James B. Wilcox, Roy D.

Howell, Paul Kuzdrall, & Robert Britney

Price Quantity Discounts:

Some Implications for
Buyers and Sellers
Price quantity discount schedules are shown to present opportunities to buyers beyond those explicit in
the discount schedule itself. The authors propose a taxononny of price quantity discount schedules, and
within that taxonomy examine the implications of price quantity discounts for the ordering behavior of
buyers and the formation of alternative channels of distribution.

ECAUSE of industry practice, for convenience,

for marketing purposes, or for all of those reasons, the use of price quantity discount schedules has
become common in many industries. These schedules, intended to act as 24-hour salespersons, present
quantity-related prices and savings to potential buyers. Though the rationale for offering such discounts
has been debated (Crowther 1964; Dolan 1978; Jeuland and Shugan 1983; Lai and Staelin 1984; Monroe
and Delia Bitta 1978), the practice has become accepted and in many cases exf)ected in marketing.
Price quantity discounts may give buyers costlowering opportunities beyond those explicit in the
discount schedule itself. To lower cost per unit, buyers may order in quantities larger than they need and
enter prearranged resale (pooled buying) agreements
or ad hoc brokerage situations. Additionally, more

James B. Wilcox and Roy D. Howell are Professors of Marketing, Texas

Tech University. Paul Kuzdrall is Associate Professor of Management,
Uniyersity of Akron. Robert Britney is Professor of Production/Operations Management, Uniyersity of Western Ontario. The authors gratefully acknowledge the partial support of this work under Natural Sciences and Engineering Research Council of Canada Grant A-5311. They
are also indebted to the numerous firms whose schedules were made
available for the research.

60 / Journal of Marketing, July 1987

formal mechanisms for the distribution of the "excess" merchandise may develop. Price quantity discounts recently have been criticized as one of the major factors contributing to the emergence of gray
markets (Donath 1985; Litley 1985), wherein the
"surplus" units reenter the market through perhaps
unanticipated and frequently unauthorized channels.
Interestingly, with the exception of some caveats by
economists (Buchanan 1953; Oi 1970), this possibility has not been addressed adequately. The common
practice of offering price quantity discounts has not
been examined as a mechanism favoring the development of such markets.
To address the issues raised by price quantity discounts, we first briefly review the literature to develop
a framework. We then describe a taxonomy of models
that have been found to fit actual price quantity discount schedules. Next, within the context of these
models, the characteristics of discounts that give rise
to the issues are examined. Finally, the seller's rationale for offering price quantity discounts is reconsidered.

Why Price Quantity Discounts?

Several reasons for the use of price quantity discounts
have been identified. Crowther (1964) suggests that

Journal of Marketing
Vol. 51 (July 1987), 60-70

sellers save in several ways by selling fewer, larger

orders to their customers. One saving is from lower
sales costs in that fewer sales calls are made, fewer
orders are processed, and so on. A second is from
lowered costs for raw materials because quantity discounts are often available to the seller. Third, the time
value of money is taken into account because larger
revenues are available for reinvestment for longer periods. Finally, longer production runs without attendant increases in holding costs are possible (see also
Monahan 1984). Monroe and Delia Bitta (1978) extend Crowther's model to recognize the interactive effects of these factors, though the reasoning behind the
discounts remains unchanged.
More recently, quantity discounts have been viewed
as a tool for achieving channel cooperation. Jeuland
and Shugan (1983), for example, see such discounts
as a subtle form of profit sharing between levels in
the channel. In their model for optimizing channel
profits they propose negotiations between the seller
and each individual buyer to allocate optimally the
savings referred to by Crowther (1964). Though they
base their work on a different theory and make different assumptions, Zusman and Etgar (1981) provide
a similar perspective.
Perhaps the most complete model has been offered
by Lai and Staelin (1984). They argue that though
quantity discounts are believed to arise as a result of
pressure from large buyers, discounts also are offered
at small quantities. They conclude that effort on the
part of the seller to maximize profits by modifying the
buyers' order policy is a more likely explanation for
the use of discounts.
One additional reason for using price quantity discounts, addressed primarily by economists, is price
discrimination. Gabor (1955) has shown that such discounts are actually two-part prices composed of a fixed
and variable component. Oi (1970) has demonstrated
that, in comparison with a single-price strategy, a twopart price is an effective means for monopolists to increase profit. The two parts are a lump sum tax or
franchise fee paid for the right to purchase the monopolist's product and a per-unit fee. The lump sum
is the mechanism used to reduce consumer surplus.
Oi notes, however, that such a strategy should seldom
be employed because of the inability of the monopolist to prevent resale. That is, in the absence of high
transaction costs of some sort, " . . . a single consumer could pay the lump sum tax and purchase large
quantities for resale to others" (1970, p. 88).
Though in some of Oi's examples the franchise
fee is a one-time payment (e.g., initiation fees for a
country club), that is not a necessary condition. All
that is required is a fixed and variable component. In
the models described hereafter, we demonstrate that
price quantity discounts meet this requirement.

