UNIT 9 DISCOUNTS AND ALLOWANCES Structure 9.0 Objectives 9.1 Introduction 9.2 Discounts and Allowances 9.2.1 Quantity Discount 9.2.2 Trade Discount 9.2.3 Cash Discount 9.2.4 Seasonal Discount 9.2.5 Promotional Allowance 9.3 Geographical Pricing 9.3.1 F.O.B. Factory Pricing 9.3.2 Uniform Delivered Pricing 9.3.3 Zone Pricing 9.3.4 Freight Absorption Pricing 9.3.5 Price Quotations in International Markets 9.4 Pricing a New Product 9.4.1 Market Skimming Price 9.4.2 Market Penetration Price 9.5 Fixed Price Versus Flexible Pricing 9.6 Unit Pricing 9.7 Let Us Sum Up 9.8 Key Words 9.9 Answers to Check Your Progress 9.10 Terminal Questions 9.0 OBJECTIVES After studying this unit, you should be able to: . - list various types of discounts and allowances. and explain their mechanisrn and rationale , explain various price policies relating to the geographic location of the custorners discuss the alternative price policies pertaining to new product describe the considerations governing the price changes explain the concept and characteristics of unit pricing. 9.1 INTRODUCTION - After deciding on the sale price for the product or service, you have to formulate appropriate strategies and po1icie.s relating to various aspects of the price structure. You may have to adjuqt the basic product price to suit any particular situation arising due to changes in cobt. clrrnand. competition, location of buyer. amount of purchase, frequency of purchase. ctc. In this context, you may face certain situations such as the following. If a cilstonler buys in bulk should ti.ere be any reduction? If' the goods are produced in Ahmcdabad factory, should the buyers throughout the country be charged the same price? If the competitor Has reduced his product price. should we also, reduce the price of our product? Should we recommend or fix the prices to be charged. by the middlemen on the re-sale of the product'? All such questions are to b.e answered H hile devising various price policig and strategies to provide guidelines and framework to the management in the matter of administering the price. In this unit you will study the strategies relating to discounts and allowances. geographical pricing, new product pricing, fixed and flexible pricing and unit pricing. 9.2 DISCOUNTS AND ALLOWANCES - As you know, manufacturers often prepare the list prices for thyir products for -. quoting to the buyers and also display it on the product labels. List price is further Dicounts and Allowancar adjusted to suit the requirements of the dealers and buyers. Such adjustments may be in the form of various reductions from the list price such as discounts, rebates, commissions and allowances. Let us study about discounts in detail. 9.2.1 Quantity Discount Selling and distribution costs are directly related to the quantity sold to a single buyer. If the buyer buys large quantities, the seller saves in selling and distribution costs. In order to provide incentive to buyers to buy in large quantities, the seller often allows a reduction in the price charged for the product. The reduction is referred to as the quantity discount. These discounts are based on the size of purchase, either in units of product or the value of the purchase. For example, if you buy one banana, the price may be Re.0.50, but if you buy a dozen, the price may be Rs.5.00 per dozen. If you buy I Kg. of rice, the price may be Rs.6, but if you purchase one quintal (100 kg.) the price may be Rs.550. In the first case, you are getting a quantity discount of Re. 1.00 on a quantity of 12 bananas or on Rs.6.00. In the second case, you are being given a quantity discount of R.s.50 (6.00 for 1.000 kilogram minus the actual amount charged Ks.5.50). There are two types of quantity discounts : I) cumulative discounts and 2) non-cumulative discounts. Non-cumulative Quantity Discounts : When the quantity discount is allowed on each single purchase of one product or several products from the same seller, it is called non-cumulative discount. Study the following illustration as an example of non-- cumulative quantity discount allowed by a manufacturer of a toilet soap taa wholesaler: Table 9.1 An illustration of Non-cumulative Discount No. of cases of soap cakes bought Discount from the list price (12 dozens in each case) in a single purchase I to 4 cases Nill 5 to 9 3% , 10 to 19 4% 70 .lild :,hoke hQ, -.- -. -. .