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The Costly Bargain of Trade Promotion

VIDEO ON THE TOPIC: Warehouse Locations

One of the most significant phenomena in retailing in recent years has been the shift in power from manufacturers to the trade. Partly as a […]. But systemic inefficiencies resulting from these short-term incentives have blossomed into huge problems: the high costs involved in paying slotting allowances, in forward buying, in diversion of goods, and in running promotion programs. These are problems for the trade and for manufacturers, but especially for manufacturers.

The costs are high for others too. In this promotion-intensive environment, consumers pay more for the goods they buy as distributors pass along the higher costs.

In the food industry, for instance, increases in manufacturer and distributor costs from trade promotion alone amount to an estimated 2. The game playing and power playing inherent in promotions and related activities, like slotting allowances, have generated an enormous amount of mistrust in channels of distribution—manufacturers, wholesalers, and retailers have big bones to pick with one another.

The mistrust has dominated the headlines in Supermarket News for two years or more. Here are sample news stories:. Battles like these are a common occurrence today now that retailers hold sway over manufacturers. Routinely, for example, department stores and other retailers demand from vendors cooperative advertising allowances, guaranteed gross margins, return privileges, reimbursement for the cost of fixtures, and in-store selling and stockkeeping help to promote their merchandise.

Mistrust inhibits industry cooperation on key issues like data exchange. Here we will examine the by-products of the promotion explosion by putting under a microscope one widespread practice, forward buying, in key product lines sold in supermarkets: dry grocery products, health and beauty aids, and general merchandise.

We examine the effects of forward buying and then of trade promotion in general on the entire distribution chain—manufacturers, wholesalers, retailers, and consumers. We suggest one pricing policy that not only helps get costs under control but also builds cooperation and trust among the parties. Analysis of the costly inefficiencies that spill out of forward buying in food supermarkets may help manufacturers and distributors in other fields put the spotlight on practices in their own backyards.

Although promotion practices are probably most widespread in the supermarket business, forward buying and diversion are also common in, say, athletic footwear, and slotting allowances are not unknown in the chain drugstores.

At the expense of advertising, promotion has received a big lift in recent years. Just how much a lift can be seen in the responses to an annual survey of marketing managers in consumer packaged-goods companies showing the breakdowns of their marketing budgets.

There are some powerful forces in motion that explain the intensifying stress on sales promotion:. Of course, there are many good reasons for undertaking a serious promotion program. They are useful in securing trial for new products and in defending shelf space against anticipated and existing competition.

They allow manufacturers to price-discriminate among consumer segments that vary in price sensitivity. Most manufacturers believe that a high-list, high-deal policy is more profitable than offering a single price to all consumers.

A portion of sales promotion expenditures, therefore, consists of reductions in list prices that are set for the least price-sensitive segment of the market. While our estimates of such cost effects apply only to food distributors and manufacturers, we believe that they will give a useful perspective on sales promotion broadly throughout the U.

During the s, marketers of food, household, and personal-care products offered more frequent and more attractive trade deals to food chains and wholesalers. These are inducements used to influence a distributor to stock or display more of a product or cut its price to consumers.

The distributors responded by:. Forward buying inflates inventories and thereby boosts interest expense, storage charges, and insurance costs. Diversion of merchandise involves trans-shipment and double-handling, which of course cost money.

To estimate the added costs from diversion would have meant determining the normal paths followed by a sample shipment from suppliers to distributors. A comparison of actual shipping and handling expenses, including diversions, with normal costs would have yielded the desired numbers.

But this would have been a monumental task given the large number of shipping points and warehouses in the United States, so we did not attempt it. Even so, we believe that the added costs of diversion are substantial. Impact on Distributor Inventories. If trade deals did not exist, food chains and wholesalers customarily would order from their major suppliers about every two weeks.

The savings that distributors realize normally more than offset the extra costs of buying, double-handling, and stocking enough merchandise to last perhaps until the next deal. Distributors usually have a good idea when the next deal will be offered because most suppliers schedule their trade deals well ahead.

So a rational distributor will make nearly all purchases during deal periods. How would average inventories then be affected? The answer depends on how often the price reductions are offered and the extent to which consumer purchases shift to the deal periods. While this estimate is based on just one set of assumptions about deal frequency and the size of deal discounts, this estimated increase agrees with information that food distributors gave us in our study. Most forward buying in the retail food sector is in dry grocery goods, household supplies, and personal-care products.

Moreover, some forward buying in high-volume frozen foods and dairy products also goes on. While this is obviously a substantial amount, it represents only between 0. Costs to the Manufacturers. So they maintain excess production capacity and carry safety stocks of finished goods, which cost money. Several leading food-industry suppliers are paying the price: they have undertaken large-scale plant closings. Costs to the System.