A Taxonomy of Price Quantity

Discount Models
According to Fartuch, Kuzdrall, and Britney (1984;
see also Britney, Kuzdrall, and Fartuch 1983a,b) there
are two basic approaches to the presentation of price
quantity discounts and variations for each approach.
The two major models are per-unit pricing (model I)
and package pricing (model II). The variations within
each type include the presence (second degree) or absence (first degree) of quantity intervals over which a
certain price per unit applies. The models and their
variations are shown graphically in Figure 1.

Model I
Model I price schedules are characterized by per-unit,
all-unit prices. That is, as the buyer orders larger
quantities, the price per unit charged applies to all units
purchased. First degree model I pricing is the limiting
case in which a unique price is associated with each
unit. Such price schedules may be presented as a long
list of quantities with the price at each quantity or may
be offered simply in terms of the fixed (F) and variable (V) components (e.g., $29 per day and 30 cents
per mile). This model is shown in Figure 1 as having
a smooth, curvilinear price-quantity relationship. If a
similar approach is used but each price applies to a
range or interval of quantities, the schedule becomes
a second degree model I. For example, any quantity
ordered in the range of 50 to 75 units would carry the
same price per unit. These schedules also can be described by a fixed and variable component. In this case,
price is held constant over a range, giving rise to the
"stairstep" schedules shown in Figure 1. Note that the
steps originate from the continuous curve, either projected backward (I-A), forward (I-B), or somewhere
between (I-A/B). Techniques for determining a
schedule's fixed and variable components (F and V)
are discussed in the Appendix. Forms of model I pricing are common and are used for such products as
steel bars, stud bolts, recording tape, integrated circuits, photocopying, stationery, office equipment, and
expendable computer supplies (see Table 1).
Model I
Model II pricing schedules refer to package pricing in
which the buyer receives no credit for taking delivery
of fewer units than the maximum quantity in the package. This type of pricing is usually the result of industry practice and perhaps physical packaging requirements. Like model I, model II has a range of
variations. Model II first degree schedules quote a
unique package price for each quantity, as indicated
by the straight-line price-quantity relationship shown
in Figure 1. Second degree schedules involve intervals of package quantities to which a single price ap-

Price Quantity Discounts / 6 1

FIGURE 1
Forms of Price Quantity Discounts

TC

TCQ^

plies and hence show a stairstep price-quantity relationship. Again, the schedule is a projection from the
continuous case. The techniques in the Appendix can
be used to decompose the schedules into F and V
components, but the type A, B, and A/B distinctions
do not apply to model II second degree schedules.
Though not as common as model I, model II schedules are used in pricing paper, photographic film,
transistors, capacitors, and electrical components.
In addition to models I and II, non-all-unit models
are possible. For example, block pricing schedules are
used by electric utilities. To get to a lower price on
the schedule, the buyer first must acquire the lower
quantities at higher prices. Such schedules are beyond
the scope of our discussion.
As shown in the Appendix, most quantity discount
schedules can be decomposed into fixed (F) and variable (V) components following either model I or model

62 / Journal of Marketing, July 1987

n pattems. As we discuss in more detail subsequently, an examination of a large number of published price lists shows a surprisingly high proportion
of schedules that "fit" one of the models depicted in
Figure 1 (r^ > .95). The discovery of a model that
fits the observed data closely does not, of cotirse,
guarantee it is the only model that would fit the data.
Similarly, one cannot claim to have modeled the cognitive process used by the price setter; the actual pricing decision could have been based on a decision process different from the model used to fit the data. This
is an important point. The issues considered by the
decision maker in establishing the discount schedule,
whether cost-, competition-, or demand-related, are
largely irrelevant to the outcome of offering price
quantity discounts. As we demonstrate, what really
matters is the result (the schedule) and not the factors
considered in its development.

