Trade Spending: Investment or Expense?

How to maximize returns from trade promotions

Packaged-goods manufacturers have good reason to be unhappy with trade promotions, which seem to grow more complex, more numerous, more expensive, and less manageable every year. Too little trade-promotion money reaches consumers, and what does reach them, whether in the form of discounts or displays, does not provide an adequate lift to revenues.

RELATED ARTICLES

Selling the cloud

INDUSTRY EXPERTISE

Consumer ProductsRetailRetail

CONSULTING SERVICE

Supply Chain ManagementMarketing & Brand StrategyStrategy

Manufacturers would like to get better results for the money they spend, and they would like to spend less, but they are frustrated on every side. Their own sales forces give them a thousand reasons why the system can't be altered. Retailers, too, resist change because they have come to depend on the money that promotions provide. Worst of all-and most surprising, given the importance they attach to return on investment in every other area-manufacturers themselves rarely know what return they are getting on the money they invest in trade promotions. Trade spending has quite simply become a standard feature of today's marketplace, and most people share a mistaken fear that any attempt to tamper with the present system, much less escape it, would have huge downside consequences. While it is impossible and inadvisable for companies to eliminate trade spending entirely, trade promotions can be rationalized and the money invested in them made as productive as any other prudent investment.

Putting Market Share In Its Place

The biggest single factor in manufacturers' reluctance to cut back on trade promotions is the fear of losing sales and market share. Of course market share is important, but the quest for market share at any price can lead companies astray. Manufacturers know that the more they spend on promotions, the more they'll sell. Many fail to notice that some market share costs more than it's worth. One sales executive used to ask the company president each month how much share he wanted. Whenever outstanding sales were needed to make the company look good or give the sales force a little extra luster, they would "rent" some share with increased trade promotions. "Rent" is the right word, because only a high level of promotional spending could sustain the market-share increase. The customers it attracted vanished the moment the extra promotions were dropped. More to the point, when the rented market share disappeared, company profits increased. Even if no one is deliberately gaming the system, it's a mistake to get too excited about a rise in share-or too upset about a decline-until it is certain that the sales in question are not costing more money than they produce.

Valuing Trade Relationships

In addition to nervousness about market share, there is a second concern that inhibits efforts to reduce or otherwise optimize trade promotions: manufacturers are reluctant to destabilize their relations with the retailers who are their conduit to consumers. The relationship is an uneasy one to begin with. Manufacturers complain about the yield loss in their trade promotions (only 50-60% of their trade promotion money ever reaches consumers) and about the rollercoaster effect of trade promotions on production and warehousing. Retailers complain about their share of the overall profit pool (typically, the manufacturer takes 80-85% of the total profit and the distributor takes 15-20%, so trade margins tend to be extremely thin).

But continuing to put up with an inefficient and frustrating system of trade promotions is a poor way to improve these relationships and no way at all to maximize sales and profits. One way for manufacturers to help themselves in both areas is by trying to align their interests with the interests of retailers in order to produce win/win promotions with benefits for both. It is not an easy task. The most recent attempt to improve relations is Efficient Consumer Response (ECR), an informal industry-wide program of protocols, meetings, and arrangements between manufacturers and supermarkets to drive out inefficiencies and pass savings along to consumers.

ECR has had some modest success at improving shipping and logistics, but it will never make any headway against most trade problems, because it is not possible to achieve an alignment of manufacturing and retail interests that stretches across the entire breadth of the relationship. When alignment does occur, it is almost always a matter of detailed economics-the velocities and margins of specific brands and products at specific retail accounts. It is this kind of specific, tailored alignment that produces win/win benefits for both manufacturers and the trade, and it is this kind of alignment that manufacturers should try to find. One good place to start looking is in product categories. Many manufacturers manage their trade spending uniformly across an entire portfolio, but in fact, trade-promotion programs for premium and value categories should be very different if they are to produce maximum win/win impact for each dollar spent.

Premium categories, for example, are less affected by in-store promotions such as price discounts and more likely to get a lift from efforts to build brand equity. As a rule, premium brands are less profitable for the trade, but retailers have to carry them in order to stay in business, since premium brands are the brands consumers make a special trip to buy. In exchange for increased sales volume, retailers are often willing to support the idea of more advertising-and fewer promotions-for premium brands. Over the long run, in fact, advertising can do more than promotions to increase volume, and in premium brands, volume is a better source of revenue for everyone than complicated promotions.

In value categories, on the other hand, it is essential that marketing strategies and trade promotions benefit retailers directly or the trade will refuse to cooperate. In all categories, but especially in value categories, the most profitable strategies are nearly always win/win alignments that create benefits for retailers as well as manufacturers.

