Changing the Channel: A Better Way To Do Trade Promotions

In the cold war between manufacturers and retailers, trade promotions are viewed with great suspicion. Regardless of the terms of a given deal, each party believes the other is trying to get the upper hand. The watchword is trust, but verify.

In theory, trade promotions should benefit everyone involved. The manufacturer offers the retailer a product temporarily at a lower price; in return for selling its goods at a lower unit cost, the manufacturer intends to earn new customers and build the loyalty of current ones. Likewise, the retailer, by selling the product at a discount, should enjoy increased sales during the promotion, while bearing little in the way of extra costs. And consumers, of course, should save money on their purchases. In practice, however, manufacturers and retailers often manipulate the system in a zero-sum game, and consumers are sometimes left out altogether.

It need not be that way. Over the past three years, we’ve examined the theoretical and practical problems associated with trade promotions, and we are convinced that it is possible to create the right kind of deal — a transparent system that generates mutual trust and, yes, produces the proverbial win-win outcome for both manufacturers and retailers. The key is proper implementation of what is thus far a little understood tool.

As most marketing managers know, the most common form of trade promotion is the “off invoice,” so called because retailers see the savings immediately reflected in their invoices. Retailers frequently abuse these promotions, however. They often purchase much more than they can sell during the official promotion period and then either continue to sell discounted products for far longer than the manufacturer had desired — thus eroding the brand’s equity —or re-establish the product’s regular price and simply pocket the savings themselves. They frequently also sell some of their discounted excess inventory to other retailers at a smaller discount, a practice known as diverting.

Increasingly, manufacturers, having wised up to these tactics, are testing another approach: the pay-for-performance trade promotion. Pay for performance means that retailers get rewarded according to how much they sell, not how much they buy. Because the promotion results are usually determined by examining scanner data, these promotions are called “scan backs.” And yet scan backs so far are unpopular, too.

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References

1. K. Partch, “The Trade Promotion Quagmire,” Supermarket Business 53 (June 1998): 130 (an Andersen Consulting — now Accenture —report summary). For a comprehensive review of issues affecting manufacturer-retailer relationships, see K. Ailawadi, “The Retail Power-Performance Conundrum: What Have We Learned?” Journal of Retailing, in press.

2. R. Blattberg and S. Neslin, “Sales Promotions Concepts, Methods and Strategies” (New Jersey: Prentice Hall, 1990).

3. D. Wellam, “Not-So-Free Trade,” Supermarket Business 53 (June 1998): 22–24.

4.For more information on actions taken by Procter & Gamble, see J. Neff, “New P&G Program Alters Trade Promotion Efforts,” Advertising Age, March 24, 1997, 6; K. Thomas, “P&G Scales Back Promotions,” Incentive 171 (April 1997): 15; “Procter’s Gamble,” The Economist, July 25, 1992, 61–62.

5. “The Prisoner’s Dilemma — Retailer View: Not Getting Their Fair Share,” and “The Prisoner’s Dilemma — Manufacturer View: No Value for Their Dollars,” Progressive Grocer 74 (May 1995): 99–101; B. Spethmann, “Trade Promotion Redefined,” Brandweek 36 (March 13, 1995): 25–32; and R. Eisman, “Survey Finds Suppliers and Retailers at Odds,” Incentive 169 (August 1995): 12.

6. R. Buzzell and G. Ortmeyer, “Channel Partnerships Streamline Distribution,” Sloan Management Review 36 (spring 1995): 85–96.

7. In addition, trade promotions impose a severe administrative burden on manufacturers, occupying 25% and 30% of salespersons’ and brand managers’ time, respectively. See R. Buzzell, J. Quelch and W. Salmon, “The Costly Bargain of Trade Promotion,” Harvard Business Review 68 (March–April 1990): 141–149.