TABLE 1
Summarized Schedule Analysis
Estimated ($)
Company

Product

9,096.00
10,512.00
40.50
54.00
78.00
27.00
25.00
24.50

1.516.00
1,752.00
32.25
48.50
87.50
65.50
104.00
26.00

Ratio
Fto V

IBM

Terminal (M-10)
Terminal (M-20)
Magnetic cards
Diskettes (D-1)
Diskettes (D-2)
Copier toner
Series 3 toner
Watermark paper

Wright

Worksurface panel
Printout paper
Binders
8V2 X 11 in folder
15 X 11 in folder
Binder adapter kit
Ring binder
Indexes
Hardcover binder
Diskettes (5V4 in)
Diskettes (8 in)
Tape seal cartridge
Tape seal belt
Hanging folder

21.00
54.00
121.50
108.00
99.00
72.00
237.50
99.00
171.00
30.00
20.00
294.00
350.00
72.00

77.25
50.50
73.00
33.00
42.50
33.00
52.50
12.50
46.00
50.00
75.00
42.00
55.00
28.00

Global

DP forms
Electrical ext.
Extension (100')
Cable (25 cond)
Double door cabinet

34.80
12.00
25.00
11.88
64.00

29.90
21.95
38.00
1.08
189.95

1.2
1.0
1.0
11.0
1.0

to
to
to
to
to

1.0
1.8
1.5
1.0
3.0

Radio Shack

Diskettes (8 in)
Diskettes (5V4 in)
Cassettes (C-10)
Cassettes (C-20)

40.00
24.00
5.94
13.20

49.95
33.95
1.25
2.49

1.0
1.0
4.8
5.3

to
to
to
to

1.2
1.4
1.0
1.0

National Semiconductor

Flip flop
RAM chip
Analog switch
Number processor

126.96
252.00
92.40
139.20

10.57
21.00
7.70
11.55

12.0
12.0
12.0
12.1

to
to
to
to

1.0
1.0
1.0
1.0

Daniel

12 X 2 stud bolt
12 X 15 stud bolt
12 X 18 stud bolt

15,273.12
15,755.52
16,242.48

1,873.01
2,294.85
2,716.70

Standco

1 % X 7 stud bolt
IV4 X 6 stud bolt
% X 3 stud bolt
% X 9 stud bolt

5,395.00
5,245.20
3,384.00
3,741.60

204.65
153.30
39.90
118.10

26.4
34.2
84.8
31.7

to
to
to
to

1.0
1.0
1.0
1.0

DRG Envelope

#7 open side
Business reply env.
Punched card return
2-fold env.
#5 invitation
Kraft X-ray env.

88.62
128.94
111.30
107.10
171.22
623.70

12.66
18.42
15.90
15.30
24.46
89.10

7.0
7.0
7.0
7.0
7.0
7.0

to
to
to
to
to
to

1.0
1.0
1.0
1.0
1.0
1.0

Canada Envelope

#7 open side
#8 grey deco
#7 open remittance

69.86
81.62
121.24

9.98
11.67
17.32

7.0 to 1.0
7.0 to 1.0
7.0 to 1.0

Blue Line Envelope

#7 remittance
2-fold open side
#5 invitation

114.66
98.14
152.32

16.38
14.02
21.76

7.0 to 1.0
7.0 to 1.0
7.0 to 1.0

6.0
6.0
1.3
1.1
1.0
1.0
1.0
1.0

to
to
to
to
to
to
to
to

1.0
1.0
1.0
1.0
1.1
2.4
4.2
1.1

1.0 to 3.7
1.1 to 1.0
1.7 to 1.0
3.3 to 1.0
2.3 to 1.0
2.2 to 1.0
4.5 to 1.0
7.9 to 1.0
3.7 to 1.0
1.0 to 1.7
1.0 to 3.7
7.0 to 1.0
6.4 to 1.0
2.6 to 1.0

8.2 to 1.0
6.9 to 1.0
6.0 to 1.0

Price Quantity Discounts / 63

TABLE 1 (continued)
Estimated ($)
Company

Product

Ratio
F to V

25.00
16.25
4.20
4.80
2.29
2.70
3.20
12.00

3.65
2.30
2.65
5.15
7.66
9.55
16.75
17.50

Day-Timers

V2 in 3-ring binder
Semirigid binder
Certificate covers
Decorator frames
Appointment diary
Deluxe portfolio
Deluxe photo album
8 x 6 custom sign

Oxford Bookshops

Photocopying

.99

.04

Holmes Roberts Ltd.

