyers who pay their invoices promptly, typically within a specified period. These discounts incentivize quick payments, improving the seller's cash flow, and reducing the risk of bad debt.
When suppliers create agreements with Walmart, they might offer a cash discount to encourage early payment. This means Walmart gets a small percentage off the invoice if they pay quickly.
For example, if the negotiated payment term is “2% / 30 net 60,” it means that Walmart will receive a 2% cash discount on the invoice amount if the invoice is paid within 30 days. If Walmart does not take advantage of this discount, the full invoice amount is due within 60 days.
Related Reading: Code 80: Cash Discounts at Walmart
Quantity Discounts
Quantity discounts are offered to buyers who purchase larger quantities of a product. The discount increases with the purchase volume, making it more attractive for buyers to order in bulk. For example, for suppliers working with Walmart buyers:
Walmart often negotiates volume discounts with suppliers based on the large quantities they purchase.
Volume discounts are tiered, meaning the more Walmart buys, the greater the discount. This volume-based discount encourages Walmart to buy in bulk, securing lower per-unit costs and helping Walmart maintain its reputation for low prices.
For example, if a Walmart buyer orders 1,200 units of a product, they will receive a 5% discount. If they increase the order to 5,500 units, the discount increases to 10%, significantly reducing the overall cost and allowing Walmart to offer competitive pricing to consumers.
Promotional Discounts
Promotional discounts are short-term reductions to promote new products or clear out old stock. These discounts are designed to create a sense of urgency and boost sales during specific promotional periods. For example, for suppliers working with Amazon buyers, Amazon employs various cooperative advertising agreements (Co-Ops) with suppliers.
Co-Ops involve suppliers funding a portion of Amazon's advertising costs in exchange for prominent product placement and marketing efforts on Amazon's marketplace.
Co-Ops are similar to trade programs or trade allowances in a brick-and-mortar store, where suppliers pay for ideal shelf placement, extra shelf space, end caps, special bins, or other promotions.
With e-commerce, shelves are digital, and so are coupons. These programs help ensure good organic search placements, promote ads to consumer's apps, and enhance visibility.
For example, if an electronics supplier might agree to a Co-Op arrangement with Amazon by contributing 5% of their sales revenue towards Amazon's marketing campaigns. In return, Amazon will feature the supplier’s products in ideal advertising spots, such as on the homepage or top search results. This increased visibility can drive higher sales volumes, benefiting the supplier by boosting product awareness in the market.
Related Reading: How to Dispute Amazon Co-Op Deductions
Seasonal Discounts
Seasonal discounts are common during off-peak seasons to boost sales when demand is typically low. These discounts help suppliers maintain a steady flow of sales throughout the year and prevent inventory buildup during slower periods.
For example, a seasonal discount might look like a clothing manufacturer offers a 15% discount on winter apparel during the summer months. This encourages retailers to purchase and stock up on winter clothes in advance, ensuring that the manufacturer can manage inventory levels efficiently.
Negotiating Trade Discounts
When presenting a trade discount to a retailer it is important to have all the details and terms clearly outlined and understand and present exactly how the discount will benefit the retailer. To ensure that the negotiation process goes smoothly, and ultimately benefits both parties, suppliers should:
Clearly define the terms of the discount.
Clearly define and show the direct line between the discount and measurable benefits for both parties.
Understand the total value that the retailer offers in exchange for the discount and be willing to negotiate for better long-term returns rather than immediate returns.
Document the process, and the terms agreed upon to help with all future communication.
Misapplied, broken, or misunderstood trade discounts can lead to revenue loss. It is important for suppliers to stay aware of established key terms and communicate early and often with retailers. Good communication helps maintain a solid and consistent supplier-retailer relationship and ensure that both parties make rather than lose profit.
By offering and negotiating trade discounts, suppliers can enhance their relationships with their partners, improve cash flow, and maintain competitive pricing. Whether the supplier is working with a manufacturer, wholesaler, retailer, or all of the above, leveraging trade discounts effectively can lead to mutual benefits and sustained growth in the marketplace.
Protect your Profits with Revenue Recovery
Are deductions eating away at your revenue? Protect your profits with SPS Commerce’s Revenue Recovery platform!