Making Trade Promotions Work Harder

There are four ways to approach the problem of trade spending and get more impact from the money spent. The first, already widespread, is to tie trade spending to the way products are marketed within the store-the input approach. Most manufacturers already pay retailers to set up particular kinds of displays in particular locations. Of course, almost any display or pricing promotion will produce some increase in sales volume, but every promotion will also increase costs and complexity, for the manufacturer as well as for the trade, and all too often the expenses are greater than the benefits. The trick is knowing precisely which kinds of promotions are most effective for each brand and category in each region of the country. In addition, for brands that lead their category, manufacturers may be able to capture the display hotspots in stores or in entire chains. But this will only work for leaders, and even then it may fail unless the manufacturer can make it attractive for retailers.

Studies have found that the one factor that best explains differences in market share from one store to another is also one of the least complex-shelf space and variety. To increase volume in ways that will drop quickly to the bottom line, the easiest rule of thumb is to design trade incentives around shelf space. Once again, however, it is essential to remember that retailers have a finite footprint and that more shelf space to one manufacturer means less to another. The key to making any input strategy work is finding win/win solutions for the producer and the trade.

The second approach is based on performance, or outputs. Rather than pay retailers for each unit sold, some manufacturers pay only for incremental improvements in sales. Their message to the trade is, "You can do whatever you want in the store to move our product, but if you sell more of it this year than last, we'll give you a performance bonus." A number of companies are also considering a variant of this approach called bundling, which would reward retailers on the basis of total sales of all of a manufacturer's products. In both cases, retailers are left to devise their own in-store tactics and to do their own optimization of promotions.

The third way to improve yield from trade spending is to move to fewer and far simpler promotions. One manufacturer found that shallow TPRs (temporary price reductions) three times a year produced a higher return on investment than 25 different promotions in different accounts. Others have adopted everyday low purchase prices (EDLPP). EDLPP has several advantages. For one thing, it attacks the costs and complexity of individual promotions. Even more importantly, it eliminates the peaks and valleys in manufacturing, warehousing, and distribution, since one stable low price all year long takes away the retailer's incentive to buy a lot one month and nothing the next. EDLPP is the new Procter & Gamble strategy, and the company claims to have cut hundreds of millions of dollars from the supply chain.

The recurring dilemma of EDLPP is what to do when a competitor undercuts an everyday low price. The best policy is almost always to wait it out, knowing that EDLPP is a long-term strategy. But as a rule it is only category leaders, with their greater resources and deeper pockets, who can afford to stick to their guns and play the EDLPP game to a profitable conclusion.

The fourth approach is to radically reduce the number of trade promotions a company conducts, cutting them by as much as 50%. Drastic as this sounds, it can be an extremely effective approach for premium brands if the outlays are transferred to advertising, because premium customers are more concerned with brand equity than with price. A number of companies have taken this approach with surprisingly positive results. In one case, a packaged foods maker eliminated 30% of its trade spending entirely, dropped half the savings to the bottom line, spent the other half on advertising, and realized significantly higher profits. One of its direct competitors cut back dramatically on trade spending without increasing its advertising budget. The astounding result: it lost a quarter of its market share but made more money nevertheless.

It's Monday Morning-What Do You Do Next?

Despite the all too obvious costs and drawbacks of the way most manufacturers now run their trade promotions, optimization calls for some careful thinking and planning. The principal questions you need to ask and answer are these:

  1. How much are you now spending, and what rate of return are you getting on the investment?
  2. Where is the money being spent? On displays or discounts, inputs or outputs? Or are you simply giving away money?
  3. How much of the money you spend reaches consumers? What rate of reflection are your competitors getting?
  4. What does each point of market share cost you? Are you renting share, or do you own it?
  5. Does your trade-promotion program focus on win/win strategies that benefit the trade as well as yourself?
  6. Are you running a single trade-promotion program and budget for your whole portfolio? Or are you managing by category or by brand? How well has your company mastered the marketing differences between premium and value brands?

The most successful trade-promotion strategies are designed around specifics. Different geographical regions, different retail chains, different product categories, different brands-all make different demands on manufacturers and present different opportunities for cutting costs, improving alignment with the trade, and enhancing results. To realize an outstanding return on every marketing dollar, companies must understand and exploit these differences, not attempt to wipe them.

Jonathan I. Mark is a Director of Bain & Company and specializes in Consumer Products. Vijay Vishwanath is a Vice President of Bain & Company and leads Bain's Consumer Products Practice.