Photocopying

.45

.15

6.8 to
7.1 to
1.6 to
1.0 to
1.0 to
1.0 to
1.0 to
1.0 to
24.8 to
3.0 to

1.0
1.0
1.0
1.1
3.3
3.5
5.2
1.5
1.0
1.0

Note: The data were obtained from manufacturer/distributors' published catalogs in the public domain. We thank those firms that
supplied information on request. The data were gathered and analyzed over the period 1980 to 1982. The data are presented to
show our research findings and not as an illustration of good or bad pricing practices.

Price Quantity Discounts:

The Buyer's Perspective
To examine the buyer's position, consider a model I
second degree schedule. Recall that in second degree
pricing a single price per unit applies to all quantities
within a range specified by the seller. Oi (1970) referred to these discounts as average price discounts.
Figure 2 represents the total cost curves for the buyer
considering such a schedule. For reasons discussed
subsequently, these total costs include only the price
of the goods purchased. Holding costs, ordering costs,
transportation costs, or other charges are not included
in this total. Figure 2 depicts a set of four curves with
three breakpoints (b,) for the acquisition of discounts.
The schedule that applies is:
TC, = P , Q i f Q < b ,
TC2 = P2Q if b, < Q < b2
TC4 = P4Q if b3 < Q

where:
TC = total cost of Q units.
Pi = price per unit in i"^ interval, and
Q = total quantity purchased.
Given that by definition Pi > P2 > P3 > P4, there
will be a set of (potentially non-integer) Q's such that
TC, > TC2, TC2 > TC3, and TC3 > TC4. That is,
such a schedule may offer the buyer the opportunity
to buy more units than originally desired at an absolutely lower or at least equal cost. The area of the
price schedule where this occurs is called a window,
and is clearly an area in which the buyer would never
wish to purchase. This phenomenon also was noted
by Oi (1970, p. 42) in a footnote. Windows are shown
as shaded areas in Figure 2 and occur because the prices

64/Journal of Marketing, July 1987

are "all units" prices. That is, the buyer pays the same
price for all of the units ordered and the price is determined by the interval into which the order fits. Thus,
when a buyer moves from one interval (i 1) to the
next higher (i) on such a schedule, the effect is similar
to a (P,_, - P.) "rebate" on all of the units. If the
total rebate is greater than the price of one unit, a
window is present.
Though a window represents a range of quantities
that the buyer should never purchase, it also represents an opportunity for negotiation. Consider the discount schedule for an IBM-AT computer.
Quantity

Unit Price ($)

5795
5099
4867
4636
4404
4230
4056

1-19
20-49
50-149
150-249
250-499
500-999
1000+

Note: 19 units @ $5795 = $110,105; 20

units @ $5099 = $101,980

An astute buyer desiring 19 units would order 20

units and tell IBM to ship only 19, in effect changing
the first interval to 1-18 units. By iteration of this
procedure the windows can be removed from the
schedule to the buyer's advantage. A more direct approach is available. A windowless schedule is one in
which moving from one interval to the next increases
total cost of the order. The upper limit of an interval
that is windowless is the quantity Q* at which:
TCQ
TCQ.

= P.Q*

* + 1).
Solving for Q*:

FIGURE 2
Windows in a Discount Schedule

MODEL
1ST

DEGREE

2ND

DEGREE

\P--F/QtV

P-F/Q-t-V

P=F/Q*V

I-A

MODEL I
ST

DEGREE

2ND DEGREE

= F+VQ

p=

P.Q* < P.^i(Q* + 1)

P,Q* < Pi.iQ* + P.+i
- P..iQ* < P.+i

Q*(P. - p.,,) < P...

Q* < P..,/(P, - P,.,).
Thus, the new upper limit for an interval is set at
integer (Q*). Applying this formula to the IBM schedule yields a new, windowless schedule very different
from the original.
Quantity
1-3
4-10
11-23

24+

Unit Price ($)

5795
4636
4230
4056

Notice that some of the intervals disappear entirely. To achieve the final schedule under these conditions, Q* must be reestimated until the process converges. This windowless schedule reflects the possible

endpoint of the negotiation process.