8. H. Lee, V. Padmanabhan and S. Whang, “Information Distortion in a Supply Chain: The Bullwhip Effect,” Management Science 43 (April 1997): 546–558; and H. Lee, V. Padmanabhan and S. Whang, “The Bullwhip Effect in Supply Chains,” Sloan Management Review 38 (spring 1997): 93–102.

9. For a more detailed analysis of these issues, see R. Lal, “Manufacturer Trade Deals and Retail Price Promotions,” Journal of Marketing Research 27 (November 1990): 428–444; R. Blattberg, D. Eppen and J. Lieberman, “A Theoretical and Empirical Evaluation of Price Deals for Consumer Nondurables,” Journal of Marketing 45 (winter 1981): 116–129; E. Gerstner and J. Hess, “A Theory of Channel Price Promotions,” American Economic Review 81 (September 1991): 872–886; E. Gerstner and J. Hess, “Pull Promotions and Channel Coordination,” Marketing Science 14 (winter 1995): 43–60; and R. Lal, J. Little and J. Villas-Boas, “A Theory of Forward-Buying, Merchandising and Trade Deals,” Marketing Science 15 (spring 1996): 21–37.

10. R. Blattberg, R. Briesch and E. Fox, “How Promotions Work,” Marketing Science 14 (summer 1995): 130. The full article presents a comprehensive summary of key findings on promotional effectiveness.

11. For a more detailed mathematical review of the options than is presented in this article, see X. Drèze and D. Bell, “Creating Win-Win Trade Promotions: Theory and Empirical Analysis of Scan-Back Trade Deals,” Marketing Science, in press.

12. For a more in-depth discussion of the optimal pricing rule in this setting, see J. Bulow and P. Pfleiderer, “A Note on the Effect of Cost Changes on Prices,” Journal of Political Economy 91 (February 1983): 182–185; and R. Tyagi, “A Characterization of Retailer Response to Manufacturer Trade Deals,” Journal of Marketing Research 36 (November 1999): 510–516.

13. While the technical details are omitted for ease of exposition, this example can be worked through in Microsoft Excel using the solver function. Details are available from the authors upon request.

14. The mathematics involved in computing the forward-buy are beyond the scope of this paper. The details are provided in X. Drèze and D. Bell, in press.

15. For ease of exposition, we focus on the case in which the retailer is made indifferent and the manufacturer is strictly better off. It is a simple matter to extend the analysis to the case in which both parties are better off.

16. For other empirical studies of trade promotion effectiveness, see M. Abraham and L. Lodish, “Promoter: An Automated Promotion Evaluation System,” Marketing Science 6 (spring 1987): 101–123; R. Walters, “An Empirical Investigation into Retailer Response to Manufacturer Trade Promotions,” Journal of Retailing 65 (summer 1989): 253–272; and S. Neslin, S. Powell and L. Schneider-Stone, “The Effects of Retailer and Consumer Response on Optimal Manufacturer Advertising and Trade Promotion Strategies,” Management Science 41 (May 1995): 749–766.

17. J. Silva-Risso, R. Bucklin and D. Morrison, “A Decision Support System for Planning Manufacturers’ Sales Promotion Calendars,” Marketing Science 18 (fall 1999): 274–300.

18. K. Ailawadi, P. Farris and E. Shames, “Trade Promotion: Essential to Selling Through Resellers,” Sloan Management Review 41 (fall 1999): 83–92.

19. Authors’ personal communication with Scanner Applications’ management team.

20. A guide to getting started is given in G. Day, chap. 9 in “The Market Driven Organization” (New York: Free Press, 1999).

21. For an excellent discussion of the theoretical and practical value of such measures, see J. Hauser, D. Simester and B. Wernerfelt, “Customer Satisfaction Incentives,” Marketing Science 13 (fall 1994): 327–350.

Acknowledgments

Special thanks to Bob Gibson, CEO of Scanner Applications Inc., for facilitating access to the data used in this study, and to Israel Rodriguez and John Ferramosca of Edgewood Consulting Group. George S. Day, Geoffrey T. Boisi Professor at the Wharton School, also provided many helpful insights.