How Do Trade Discounts Work?

Learn about:

• What are Trade Discounts?

• Types of Trade Discounts

• How Trade Discounts are Calculated

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 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 the purchase volume or specific business arrangements. 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• Move Inventory Quickly: Trade discounts can help move excess or outdated stock by offering a price reduction.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 Trade Discounts Are 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.

For example, if a retailer purchased products with a list price of $1,000 and received a 15% trade discount, it would mean that they would receive a discount of $150 ($1000 x 15% = $150), resulting in the net price being $850 ($1000 - $150 = $850). Trade discounts are applied to the list price, not the discounted price resulting from other discounts. Understanding this formula is important to set competitive prices, manage costs, and maintain accurate accounting records, aiding in informed pricing, budgeting, and 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 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 debts.

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 implies that Walmart will receive a 2% cash discount on the invoice amount if payment is made 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.

• 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.

• Example: If Walmart orders 1,200 units of a product, it receives a 5% discount. If they increase the order to 5,500 units, the discount increases to 10%, significantly reducing the overall purchase 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 a specific promotional period.

• 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 platform. These arrangements are similar to trade programs or trade allowances in the brick-and-mortar world, where suppliers pay for ideal shelf placement, ample shelf space, end caps, special bins, or other promotions like coupons or discounts in flyers. In e-commerce, the shelves are digital, and so are the coupons. These programs help ensure good organic search placements, promote ads to consumer's apps, and enhance visibility.

• Example: A supplier of electronic gadgets agrees to a Co-Op arrangement with Amazon, contributing 5% of their sales revenue towards Amazon's marketing campaigns. In return, Amazon features its products in prime advertising spots, such as the homepage or top search results. This increased visibility can drive higher sales volumes, benefiting the supplier by boosting product awareness and market penetration.

Related Reading: How to Dispute Amazon Co-Op Deductions

Seasonal Discounts

Seasonal discounts are provided during off-peak seasons to boost sales when demand is typically low. These discounts help sellers maintain a steady flow of sales throughout the year and prevent inventory buildup during slower periods.

For example, 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 well in advance, ensuring that the manufacturer can manage inventory levels efficiently.

By offering and negotiating trade discounts, businesses can enhance their relationships, improve cash flow, and maintain competitive pricing. Whether you're a manufacturer, wholesaler, or retailer, leveraging trade discounts effectively can lead to mutual benefits and sustained growth in the marketplace.

Trade discounts can also lead to revenue loss when the negotiated terms are misapplied, broken, or misunderstood. Staying aware of established terms is key to accounting on both the supplier and retailer side.

Further Reading and SupplyPike's Help

Subscribe to our newsletter to stay informed about all things concerning retail suppliers. We produce articles, webinars, Cheat Sheets, and eBooks on a variety of the most important subjects for suppliers, from packaging to item setup!

SupplyPike helps suppliers by providing automation in the deductions space and oversight into supply chain performance. Schedule a meeting with a team member to see if our solution is a good fit for your business.