The question, of course, is why would IBM allow
a buyer to do this? In a simplistic sense, economic
rationality would demand that they do so. Such a procedure would enable IBM to acquire AT computers
for less than production cost. That is, IBM can sell
20 units at the quoted price and keep one "free," thereby
lowering their production cost. More realistically, IBM
probably would not cooi)erate, at least to the extent
suggested by the windowless schedule. It is more likely
that the buyer would simply seek altemative outlets
for the extra units acquired to achieve the lower price.
At least three altematives are possible. If other buyers
are purchasing from the same schedule, an informal
"pooled buying" arrangement could be considered.
When several buyers are needed in the pool of orders
to obtain attractive discount levels, or when order timing and logistics make pairwise arrangements inefficient, an informal or ad hoc brokerage situation could
be arranged. The ad hoc broker may be a buyer or an
outside party who establishes a framework for pooling

Price Quantity Discounts / 65

orders and handling the details of the transaction.' In

still other cases a formalized mechanism (a gray marketer) may be available for buying and reselling the
"excess" units of individual buyers. In this case, if
the buyer is facing a schedule with windows, it may
be possible to sell the extra units for less than they
cost IBM to produce and still come out ahead. The
result is a fairly attractive price in the secondary market. Because of either negotiation with IBM or resale
to a secondary market, the windowless schedule is more
representative of the true prices faced by the buyer.
The resale market also may offer opportunities beyond those suggested. Given a windowless schedule,
buying one more unit increases total cost but probably
by less than the amount for which one unit could be
resold. Assume that the one extra unit needed to qualify for the next quantity interval can be sold for a value
of R. The effect will be a lowering of the upper limit
to the buyer. The determination of the new Q* is similar to creating the windowless schedule except for the
recovery of R from the resale.
T C Q.

TCQ+I R

P,Q*
-P,..Q*<P,.,-R
Q*(P,-P,,,)<P,,,-R
Q* < [(P,.,)/(P. = new limit.

- R/(P. -

If the one additional unit can be resold for R =

the lowest price in the schedule, R = P,+ i for the last
interval and
Q* < [(P..,)/(P, - P,..)] - R/(P, - P..,) = 0.
That is, the schedule must collapse entirely. It is also
worth noting that a windowless schedule is not required for this to work; the presence of windows simply accelerates the process by providing lower average costs.
Essentially, the economists' p)erspective is that as
long as there are other buyers, resale is possible unless prohibitively high transaction costs are present.
Such costs could include order processing, inventory
carrying, transportation (Levy, Cron, and Novack
1985), and all marketing costs incurred by the original
buyer in order to deal with the secondary market.

'This ad hoc situation may be formalized over time as an additional

level in the channel of distribution closer to the manufacturer; that is,
a distributor or wholesaler large enough to purchase in quantities that
qualify for lower prices may emerge. In such cases, the pdce quantity
discount acts as a trade or functional discount.

66 / Journal of Marketing, July 1987

Transaction Costs and Barriers

to Resale
Though specific data are not available, several facts
about transaction costs can be deduced. First, in Oi's
1970 presentation, barriers included the need for the
buyer to be physically present to receive the good or
service (e.g., amusement park fee or country club dues).
In addition, custom tailoring of goods for the recipient
would create an adequate barrier.
Much less attention has been directed to the financial side of transaction cost barriers. It seems likely
that such costs would create barriers to resale only if
they were larger than the total "rebate" available from
the discount schedule. If the rebate were greater than
the additional cost of reselling the surplus units, the
buyer would come out ahead (lower total cost for the
goods required) by seeking cooperative and/or secondary markets. Because rebates are a function of the
fixed component in the schedule, the issue depends
on the magnitude of F and the additional costs incurred by the buyer. The proprietary nature of cost
and pricing data makes direct comparison of F and
transaction costs difficult. The two can be considered
separately, however.
The Fixed Component
Absolute judgments cannot be made, but the likelihood of profitable resale clearly increases as F increases. Table 1 lists values of F determined from numerous published discount schedules by techniques
described in the Appendix. Notice that the values of
F range from a low of $.45 to more than $16,200 for
stud bolts. The F to V ratio in Table 1 serves as an
index of the magnitude of the potential rebate.' The
higher the ratio, the greater will be the rebate (in dollars and as a percentage of price) for any given quantity. As the rebate constitutes a larger percentage of
price, the likelihood of profitable resale increases.
Assessing how a particular schedule is determined
is beyond the scope of our article. However, several
patterns emerge. Consider the case of the IBM model
20 display terminal. The relatively high fixed component of $10,5(X) might suggest that IBM does not
want to handle small orders (Lambert, Bennion, and
Taylor 1983). Notice that the ratios of fixed to variable components are all equal (7:1) regardless of the
item for DRG Envelope Company, despite fixed components that range from $88 to more than $600 per
order. Even more remarkable is that this seven-to-one
ratio is the same for the two other envelope compa-

