Trade promotions: a call for a more rational approach.

Power retailers have come to dominate retail competition in recent years. A new class of merchants, they not only have begun to rule their tier of the channel, they are also exerting tremendous influence over their suppliers. Nowhere is this more evident than in the packaged goods industry, where retailers have been able to demand trade deals from manufacturers previously believed to rule the distributive trade with an iron hand. Manufacturers have responded by engaging in what seems to be a never-ending escalation of promotional and price allowances aimed at buying their way onto the retailers' shelves.

Although the short-term success of many of these promotions is uncertain, the long-term implications of trade-based incentive plans are likely to be negative. This point is becoming increasingly salient to manufacturers, especially those whose products are resold in the grocery trade. It has been estimated that between 70 and 90 percent of all shipments to the grocers' warehouses are on deal. Consequently, manufacturers are searching for ways to gain control of their products' fate in the marketplace without cutting off their lifeline to the consumer.

STATE OF THE TRADE: WHAT CAUSED TODAY'S CRISIS?

Manufacturers have found that a growing portion of their budgets must be spent on promoting their goods to channel members. By the late 1980s the amount of money spent on trade promotions exceeded that spent on media advertising. In 1990, 44 percent of manufacturers' promotion budgets were in the form of trade promotions, compared with 31 percent for media advertising and 25 percent for consumer promotions. Trade promotions are a major concern among executives from each level of the channel. This is evidenced by a 1991 survey published in Progressive Grocer, which reported that manufacturing, wholesale, and chain store executives claimed that promotional programs, such as slotting allowances, were a top concern for their firms.

Several factors have led to this situation. First, sales of packaged goods to consumers have tended to increase very slowly in the aggregate. This is largely due to a population growth of less than 1 percent and a 2 percent rate of new household formations, as well as the general aging of the American consumer market. Such slow growth has forced retailers to compete for market share rather than for category or industry growth. In doing so, retailers have insisted on trade promotions from manufacturers to enhance retailer competitiveness in the marketplace.

Second, the retail trade has been characterized by a consolidation of outlets, while at the same time the square footage of the average outlet has been increasing dramatically. During the 1980s large retailers were expanding their number of locations through takeovers and internal expansion, whereas many smaller retailers were leaving the marketplace. Concurrently, retailers were rediscovering the benefits of large stores in terms of the economies of scope they offered to the customer (one-stop shopping, enhanced assortments of products), as well as economies of scale (lower labor costs, licensing fees per square foot). These factors led to fewer retail firms that in turn command a larger share of the market. Such consolidation has also partially induced a shift in the manufacturer/retailer power balance: Manufacturers have fewer routes to the marketplace, and those that are available represent significant portions of their markets.

Third, the advent of information technology (especially scanner data) has produced a more level playing field for negotiations between the manufacturer and the retailer. Armed with abundant information on profitability, product movement, and customer demand for a class of goods, retailers are developing sophisticated purchase and storage policies to take advantage of the trade promotions available from manufacturers. For instance, a retailer may engage in "forward buying"--that is, purchasing more goods during a promotional period than it expects to sell, thereby reducing the average cost of future inventory. Or a retailer may use diversion strategies--buying products in one market, where they are being sold to the trade on promotion, then reselling them in another market where the promotion is not available.

Fourth, in addition to products already on the shelves, it is expected that the average grocery store owner will have between 10,000 and 15,000 new products to choose from annually. Such product proliferation has given great power to retailers who act as gatekeepers to the consumer, causing manufacturers to look desperately for ways to enlist their support. Combined with marketplace stagnation, shelf space consolidation, and information accessibility, this has catalyzed the escalation of trade promotions.

Fifth, once the cycle of trade promotions has begun in an industry, it is difficult for manufacturers to negotiate on even terms with retailers. Competitive manufacturers are not allowed, by law, to coordinate their promotional programs; but retailers are able to use the promotional information of multiple manufacturers to coordinate and negotiate their purchase and inventory programs. Retailers are free to develop their buying strategies with full information of promotional programs offered and available from the manufacturers. The ability to pit one manufacturer against another in this situation has led to the category rotation programs we often see employed by grocery and appliance retailers. An example of this would be a retailer who carries the brands of four …