Trade promotions and discounts are a huge part of the consumer goods industry. Consumer goods companies spend hundreds of billions of dollars annually on trade programs. Yet, the return on investment on most trade dollars spent is insignificant, if any, thus fueling a long-standing debate regarding the effectiveness of trade promotions. Without trying to add to the debate, there are some considerations that practitioners should keep in mind to make better promotional decisions.
Firstly, it is important to understand why the consumer goods industry is so drawn to trade promotions given their questionable return. We often hear:
- “I need incremental or deeper activity to grow volume/share”
- “We did that promotion last year! We need lapping activity plus new events”
What I call the “salesman perspective” most often stems from volume or revenue targets that sales teams are challenged to exceed. It is easy to see how this situation can get out of control and inflate the amount of trade dollars being spent. This mentality often leads to unintentional consumer consequences such as “stocking up” on promotion or “waiting” for promotional offers. These repercussions are worsened by price comparison technology which compare prices across multiple retailers along with brick and mortar retailers who offer “price matching” services.
Given the traditional sales mentality and the mounting pressure of technology and competition, the incentive to improve the efficiency of promotional spend has never been greater. Many companies spend millions of dollars on trade promotion management and optimization tools, while others engage consultants to build statistical elasticity and incrementality sales models in house. Both are great options, but before breaking out the cheque book or taking an advanced multivariate statistics course, there are some simple questions and analyses anyone can ask and execute to make better promotional decisions.
The questions and analyses are based on the following four promotional pillars:
1. Depth
Simply, this is the level of discount that is being offered.
Depth is important because too small will not drive customer purchase whilst too much may surrender value. For example, Best Buy has a $20 discount on an Apple iPad priced at $789.99. Surely, the number of incremental purchases of this iPad cannot be significant given the size of the discount in relation to the price and, in most cases, the iPad would have sold at regular price anyway. This is the equivalent of leaving $20 on the table with every sale.
Conversely, if the offer is too deep it can destroy the value that exists in the marketplace. An example of this is Ben & Jerry’s ice cream; almost everyone is familiar with its ooey-gooey flavours with fun names. The benefits of the B&J brand over private label competitors is obvious but when promoted from $4.99 to $2.50, they are equivalently priced to their bland, boring private label counterparts. Do they really need to give away so much value?
To help guide the depth decision remember to:
- Use competitive benchmarks. There are no winners in a price war.
- Check the profitability. There is no excuse for negative profit.
- Ensure the brand position. Selling premium products at or below the price of private label offerings can destroy long term value.
2. Frequency
Frequency is how often a promotion occurs.
The “salesman perspective” tends to increase the frequency over time but this is a dangerous game to play because there is no going back. Promoting too often can drive customer behaviour to only purchase when there is an offer. A classic example is JC Penny’s attempt to eliminate their promotional flyers and move to an ‘Everyday Price’ structure. The company experienced a massive backlash from the market when customers stopped coming to their stores. JC Penny shoppers ingrained behaviour was too big an obstacle to adapt to the new ‘Everyday Price’ structure.
Another issue is the “New Price” effect. Over time as promotion frequency increases, the effectiveness of individual offers decrease because customers eventually perceive the promotional price to be the regular price.
To help guide the frequency decision remember to:
- Use Competitive Benchmarks.
- Measure Post Promotion. Dropping volume post promo is a sign of loading.
- Track Windows/Weeks. Knowing this can help prevent promo escalation.
3. Timing
Promotional timing refers to the period in which the promotion occurs.
Almost every industry has peak and non-peak sales periods. Ascertaining the volume that would have been sold without the promotion and the incremental volume because of the promotion is key to being successful. But, this is hard to determine without a Trade Promotion Management System, Trade Promotion Optimization System or advanced statistical modeling. In the end, tempering with common sense is a must.
A light beer brand spent thousands of dollars offering a free gym membership when buying a case of beer in the month of January. What the brand managers failed to consider for this promotion was the fact that gyms naturally see their highest volume in January when beer sales are normally the lowest. The potential for repeat sales or customer retention was slim considering the correlation between fitness and beer consumption. I cannot help but think the beer promotion would have been successful in another period with a different linkage. Maybe one with less resolutions!!
To help guide the frequency decision remember to:
- Understand Key Selling Periods. It might make sense to promote or hold price in these periods based on what is sold regardless of promotion.
- Execute in parallel. When promoting price try and line up to marketing spend.
4. Mechanism/Communication
This is the cool and interesting stuff emerging from behavioural economics. More companies are starting to test the limits of how promotions are communicated to customers.
Is “Buy One Get One Free” more or less effective than “50% off” or “$2.50 off”? The goal is to increase volume lift with less investment. Unfortunately, it is difficult to understand the best mechanism and communication without statistical analysis and research tools. Exploring these ideas is best when an organization already has a good grasp on the basics of depth, frequency and timing.
Some simple things to guide the communication decision are:
- Test and Learn. Try different mechanism or communication.
- Use Best Practices. Many companies are doing this work and investing heavily. Look in the market and find some best practices.
The simple considerations around depth, frequency, timing and mechanism above are a great starting point to improving promotional effectiveness. When analyzing results, the typical metrics of volume, share and revenue improvement are often helpful in identifying success. But, sometimes these metrics can be deceiving, so it is important to broaden the scope and consider also the following three metrics:
Portfolio Mix Impact
This is the normalized impact of trading customers up or down within the portfolio. For example, if a promotion switches customers from $10/unit net revenue to a $5/unit net revenue product the mix impact is -$5. This is important to watch to make sure cannibalization is kept to a minimum when promoting.
Incrementality
This is the amount of sales that would not have occurred without a promotion. Incrementality helps identify the cost/benefit of the promotion – incremental contribution margin versus incremental promotional spend.
Margin Pool
Margin pool is the percentage of the total sale price. For example, if a product is sold at $5 but purchased from the manufacturer at $2, the manufacturers revenue pool is 40%. Revenue pool helps identify the level of investment from all participants to generate incremental sales and help guide joint business planning.
Final Thoughts:
Price and trade promotions are complicated! Getting them right is not always easy and, almost everyone has a slightly different approach. For those who are not focusing on improving promotional spend, start now! You do not need a fancy system or software. Start with the basics, improve and sophisticate over time. For those of you who are actively working on efficiency and excellence do not forget the basics
ABOUT THE AUTHOR Michael Stanisz is a Partner at Revenue Management Labs. Revenue Management Labs help companies develop and execute practical solutions to maximize long-term revenue and profitability. Connect with Michael at mstanisz@revenueml.com