'Because P = F/Q + V, as Q increases, P approaches V. Therefore,

/ can be used as a single-valued surrogate for P.

nies. Notice also the difference in pricing approaches

listed for the two photocopying services at the bottom
of Table 1. Oxford prices with a high fixed but low
variable component whereas Holmes Roberts does just
the opposite. Finally, compare ihe fixed components
assigned by Radio Shack to orders of its C-10 and C20 cassettes, products that differ only in quantity of
tape. Though the variable components are expected to
increase, the fixed components are in more than a twoto-one ratio.
The preceding issues are somewhat peripheral to
our topic, but do suggest that insights can be gained
by decomposing a schedule into its fixed and variable
components. As the schedules in Table 1 are not a
random sample, broad generalizations about the magnitude of F and the F to V ratio are not possible. However, several of these values appear to offer the opportunity for substantial rebates.
Transaction Costs
Recall that transaction costs comprise all marketing
and distribution costs incurred by the original buyer
in reselling excess quantities purchased to take advantage of lower prices. These costs can differ considerably depending on the type of resale arrangement. For the pooled buying and ad hoc brokerage
situations, the only costs may be a few phone calls
and some additional transportation. These costs, however, may be substantial (Levy, Cron, and Novack
1985).
The gray market situation differs from the other
arrangements in several ways. Additional marketing
functions must be performed because ultimate buyers
have not been identified in this case. Risk is involved,
as are promotional and order-taking costs. However,
the gray marketer has the advantage of having many
marketing functions performed by the original (intended) channel and need not duplicate these efforts.
This fact, coupled with technological advances (WATS
lines, direct marketing via mass media and catalogs,
etc.), may reduce transaction costs to the point where
they are no longer a barrier to resale (Howell et al.
1986).

Implications for the Seller

The factors and processes we describe would tend to
increase the proportion of purchases made at the higher
quantity intervals of a price quantity discount schedule. That is, given (1) informed and aggressive buyers, (2) the negotiation opportunities provided by windows in the schedule, (3) the possible development of
pooled buying, (4) the possible development of ad hoc
brokerage, (5) the possible development of higher level
channel intermediaries, and (6) possible development

of altemative gray market channels,' sellers who offer

a price quantity discount schedule should be prepared
to sell a large proportion of their output at the lowest
price on the schedule.
The seller should be indifferent to where on the
schedule the orders fit (assuming channel structure and
control is not an issue) if the fixed component (F) is
truly refiective of a fixed cost per order. That is, the
seller should be indifferent if dealer commitment to
and support of the product in a traditional channel are
not diminished by distribution through altemative
channels or if the presence of an additional intermediary is not objectionable. However, if F reflects
something other than true fixed cost per order, increasing order sizes may result in lower than expected
profit for the seller when the total quantity sold does
not change.
In certain situations the distribution of orders may
be concentrated at lower quantities. Customized products with little or no utility for other than the original
buyer are an obvious example. Likewise, products with
low brand recognition/preference or for which an established dealer network is not available to provide
necessary support activities are not candidates for gray
markets (Howell et al. 1986). In still other cases, the
product may not be important enough to warrant the
additional effort required for negotiation or resale
(Shapiro 1979).

Other Considerations
We do not explore the impact of price quantity discounts in the case of elastic demand in the end-user
market or a segment thereof. If, through the mechanisms we discuss, intermediary buyers are able to purchase at lower price intervals on the discount schedule
and thus sell the product at lower prices, the total
quantity sold by the manufacturer may increase instead of staying constant with fewer orders. It is particularly interesting to speculate on the use of price
quantity discounts to encourage sales through a gray
market. A manufacturer may be able to engage in price
discrimination, selling to a more elastic segment (requiring fewer dealer support services) at a lower price
while maintaining an established, full-service dealer
network. Any "leakage" to the lower priced market
of buyers who would have paid the higher price (see
Gerstner and Holthausen 1986) normally would generate demands for protection and complaints from the
dealer network. However, it is the dealers themselves
who are supplying the lower price channel with merchandise.
'Price quantity discounts are neither a necessary nor sufficient cause
of gray markets. Many factors (e.g., arbitrage, currency fluctuations)
may contribute to their formation.

