Trade Promotion: Essential to Selling through Resellers

Trade promotion expenditures in the packaged goods industry have steadily increased from less than 35 percent in 1983 to almost 49 percent in 1994. In fact, when they peaked at 52 percent in 1993, the trade-promotion budget was more than twice the size of the media advertising budget.1 It is often claimed that this is symptomatic of a shift in power towards retailers and away from manufacturers. In 1996, the percentage of total retail sales made “on deal” across forty packaged goods categories included in the Market Fact Book averaged about 37 percent —up almost 5 percentage points from 1991.2

As firms sell more goods on deal, there are more complaints that promotions are eroding the power of brands. Complaints come from managers who prefer “everyday low prices” (EDLP) rather than strategies that involve price discounts and other allowances. Even those who accept the need for occasional consumer discounts often tout the advantages of EDLP to the trade. Some call this the “everyday low purchase price” (EDLPP); others refer to it as “back-door EDLP.”3 A single price to the trade sounds attractive for several reasons. First, trade promotion often involves reducing list prices to a retailer in return for a larger quantity bought and presumably sold by the retailer, and managers dislike reducing the list price.4 Second, controlling purchase quantities for temporary off-invoice allowances and other special discounts is problematic. Retailers buy more of the product at the temporary low price than they intend or are able to sell during the promotional period. Instead, they stockpile it for future sale at higher prices, causing booms and busts in retail demand and inventories that require higher manufacturing capacity. These large swings in demand, inventory, and production are referred to as the “bullwhip effect.”5 Manufacturers suffer doubly from this forward-buying. Large variations in demand increase their production and distribution costs, and they also lose margin on the product that the retailer stockpiles but does not sell at reduced prices.

Does this mean that all trade promotions hurt manufacturers? Many industry observers contend that retailers are becoming increasingly powerful because of their higher concentration, their access to point-of-sale information, and increases in trade promotion.

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References

1. 17th Annual Survey of Promotional Practices (Donnelley Marketing Inc., 1997), pp. 12–13.

2. IRI Market Fact Book. Grocery Edition. Annual Report (Chicago: Information Resources, Inc., 1991); and

IRI Market Fact Book. Grocery Edition. Annual Report (Chicago: Information Resources, Inc., 1996).

See also:

F.H. Alpert, M.A. Kamins, and J.L. Graham, “An Examination of Reseller Buyer Attitudes Toward Order of Brand Entry,” Journal of Marketing, volume 56, July 1992, pp. 25–37;

W. Chu, “Demand Signaling and Screening in Channels of Distribution,” Marketing Science, volume 11, Fall 1992, pp. 327–347;

R.D. Buzzell, J.A. Quelch, and W.J. Salmon, “The Costly Bargain of Trade Promotion,” Harvard Business Review, volume 68, March–April 1990, pp. 141–149;

J.M. Olver and P.W. Farris, “Push and Pull: A One-Two Punch for Packaged Products,” Sloan Management Review, volume 31, Fall 1989, pp. 53–61;

IRI Market Fact Book (1991); and

IRI Market Fact Book (1996).

3. Buzzell et al. (1990); and

S.J. Hoch, D. Xavier, and M.E. Purk, “EDLP, Hi-Lo, and Margin Arithmetic,” Journal of Marketing, volume 58, October 1994, pp. 16–27.

4. Managers may not realize that the price they must charge in the absence of trade promotions would be considerably lower than their current list price.

5. H. Lee, V. Padmanabhan, and S. Whang, “The Bullwhip Effect in Supply Chains,” Sloan Management Review, volume 38, Spring 1997, pp. 93–102.

6. P. Farris and K. Ailawadi, “Retail Power: Monster or Mouse?” Journal of Retailing, volume 68, Winter 1992, pp. 351–369.

7. K.L. Ailawadi and S.A. Neslin, “The Effect of Promotion on Consumption: Buying More and Consuming It Faster,” Journal of Marketing Research, volume 35, August 1998, pp. 390–398; and

R. Lal, “Price Promotions: Limiting Competitive Encroachment,” Marketing Science, volume 9, Summer 1990, pp. 247–262.

8. Our focus is not on the thorny legal questions that surround the ability to fix resale prices (and thus channel margins), but on practices that marketersuse to indirectly influence the channel margins.

9. Lee et al. (1997).

10. In the short term, dominant national brands that are sold at zero or negative retail margins and private labels that barely cover the cost of manufacture illustrate the extremes. We do not address the interesting issues related to how one should measure profits.

11. Manufacturers seeking to maximize channel profits may also be thwarted by resellers who charge a fixed percentage margin, regardless of the quantity sold.

12. This is all the more interesting, given that accounting for promotion costs is difficult and costs may be exaggerated. Consider that when a price-up and deal-back strategy results in a large percentage of volume sold on deal, promotion costs calculated from “list prices” are essentially fictional. To understand what the real cost is, marketers must establish the price to charge when offering no promotion. In most cases, eliminating promotions means lowering the list price as well. See also:

K.L. Ailawadi, D. R. Lehmann, and S.A. Neslin, “Understanding the Impact of a Long-Term Change in Marketing Mix: An Analysis of P&G’s Value Pricing Strategy” (Hanover, New Hampshire: Dartmouth College, Tuck School working paper 1999).

13. “The Perils of EDLP,” Progressive Grocer, volume 72, October 1993, p. 72.

14. For an excellent discussion of retail margins and marketer power, see:

R.L. Steiner, “Marketing Productivity in Consumer Goods Industries: A Vertical Perspective,” Journal of Marketing, volume 42, January 1978, pp. 60–70.

15. J. Quelch, “General Electric Company: Consumer Incandescent Lighting” (Boston: Harvard Business School case 9-587-014).

16. J.J. Spengler, “Vertical Integration and Antitrust Policy,” Journal of Political Economy, volume 48, 1950, pp. 347–352.

17. A. Jeuland and S. Shugan, “Managing Channel Profits,” Marketing Science, volume 2, Summer 1983, pp. 239–272.

18. Buzzell et al. (1990).

19. The Robinson-Patman Act prohibits price discrimination when it reduces competition. Because retailers may compete with each other, manufacturers offer most trade promotions to different classes of trade on a “proportionate” basis. Several manufacturers that have used the programs described in our article judged them to be consistent with the relevant provisions of the Robinson-Patman Act.

20. 17th Annual Survey of Promotional Practices (1997).

21. F. Everett, “Price Promos Can Protect Brand Equity,” Brandweek, volume 39, 4 May 1998, p. 20.