Your customers are not stupid

Some time ago, our company wanted to send direct mail to large corporations in the country to present our consulting services. To do so, we contacted a courier and messaging company, where they explained the shipping prices: if we sent fewer than 100 letters, the price was $5,000 per unit, but if the shipment exceeded 100 letters, it would be considered bulk mail and the price per letter would be $1,000. Since the direct mail we wanted to send consisted of 80 letters, we proposed to the courier’s representative that we pay for 100—to access the bulk mail price—but only send the 80 we needed. This way, the total shipping cost would be $100,000 instead of the $400,000 we would have paid had we not “met” the minimum volume for bulk mail.

Months later, we made another shipment of 80 letters, but decided to contact a different courier company. The commercial conditions they presented were practically identical to those of the previous company, and we proposed the same deal to the new sales representative. However, in this case, they explained that we could not pay for 100 letters if we were only sending 80: we had to send the full 100 letters required for the shipment to be considered bulk. What could we do then, if we only needed to send 80? We had no choice but to complete the remaining 20 letters by sending some empty envelopes to ourselves. Even so, this effort—ridiculous, of course—was justified to save $300,000 on the shipment of the 80 letters.

When the customer finds reasons to deceive us
​This story illustrates one of the many cases in which customers take advantage of flaws in companies’ pricing structures to obtain better prices or higher discounts. What was the mistake made by the two courier companies described here? The price difference between the two volume ranges was so large that almost any customer would prefer to meet the bulk mail condition. In fact, whenever the customer needs to send at least 20 letters, it becomes justified to pay for 100, even if they don’t actually need them.

What could have been done, then, to avoid this arbitrage that customers exploit? One alternative would have been not to offer retroactive volume discounts, but rather the so-called tiered discounts. This option allows companies to offer discounts only to the extent that the customer actually meets the conditions. It would be equivalent, for example, to having a price of $5,000 for the first 50 shipments, another price of $2,500 for the next 50, and finally charging $1,000 per letter thereafter. Thus, if the customer needs to send 80 direct-mail letters—as in our case—they would pay $325,000 in total ($5,000 x 50 + $2,500 x 30). This way the customer would have no economic incentives to “lie” about their needs, and the company would not leave money on the table.

Distribution channels aren’t stupid either
But these kinds of “deceptive” behaviors are not exclusive to end customers. Distribution channels also sometimes find reasons to behave undesirably when they must meet conditions that make no sense in their suppliers’ commercial policies. It is common to find retailers who find it more profitable to buy from a distributor or wholesaler than directly from the manufacturer. In other cases, distributors find incentives to lie about the area where they will carry out distribution—such as remote towns. In this way, they access higher discounts when in reality they sell their products in urban areas.

The solution to these kinds of situations is the use of so-called functional discounts. These consist of remunerating channels according to the functions they perform to add value to products in the sales process. To do this, the economic cost of the activities they carry out must be quantified. By calculating the optimal discounts to grant the different types of distributors, companies avoid large price differences between them, which incentivize the creation of parallel markets. For example, the function of numeric distribution should remunerate the cost incurred by distributors in performing this activity. Similarly, the function of display and advisory services performed by some high-service retailers should be compensated to offset the additional costs they incur compared to low-service retailers.

In summary...
It is important to understand that customers do not intend to deceive us. They simply aren’t stupid; they rightly take advantage of any opportunity to obtain better prices or discounts by meeting meaningless conditions in our commercial policies. The goal of every marketing manager should be to structure proactive and transparent price and discount menus that ensure that only the customers most sensitive to price meet the necessary conditions to obtain discounts.