Volume-based quantity discount

Pharmacies often choose one pharmaceutical wholesaler and esfablish a prime vendor relationship. The prime vendor relationship is an agreement that stipulates that the pharmacy will purchase a set amount of drugs from the wholesaler. In return for guaranteed purchases, wholesalers provide a discormf to fhe pharmacy. As parf of the agreement, wholesalers may provide further discounts based on purchase volume. Some pharmacies might also retain a secondary wholesaler to use as an alternative source of pharmaceuticals. However, purchases from fhe secondary wholesaler are usually kept to a minimum so as not to jeopardize quantity discounts from the primary wholesaler. 

PRICING FOR COORDINATION In many instances, suitable pricing schemes can help coordinate the supply chain. A manufactmer can use lot-size-based quantity discounts to achieve coordination for commodity products if the manufacturer has large fixed costs associated with each lot (see Chapter 11 for a detailed discussion). For products for which a firm has market power, a manufacturer can use two-part tariffs and volume discounts to help achieve coordination (see Chapter 11 for a detailed discussion). Given demand uncertainty, manufactmers can use buyback, revenue-sharing, and quantity flexibility contracts to spur retailers to provide levels of... 

Volume-based quantity discount Observe that the two-part tariff is really a volume-based quantity discount whereby the retailer DO pays a lower average unit cost as it purchases larger quantities each year (the franchise feeffis amortized over more units). This observation can be made explicit by designing a volume-based discount scheme that gets the retailer DO to purchase and sell the quantity sold when the two stages coordinate their actions. 

At this stage, we have seen that even in the absence of inventory-related costs, quantity discounts play a role in snpply chain coordination and improved supply chain profits. Unless the manufacturer has large fixed costs associated with each lot, the discount schemes that are optimal are volume based and not lot-size based. It can be shown that even in the presence of large fixed costs for the manufacturer, a two-part tariff or volume-based discount, with the manufacturer passing on some of the fixed cost to the retailer, optimally coordinates the supply chain and maximizes profits given the assumption that customer demand decreases when the retailer increases price. 

A key distinction between lot-size-based and volume discounts is that lot-size discounts are based on the quantity purchased per lot, not the rate of purchase. Volume discounts, in contrast, are based on the rate of purchase or volume purchased on average per specified time period (say, a month, quarter, or year). Lot-size-based discounts tend to raise the cycle inventory in the supply chain by encouraging retailers to increase the size of each lot. Volume-based discounts, in contrast, are compatible with small lots that reduce cycle inventory. Lot-size-based discounts make sense only when the manufacturer incurs high fixed cost per order. In all other instances, it is better to have volume-based discounts. 

One can make the point that even with volume-based discounts, retailers will tend to increase the size of the lot toward the end of the evaluation period. For example, assume that the manufacturer offers DO a 2 percent discount if the number of bottles of Vitaherb purchased over a quarter exceeds 40,000. This pohcy will not affect the lot sizes DO orders early during the quarter, and DO will order in small lots to match the quantity ordered with demand. Consider a situation, however, in which DO has sold only 30,000 bottles with a week left before the end of the quarter. 

To get the quantity discount, DO may order 10,000 bottles over the last week even though it expects to sell only 3,000. hi this case, cycle inventory in the supply chain goes up in spite of the fact that there is no lot-size-based quantity discount. The situation in which orders peak toward the end of a financial horizon is referred to as the hockey stick phenomenon because demand increases dramatically toward the end of a period, similar to the way a hockey stick bends upward toward its end This phenomenon has been observed in many industries. One possible solution is to base the volume discounts on a rolhng horizon. For example, each week the manufacturer may offer DO the volume discount based on sales over the past 12 weeks. Such a rolling horizon dampens the hockey stick phenomenon by making each week the last week in some 12-week horizon. 

Devise appropriate discounting schemes for a supply chain. Quantity discounts are justified to increase total supply chain profits when independent lot-sizing decisions in a supply chain lead to suboptimal solutions from an overall supply chain perspective. If suppliers have large fixed costs, suitable lot-size-based quantity discounts can be justified because they help coordinate the supply chain. Volume-based discounts are more effective than lot-size-based discounts in increasing supply chain profits without increasing lot size and cycle inventory. 

What is the difference between lot-size-based and volume-based quantity discounts ... 

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