Price Quantity Discounts / 67

Conclusions
We attempt to provide a taxonomy of price quantity
discounts and a set of methods for decomposing them
into fixed and variable components. Using this information, we examine the implications for price quantity discount use. The issues addressed are not exhaustive of those that could be considered, but
preliminary findings suggest the impact of price quantity discounts is more complex, more subtle, and more
pervasive than work to date has suggested. We do not
imply that price quantity discounts are either good or
bad, but rather that many factors must be considered
in assessing the advisability of their use.

APPENDIX
Types of Discount Schedules

17.60 = F/1 + 2.62

Model I. Unit Prices

Most simply, these schedules present increasing quantities and decreasing unit prices. They are common in
many industries. Calling F a fixed component (including profit and fixed costs) and V a variable component (including variable costs and profit) we can
generate the model I schedule in its pure form from
P = F/Q + V

Determining the Pricing Parameters F and V

Given the Schedule
Three ways of working backward (i.e., given the
schedule, finding F and V) may be useful.
Method 1. The first method is most straightforward. It is simply asking the developer how the
schedule was generated.
Method 2. Pick a price from the schedule, or have
the supplier quote a price, at a very large quantity.
Equate that price to V and substitute any other schedule price and quantity into equation 1 to obtain F. If
the price at quantity 1000 for our data has been quoted
at $2.62, it is a good estimate of V. The first term of
equation 1 is a diminishing function of quantity. Substituting the first price and quantity data into equation
1 using the estimates gives

(1)

F = 14.985
which is close to the "true" F of $15.00. One must
remember the procedure is one of estimation and often
gives good, not exact, results.
Method 3. For persons who have a computer or
hand-held calculator with regression capabilities, the
price equation can be regressed with a simple transformation of variables. If the factor 1/Q in its first
term is called X, it becomes

where Q is a quantity. Observe that for each quantity,

a unique unit price is generated.

P = F(l/Q) + V

Example of Model I Schedule Generation

Suppose processing a customer's order costs $10.00,
the seller wants to make $5.(X) on every order (regardless of quantity), the product costs $2.00 per unit
($1.00 direct labor, $1.00 direct material), and a 30%
markup on cost is desired. First, F is determined to
be $15.00 by adding the quantity-independent (yet
order-dependent) factors. The variable component V
is determined by the cost and profit objectives. In this
case it is $2.00 plus the profit of $.60 per unit or $2.60
each. Now the schedule can be generated. Substituting the values of F and V in equation 1 gives a price
for any desired quantity.

In this form, the price-quantity relationship is graphically a straight line. Parameters can be estimated directly from the graph or the regression coefficients.
In either case, care must be used as the estimates must
be "retransformed" to the original equation.
The quality of the estimate can be an issue in this
case as it is in the preceding example. The coefficient
of determination should be high (in excess of .95). If
not, some "kinks" in the line may be present. They
can represent changing schedule parameters that may
apply to a relevant quantity range. Beyond that range
the production process may change (usually a substitution of capital for labor typified by increasing F's
and decreasing V s ) , indicating economies of scale.
Thus this type of schedule shows the changing cost
structure of the producing firm (as it should) and gives
additional insight as part of the decomposition analysis.
This point leads to another benefit of schedule
analysis. Discontinuities of this nature must be consistent and cost justified. A quick examination of the
price-quantity graph will show any deviations that could
portend trouble under cost justification. If, for example, a "favorable zone" for one class of customers
is found, it may be construed as discriminatory.

P = 15/Q + $2.60

(2)

The following price quantity discount schedule is obtained.

Quantity

Unit Price ($)

17.60
10.10
7.60
6.35
5.60
5.10
4.74

2
3
4
5
6
7

68 / Journal of Marketing, July 1987

= FX + V.

Finally, if the schedule is well-behaved, the pricequantity relationship can be estimated by using linear
algebra and solving two equations for two unknowns.
Simply take any two prices and associated quantities
from the schedule and substitute into the previous formula. In the following example we use prices associated with quantities 2 and 5.
10.10 = F/2 + V

Unit Price ($)

4,10
3.35
3.10
2.98

Calling the upper quantity in its associated interval

Q', we modify the pricing formula to reflect I-A pricing as follows.