- The st I-uctureof non-cumulative discount may also be expressed in a slab system of price. I tltlk at I i~hle9.2 for an illustration. Table 9.2 Non-cumulative Discount Shown in a Slab System Size of the Order Selling Price (No. of Soap Cakes) (Rs. per soap cake) 5.00 100 to 499 4.85 500 to 999 4.80 1,000 to 4,999 4.75 5,000 and above 4.70 Non-cumulative discounts provide inducement to the buyer to place large orders. The large orders result in reduction of various costs to the seller which vary with the size of the order. These costs include the selling costs, order processing costs; packing and transportation costs, delivery and collection costs. Large orders may also reduce production costs to the extent that they facilitate production of the goods on more economical scale. Cumulative Quantity Discounts : This type of discount is the reduction in price of product or a group of products based on the total amount of purchases made by a part-icular buyer from the seller during a specified time period, generally a year. It is also called a 'deferred or patronage discount' since it represents a reward to the buyer for patronising the seller for a relatively longer period. Moreover, he gets the discount at the end of a specificperiod. The more he buys during the period, the more amount of discount he gets since the discount is often in slabs based on the sales volume. This type of discount is illustrated in Table 9.3 by the discount schedule used by a manufacturer of lreadymade garments. I Table 9.3 An Illustration of Cumulative Quantity Discounts 'Total Annual Purchase Quantity Discount Below 50.000 Nill Rs 50.000 to 99.999 I .O% Rs. 1,00,000 to 1.49.999 l.5',; Rs. 2,00,000 to 2.49.999 2.0(;; Rs. ?.50,000 to 1.94.999 2.55~ Ks. 4.00.000 to 4.99.999 Rs 5.00.000 and &tborc 9.2.2 Trade Discount The trade d~scount,also called funct~onaldiscount, IS a reduction in price allowed to the distributing middlemen (wholesalers and retailers) for performing specific functions such as storing, selling, information gethering, complaint handl~ng, customer serviqng. etc. Different types of middlemen may be allowed different rates of discounts depending upon the functions and services prov~dedby them to the manufacturer. However, the middlemen at the same horizontal level (e.g. all wholesalers) must be given the same rate of trade discount. Otherwise, the practice will amount to discriminatory dealing which may generate ill-will among the dealers 1 and may also be objectionable under the law. Trade discount may also reflect the buyer's keenness of doing business. since this is an important consideration if the seller needs the volume from a certaln class of buyers. 9.2.3 Cash Discount Any reduction from the amount of the bill to encourage the buyer to pay the b~ll promptly is known as cash discount. This is often done when the sales are made on credit. The cash dacount is calculated on the amount after deducting the trade and quantity d~scountsfrom the list price. A typical example is 21 10, n/30 which means that the payment is due w~thin30 days, but if the buyer pays the bill within 10 days he can deduct two per cent of the amount. You can use this cash discount strategy to : I) collect the bills more quickly, 2) reduce credit risk (i.e., bad debts). 3) improve liquidity position. 4) reduce the cost of borrowing to finance the credit, and 5) reduce the cost of account keeping and collection staff. From the buyer's point of view also it isadvantageous to earn 2% discount by paying the invoice just 20 days earher than the day on which it has to be paid any way. If we 9 calculate it on annual*basis, it amounts to 36% per year, whah is a big amount. A very high cash discount may not be justified on the basis of encouraging prompt payment. On the other hand, a very low cash discount may not be able to motivate the buyer to. make prompt payment, The rate of cash discount should be decided after taking into account both the above aspects. In many cases. the cash discount 1s given only because it is expected and has become a custom in the trade. In order to avoid discrimination among the buyers, the cash discount must be offered to all buyers at the uniform rate.. 9.2.4 Seasonal Discount Sometimes, a discount is allowed fro111 thc list price during off-season. This is done to encourage the buyer to buy the product in the face of lack of demand in off- 9 season. This discount is known a\ thc wasonal discount. As you are aware, for example, manufacturers of refrigerators offer discount during the winter season when there is less demand for refrigerators.