Pay-for-Performance Trade Promotions

Edition: October 2001 - Vol 9 Number 10
Article#: 1080
Author: Repertoire

Excerpt from ''Pay-For-Performance Trade Promotions Can Ease Friction Between Manufacturers and Retailers,'' Knowledge@Wharton newsletter, Aug. 29-Sep. 11.

The former head of Procter & Gamble's U.S. operations, Durk Jager, recently characterized the existing trade promotion system between manufacturers and retailers as ''impossibly inefficient.'' …A common practice in the packaged goods sector, trade promotion involves manufacturers giving cash or a discount to retailers in hopes that the retailer will in turn discount or promote their product to consumers.

According to Progressive Grocer magazine, two-thirds of retailers feel they don't receive a fair share of trade promotion dollars. But manufacturers aren't happy either, with 85 percent believing that their trade promotion dollars are not being spent effectively.

[Wharton marketing professor David] Bell is the co-author, with Xavier Dreze of UCLA's Anderson School of Management, of a paper entitled ''Pay-for-Performance Trade Promotions: Why They Work and How to Implement Them.'' Bell and Dreze assert they have found a path out of this vicious cycle for both manufacturers and retailers. Their solution lies in a variation on a relatively new type of trade promotion known as pay-for-performance….

In explaining why trade promotion is such a thorn in the side of manufacturers in particular, Bell and Dreze detail some of its unfortunate side effects. In the traditional type of offer, known as an ''off-invoice'' deal, the manufacturer rewards the retailer based on the number of units purchased over a set period. Retailers, eager to maximize their own profits, have responded by loading up on the product while it's being offered at a discount, then deliberately not passing the discount on to consumers. Instead, they sell the product later at the regular price (forward-buying). Or they sell it to other retailers for a profit (diverting).

''A manufacturer usually offers a deal in only certain regions of the country. So the smart retailer in Boston might buy much more than he needs for his own store, put the rest on a truck and ship it to a retailer in Philadelphia,'' Bell says. Not only does the manufacturer lose out, but the retailer loses out in that he or she must tie up money and effort in warehousing, refrigerating or shipping the excess inventory.

In response, manufacturers have come up with a new form of deal known as pay-for-promotion, or scan-back….Retailers get rewarded only for as much product as they can prove was sold from their particular store in the given deal period. This type of deal has become more feasible with the advent of modern store scanners, which makes it easier to record and verify sales. Pay-for-performance helps eliminate forward-buying, because only the units sold to customers during the promotion period get the price discount; it also helps eliminate diverting because the eligible units must be sold from the retailer's own store….

Are scan-backs really more cost-effective for the manufacturer? The researchers report findings from a national brand beverage manufacturer that field-tested both off-invoice and scan-back deals. The results revealed that when using scan-backs rather than off-invoice, this manufacturer experienced much less forward buying, a larger pass-through of the deal to consumers and more stable retailer demand.