What is a Trade Discount?
Many businesses are resellers of manufactured goods. The business model involves marking up the price of the product beyond what it costs to acquire it from the manufacturer, to sell it at a profit. On the flip-side, it can also mean acquiring the good for less than retail price from the manufacturer. This is a trade discount: the amount or rate reduced from the retail price of an item that’s agreed upon when sold to a reseller. It can vary depending on quantity purchased.
Like any discount, a trade discount represents a reduction in price. It’s an incentive offered by manufacturers to attract resellers and create a symbiotic partnership. Resellers have the ability to turn a profit selling pre-made goods; manufacturers focus on production by outsourcing sales.
Here’s a look at what a trade discount looks like and how it serves to bring manufacturers and sellers together in meaningful, mutually beneficial ways.
How to Calculate a Trade Discount
Calculating trade discount is the product of knowing the list price of an item ($) and the discount rate offered by the manufacturer (%). The equation for trade discount is simple:
Trade Discount = Discount Rate × List Price
- Trade discount: The total dollar value of the discount applied.
- Discount rate: The percentage of reduction in price.
- List price: The manufacturer’s suggested retail price (MSRP).
For example, a manufacturer might offer a product with a unit list price of $500 at a 10% discount. The formula for calculating the value of the trade discount is 500 × 0.10 = $50. That means every unit purchased by the reseller costs $450 instead of $500.
The beauty of this simple formula is that it’s easily adapted to identify any one of the three variables. For example, if a reseller doesn’t know the list price but knows their $50 savings equates to a 10% discount, they can simply divide the difference by the discount rate: 50/0.10 = $500.
It also works for finding the discount rate—just divide the amount of the discount by the list price and multiply by 100 to get the trade discount. So, in this example: (50/500) ×100 = 10%.
Trade Discounts Depend on Volume
Manufacturers and resellers can agree on trade discounts at any rate that’s mutually beneficial. That said, it most often depends on volume. Manufacturers have an incentive to raise the discount for resellers willing and able to purchase larger volumes of product. Moreover, resellers capable of purchasing in bulk use this leverage to command better discounts.
For example, if the MSRP on a Green Widget is $5 and a reseller purchases 100, it might get a $1 discount per unit. That discount might rise to $1.50 per unit at 500 units or $2 at 1000 units. The ability to produce in bulk means manufacturers can buy components in bulk to keep costs lower. This is economies of scale at work.
Other Contributing Factors
Volume isn’t the other reason manufacturers offer trade discounts. There are additional benefits to offering an enticing discount to resellers, including:
- To acquire new resellers or break into new markets
- Liquidate already-assembled stock or overstock
- Reward long-term, reliable partners or retain business
- Attract resellers with extensive distribution networks
Manufacturers need to be very careful in setting clear terms for discounts and moderating discount levels. Agreeing to steep discounts can put manufacturers at an imposition in the event a reseller finds new leverage. The key is understanding exactly how much it costs to produce a product and the minimum viable margin for selling it.
How Trade Discounts Benefit Manufacturers
Trade discounts are first and foremost a way for manufacturers to attract resellers. Without them, producers would need to sell their own products, which means shouldering more overhead and orchestrating sales channels in-house. By simply lowering the cost to acquire goods for resellers, manufacturers simplify their value stream.
Trade discounts also help manufacturers maintain a competitive advantage. Offering resellers better margins on products makes it easier for them to do business with you and not your competition. It not only brings in more distribution partners, but also higher-caliber distributors with larger networks.
How Trade Discounts Benefit Resellers
Trade discounts are what make it possible for resellers and distributors to operate. If they bought at-cost and marked up product, they’d exceed MSRP, which would drive customers to purchase from the manufacturer directly. Buying at a discount and selling at MSRP builds in margins and creates a viable, sustainable business model.
Resellers also benefit from this discount as they grow and their own costs become more streamline. Because volume often factors into discount rate, distributors can grow unencumbered by additional COGS, since they’re not responsible for production. Instead, their costs actually decrease as their discount rate improves.
Establishing Economies of Scale
Ultimately, the concept of a trade discount helps manufacturers and resellers connect and establish economies of scale. A balanced discount exposes manufacturers and their products to broad sales channels, while giving distributors incentive to sell those products. A healthy trade discount is an enablement tool that rewards both parties.
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Establishing the ideal discount rate comes down to understanding the situation. What’s the list price of the product? How big is the distribution network? What’s the level of purchasing volume? As manufacturers and resellers broker an agreeable rate, they’re also setting a precedent for their partnership. After all, one can’t succeed without the other!