Volume Price Breaks: Are You on the Wrong End of the Scale?

Why should the leader of a supply chain organization worry about something so mundane as how buyers choose the volume price breaks to purchase components? Because it could very well be an easy way to squeeze significant dollars out of the cost of custom parts.

First, let’s align on what we are discussing. Volume breaks (also known as “scale pricing” or “price breaks”) are a common way for suppliers to price products that have significant set-up costs, or in cases where a supplier wants to incentivize larger purchases. For our purposes, we are going to focus on custom subassemblies and build-to-print parts that have a relatively large set-up (e.g., PC boards, PC assemblies, machined parts, plastics, sheet metal, etc.), since that is where you can have the greatest impact. 

So how do organizations normally choose between different volume breaks? The short answer is, “not very well.” We have reviewed the processes and policies of dozens of companies, and have found that most rely primarily on the buyer’s intuition. There was a tremendous amount of inconsistency between buyers, and each company had their own slant based on their way of doing business. We were repeatedly surprised at how unsophisticated the tools, policies, and processes were surrounding buyers’ behavior in this critical area. 

Let’s look at an example based on a recent client project to see what lessons we can extract. This is a sample of a fabricated part that our client purchased:

Given this information, how do you decide what quantity to buy? How do you determine if the supplier’s pricing is reasonable? What levers do you have to manage cost and inventory? In this case, the buyer was buying 32 at a time, at a price of $390. That seems like a nice midpoint number. 

When we analyzed the volume breaks to look at fixed and variable costs, we determined that the lot charge or fixed cost was ~$4,400/lot. Factoring in this information, along with other considerations such as demand volume and stability, storage costs, risk of obsolescence, etc., we calculated that the best solution was to order in quantities of 128 at a time. Although we think companies should be wary of just adding inventory, it was justified in this case. The price dropped by 26%, and offsetting that with the inventory-carrying costs, the net savings were ~20% per year. 

Another side benefit of choosing the right volume price break was that it helped optimize the supplier’s capacity utilization. Running smaller-than-optimal lot quantities increased the number of set-ups, and took valuable time away from actually producing components.

The insights we gleaned from this analysis into the supplier costing were even more compelling. We had been in the factory where this product was built and had a good understanding of the labor costs, the costs of the machines, and the changeover time for the component. Even if we used very conservative numbers, the lot charge should not have been anywhere near $4,400. Because we had the data, we had a productive discussion with the supplier and found the disconnect between the pricing and their real cost of producing the component. Based on that, the lot charge was reduced to $1,800, and the best quantity was 80 pieces at a price of $272, leading to a 30% drop in price and a total net savings 25% (factoring in inventory costs). Across the whole category, we saved over 10% simply by making more informed decisions on price breaks and the underlying set-up costs, or ordering costs. 

In our experience, buyers generally do not have the right tools or training to make appropriate trade-offs in these situations. Even the most conscientious buyers do the best that they can, but they simply do not have the resources to make better and more informed decisions. By giving buyers access to a tool that can analyze and recommend volume breaks, your company can better equip them to make these decisions. Furthermore, by having a solid process and policy for managing volume breaks in place, you can deliver stronger and more consistent results for your company. 

If you are interested in seeing how better processes, tools, and training could help your purchasing staff in this area, please let us know. You can request information by contacting us.