Today’s Guest Post comes from Prof. Chuck Munson, at Washington State University. Jay and I are pleased that Chuck is joining us as co-author on the new edition of our texts, coming out in January, 2016.
We can’t walk down most any aisle of the local grocery store without seeing multiple package sizes for products with (quite often) a quantity discount in the form of a lower price per unit for purchasing the larger size. Companies experience the same thing. Firms responding to a recent survey reported a large level of quantity discount pricing in business-to-business transactions, and 67% of respondents negotiate more than half of their prices.
Some of the most common operations reasons for the existence of quantity discounts include: (1) to receive cost savings due to economies of scale, (2) to increase order size and decrease order frequency, (3) to take advantage of truckload rates and transportation discounts, and (4) to be able to ship in standard package and container sizes. Quantity discounts are used for marketing purposes as well, including: (1) to increase annual demand, (2) to lock in customers for the long term, and (3) to win large orders from business customers.
If you’ve ever taught the EOQ model with quantity discounts (Ch. 12 in the text) in your OM class, your students may be like mine. For some reason, many seem to have difficulty grasping the solution technique. Rather than give up, though, I keep teaching it because quantity discounts are so prevalent in industry. Apparently, proper ordering techniques are not yet widespread in practice. Thirty percent of sellers and buyers in the recent survey claimed to base discounts and order quantities on intuition rather than on models and algorithms. Further, 1/4 of the buyers often order at a price breakpoint of incremental quantity discount schedules, which is never optimal. Clearly, companies are leaving a significant amount of dollars on the table.
For more details and a literature review of more than 250 papers on quantity discounts, see: www.cbe.wsu.edu/~cmunson/Research%20Papers/Quantity%20Discounts%20TOM-041.pdf