4.50 = F ( l / 2 - 1/5)

P = F/Q' + V

F = 15.
The preceding examples are generated for illustrative purposes. Often prices must be "rounded" to the
nearest cent, which introduces some inaccuracies in
the estimation procedure. Again, we emphasize that
the procedure is one of estimation and generally produces good results that may not be exact.
Quantity Intervals
The pricing formula will produce very lengthy schedules if a market with a broad spectrum of quantity
requirements is served. Such schedules can be accommodated by collapsing them into brackets or quantity
intervals, a common practice for the model I schedule. They do raise some issues, however. Specifically, what should be used for Q in the formula?
The decision maker has two extreme options: (1)
the Q associated with the lowest quantity in an interval can be used and the associated price applied to
higher quantities in the interval or (2) the largest
quantity in the interval can be used and the price extended to the lower quantities in the interval. For discussion, these variations on unit price schedule generation are termed model I-B and Model I-A,
respectively.
Model I-B schedule generation. Using the same F
and V, we modify the formula to refiect I-B strategy.
Assume intervals of a 10-unit width are desired. Calling QL the quantity associated with the lower bound
of the interval, we obtain the new schedule.
1-10
11-20
21-30
31-40

Quantity
1-10
11-20
21-30
31-40

5.60 = F/5 + V
Subtracting:

Quantity

for price determination, extending the price to lower

quantities within the interval. Using the same F and
V, we obtain the following model I-A schedule.

Unit Price ($)

17.60
3.35
3,10
3.08

This schedule was obtained by substituting values of

1, 11, 21, and 31 for QL into
+ V.
P=
Model I-A schedule generation. In the other extreme, model I-A uses the upper bound of an interval

The preceding schedule uses the values of 10, 20, 30,

and 40 for Q' to generate interval prices.
There is a difference between the two approaches,
given the same F and V. Clearly, interval width and
model selection have a major role in the appearance
of the schedule and, more importantly, how it relates
to the market demand and the firm's profitability objectives. As quantities become very large, models I-B
and I-A converge.
Decomposition is more difficult for I-A or I-B
schedules than for a "pure" model I schedule. One
must make an assumption as to whether the schedule
is I-A, I-B, or somewhere between (I-A/B). We suggest multiple runs using the regression technique be
made and the run with the best coefficient of determination be used.

Model II. Package Pricing

In model II pricing, schedule prices increase proportionately with quantity, in contrast to model I price
behavior. The underlying price-quantity relation is
P - F + VQ.
In this instance, F is translated directly into the schedule price. In models I-A and I-B, the importance of
F to price is affected by quantity. In model II pricing,
F is always recovered in the price, thus making it useful in forcing the buyer to discrete quantity points if
intervals are offered. This pricing technique may have
arisen from an unwillingness to "break down" quantities shipped according to industry trade practices.
For the same F and V given in previous examples,
the following schedule can be generated.
Quantity

Package Price ($)

1
2
3
4

17.60
20.20
22.80
25.40

One can apply the previously noted methods (linear

algebra, ask the supplier, regression, graphic analysis) in decomposing the schedule with the following

Price Quantity Discounts / 69

exceptions: (1) transformation of quantities is unnecesssary as the price-quantity relationship in the

schedule form is a straight line and (2) the selection
of an exti-eme point (in this case quantity 1 ) is not very
accurate.
Model II pricing can be applied to intervals by taking the highest quantity in the interval and substituting
it into the pricing equation. Using the lower quantity
makes no sense as it exposes the supplier to losses.
Thus, calling the upjjer quantity Q' and establishing
a schedule with an interval of 10-unit width, we obtain the following figures.
Quantity
1-10
11-20
21-30
31-40

Package Price ($)

41.00
67.00
93.00
119.00

Buying 20 units once rather than 10 units at two separate times results in savings (only a single F is paid).
Buyers may find this an attractive discount schedule.

Summary Model I and

Model II Schedules
The schedules presented are related linearly to quantity either in the given form for model II or when
transformed (X = 1/Q) in the case of model I. Each
type can be presented by a continuous function applying to all quantities, which is called first degree
price differentiation. When intervals are presented,
discrete prices arise and the decision maker has some
latitude in the selection of the quantity at which to peg
the price. This option applies in model I but not in
model II pricing. In each case, the schedule is discrete
and appears as stairsteps. This second degree price
differentiation makes schedule decomposition more
difficult in the case of model I.
In all cases, several techniques are available to estimate F and V, depending on the type of schedule
presented. The analysis and resultant estimates of F
and V have several uses, including negotiation, finding economies of scale, lot sizing, determination of
production process, and detection of illegal schedules.

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