What is a Trade Discount?
Definition: Trade discount in the business world is a common term that is used to describe the price reduction that a manufacturer is usually willing to give to wholesalers. It is a discount that lowers the price from the initial price at which the manufacturer is willing to supply its products to wholesalers.
Trade discounts are important for both the manufacturer and also the reseller or wholesaler. The manufacturer offers the discounts depending on the volumes that the wholesaler will purchase. For example, the manufacturer may decide to give a noteworthy discount to a manufacturer those purchases in bulk to encourage them to continue buying in bulk. This also strengthens the relationship between the two parties, thus increasing the chances that the wholesaler will become a repeat customer and perhaps even encourages other buyers to jump on board.
The trade discounts are also a big advantage to the wholesalers because it allows them to increase their profit margin per unit when they sell to the final consumer. It also gives them more pricing room to play with as far as discounts to consumers are concerned. The other major benefit to wholesalers or retailers is that it allows them to compete more effectively with other similar products in the market by setting the retail price at levels that consumers can worth with.
Why do companies issue trade discounts?
As noted earlier, a manufacturer may provide a trade discount to wholesalers in an attempt to solidify their relationship in pursuit of perpetual business partnerships. The manufacturer may also decide to give a trade discount to wholesalers or retailers that have strong distribution networks.
The strategy in such a case involves offering bigger discounts if the wholesaler orders more units. This approach is aimed at promoting the distribution of more of its products and higher distribution capacity means that the manufacturer’s product will have more exposure in the market.
Why and how do manufacturers try to avoid trade discounts?
As you may have guessed, trade discounts eat into a company’s profit margins. However, they are a necessary evil for manufacturers especially when the manufacturer does not have a distribution network. In such cases, they have to motivate wholesalers and retailers to distribute and sell the products on behalf of the manufacturer.
But what if the manufacturer could create its own distribution network? Then the manufacturer would not have to issue trade discounts. Instead, it would provide the products to the wholesalers and retailers at higher prices or full retail prices, to account for the cost of distribution.
Trade Discounts vs Sales Discounts – What’s the Difference?
There is a huge difference between trade discounts and sales discounts.
- Trade discounts are given by manufacturers to wholesalers or retailers. Sales discounts, on the other hand, are discounts offered by retailers or wholesalers to final consumers.
- Trade discounts also happen to have fewer restrictions than sales discounts.
- Trade discounts are based on the quantity of products that wholesalers and retailers purchase. It usually applies when bulk goods are purchased. Sales discounts are often given to customers or consumers even when they purchase a single unit.
Trade Discount Example
Picture a situation where a biopharma makes a particular drug for treating a specific health condition. The listed price for the complete dose of the medicine is $100 as per the manufacturer’s indicated retail price. However, the biopharma may decide to offer a $20 discount per dose when pharmacies purchase more than 500 doses. This means that a pharmacy purchasing the drugs will spend $40,000 to purchase the 500 doses therefore saving $10,000 courtesy of the discount.
In the above example, the pharmacy manages to slash $10,000 from its cost of purchasing the drugs, thus allowing it to increase its profit margin once it sells the drugs. This type of situation might encourage the pharmacy to purchase more of the drug so that they can make higher margins especially if the demand for the medicine justifies the purchase.