Pricing Tiers by Customer Size: Do a Distributor's Discounts Still Make Sense?

The problem: Discount tiers were set years ago against a cost to serve nobody has re-measured, so the biggest customers may be the least profitable ones to keep.

The solution: Attach picking, delivery, invoicing, and returns cost to the account that generates it, so each tier can be tested against what serving it actually costs today.

Most distributors at this size run three or four price tiers. The logic behind them is sound and everybody in the industry uses some version of it: bigger customers buy more, bigger orders cost less per dollar to fulfil, so bigger customers get a better price. Nothing about that reasoning is wrong.

What is worth checking is when the tiers were set, and against what. In a lot of businesses the answer is that the tier structure was built six or eight years ago by someone who thought carefully about it at the time, and has been inherited since. Meanwhile the cost of a delivery has changed, fuel has changed, warehouse wages have changed, the mix of what customers order has changed, and the biggest accounts have gradually reshaped how they buy. The discount is still 22 percent. Almost nothing behind that number is still what it was.

Volume is not the thing that drives cost

The tier assumes that volume and efficiency move together. Sometimes they do. Often the biggest accounts are the ones that have negotiated their way into the least efficient way of buying.

A large customer with tight storage does not want a monthly truckload, they want three drops a week. A large customer with multiple locations wants each one served separately, and each stop is a stop whether it carries $400 or $4,000. A large customer with buying power asks for special packaging, split cases, or an EDI feed your team maintains by hand on the receiving end. A large customer with leverage takes 60 days to pay while the smaller ones take 30.

Every one of those is a cost, and every one of them landed after the tier was agreed. None of them changed the discount, because discounts are negotiated as a percentage off list and cost to serve is not a line item in that conversation. So the tier structure quietly stopped describing anything true, and it kept being applied at every order.

Cost to serve is the number nobody has

Ask a distributor what gross margin they make on their largest account and the answer comes quickly, because that is invoice price against landed product cost and both are in the system. Ask what it costs to serve that account, and it goes quiet.

The cost is real and it is made of things the business already pays for:

• Picking and packing time, which scales with lines and orders, not with dollars.
• Delivery stops, which cost roughly the same whether the drop is large or small.
• Order entry and customer service time, which some accounts consume constantly and others almost never.
• Returns, credits, and short-ship corrections, which cluster heavily in a few customers.
• Payment terms, which are a financing cost with a real rate whether or not anyone books it.

All of that data exists. Warehouse hours are in payroll, routes are on the delivery schedule, order lines are in the order system, credits are in accounting. It is just never assembled against the customer, so the only customer-level number anyone can produce is gross margin, which stops at the loading dock.

Why the tiers never get revisited

Partly because reopening a price with your largest customer is uncomfortable, and partly because there is no evidence to reopen it with. Without cost to serve, the conversation is "we would like a better price" against a customer who can say no, and the sales team correctly points out that the volume matters.

With cost to serve, the conversation changes shape entirely. It is not about wanting more margin, it is about the way the account buys. Three small drops a week instead of one consolidated delivery has a number attached. Split cases have a number. A minimum order value, a delivery day, or a charge for extra stops is a much easier conversation than a rate increase, and it usually recovers more.

A look at a wholesale distributor

Consider a wholesale distributor doing about $11 million a year, roughly 40 employees, four price tiers, and its own small delivery fleet. The top tier gets 22 percent off list. The owner considers the largest account the anchor of the business, and in revenue terms it is.

Suppose the company starts attaching delivery stops, warehouse pick time, order entry, and credits to the account that generated them. Within a quarter, you would expect the customer ranking by gross profit and the ranking by what actually reaches the bottom line to come apart.

Put a number on it. The largest account buys about $1.4 million at the top tier, which after the 22 percent discount leaves something like 13 points of gross margin, roughly $182k. It takes three deliveries a week to two locations, close to 300 stops a year, and once driver time, vehicle cost, pick and pack, and the order entry it consumes are counted at something like $280 a stop, that is about $85k. Add credits and 60-day terms and the account is netting somewhere near $97k, or about 7 percent.

Now a mid-tier account buying $300k at 8 percent off list, so around 24 points of gross margin, or $72k. It takes a consolidated delivery roughly weekly, about 60 stops a year, call it $5.7k, and it rarely calls. It nets close to $66k, or 22 percent. The big account produces more dollars, which is why it feels like the anchor. It produces them at roughly a third of the rate, on capacity that could serve a dozen accounts like the second one.

What the owner would likely do is not raise the discount tier and risk the relationship. What would probably change is the way the account is served: a delivery day structure instead of on-demand drops, a minimum order value per stop, a charge for additional stops beyond the agreed schedule, and a look at whether the tier thresholds themselves are set at the right revenue levels. You would expect most of the recovery to come from how the customer buys rather than from what they pay.

How to start

You can do this with one quarter of order and delivery history.

1. Cost a stop and cost a line. Two loaded numbers, one for a delivery stop and one for an order line picked. Rough is fine. This is most of the model.
2. Count what each account consumed. Stops, order lines, service calls, and credits for your top twenty customers over a quarter.
3. Subtract it from gross profit. The result is net contribution per account, which is the first time the ranking will mean anything.
4. Test the tier boundaries. Sort accounts by net contribution rate and see whether the tier they sit in matches. Where a whole tier underperforms, the threshold is the problem, not the customer.
5. Fix the behaviour before the price. Minimums, delivery days, and stop charges are easier to agree and often recover more than a rate change.
6. Let it stay current. Set automation to recalculate cost to serve as orders and deliveries happen, so an account drifting out of its tier appears immediately rather than at the annual review.

The takeaway

A discount tier is a statement about cost that stops being true the moment costs move, and in most distributors nobody has re-measured them since the tiers were written. Volume and efficiency get assumed to travel together, when the largest accounts are often the ones that negotiated their way into the most expensive way of being served: more stops, smaller drops, split cases, longer terms. Cost a stop, cost a line, subtract them from gross profit, and rank the customers by what actually lands. The first honest ranking is likely to change your delivery schedule, your minimums, and where the tier boundaries sit, well before it changes anyone's price.