Forward buying is of course impractical for perishable merchandise, like fruit and vegetables, or short life-cycle merchandise, like fashion apparel. Moreover, these substantial amounts represent only a part of the true costs of trade promotion, let alone the total cost of all forms of sales promotion. Other expenses, which we have not tried to quantify, include.

These hidden costs of promotion could easily equal or exceed the more tangible costs that we explored. Reduction of these costs would produce savings that could greatly benefit consumers and retailers, wholesalers, and manufacturers. In addition to impairing the efficiency of the distribution system, the explosion in sales promotion expense has other important, harmful effects on the distribution chain. Since there has been no noticeable decline of manufacturer and distributor profits, the consumer has presumably absorbed these costs.

This cost burden has not affected all consumers equally. Other consequences of higher sales promotion expenses have affected consumers too. Because it is harder to predict the rate of sale of merchandise offered at special prices, stock-outs of preferred brands may be more frequent.

This phenomenon would apply more to risky, short life-cycle fashion merchandise offered at special prices than to staple items where forward-buy inventories probably offset the less predictable sales rate of merchandise that is sold on specials. Another probable effect of the availability of more merchandise at special prices is a deterioration of in-store service. Special sales exaggerate the normal peaks and valleys of store traffic and thus impair service, whether it is the availability of a salesperson in a department store or the length of a checkout line in a discount store or supermarket.

The extra costs that trade promotions impose on distribution channels do not affect all classes of trade equally. Such distributors as deep-discount drugstores and warehouse clubs—which carry few items in each category and have no commitment to item continuity—favor heightened manufacturer sales-promotion activity.

Warehouse clubs especially have this attitude. The burgeoning volume of trade deals, in particular, means that more items or the same items more often are available to them at sharply reduced prices.

Moreover, since they usually offer only a few brands and sizes in a category, they can quickly dispose of the promoted items with no effect on the movement of competing items. Food wholesalers are ambivalent about promotion practices. While they vigorously condemn the allegedly better treatment that nonfood channels receive, they do not advocate elimination of these practices.

Because quasinational or multiregional operators dominate food wholesaling, they have established their own internal diversion networks. Moreover, the difference between forward-buying income and expense gives them added flexibility. While passing on some of these funds to customers in proportion to their purchases, they can use a portion of the income to subsidize weak areas, underwrite new operations, support added services for retailers, or boost their own profits.

They argue that the labor and storage costs of forward-buy inventories and the extra transportation costs in diverting merchandise, while more than offset by lower purchase prices for merchandise, nevertheless add to their costs of goods sold. These expenses, many retailers assert, undercut the advantages of just-in-time replenishment practices for their regular inventories.

They fear that an overriding concern for buying at the lowest cost diverts their merchandising organizations from the primary goal of serving consumers better. What these retailers would prefer is a system that provides them with the lower purchase prices for merchandise without the added costs of forward buying and diversion.

Producers of health and beauty aids and food also take exception to these promotion practices. Apart from the incremental manufacturing or inventory costs they incur, they perceive serious, though non-quantifiable, consequences. Among them is a decline in brand loyalty arising from elevated consumer price sensitivity.

Even consumers once faithful to certain brands may switch to other products that are on deal or time the purchase of their preferred products to coincide with available deals. Food manufacturers also complain that retailers often fail to discharge their responsibility to provide temporary price reductions, special displays, or feature advertisements.

Often retailers allegedly accept promotional allowances for more deals than they are able to fulfill. The aforementioned trade-deal terms that favor limited-line distributors, like warehouse clubs, are another sore spot for manufacturers. Because the main goal of limited-line distributors is to sell merchandise at the lowest prices rather than have particular brands always in stock, their priorities inherently conflict with brand loyalty.

The trade promotion climate has had two disturbing effects. First, as we have indicated, it has aroused mistrust between manufacturers and distributors. This could inhibit cooperation on matters that benefit the whole distribution chain, including electronic-data interchange, modular packaging, and more use of direct product-profit accounting. The Federal Trade Commission has been studying slotting allowances for some time. If the Bush Administration decides to renew enforcement of the Robinson-Patman Act, manufacturers and distributors would be endangered.

Running afoul of this law in the past has resulted in prolonged and costly litigation, stiff fines, and government-imposed sanctions and reporting requirements that are competitively disadvantageous. Improving sales promotion practices ethically and legally would reduce this threat.

Despite their concern about the situation, manufacturers have not acted in concert to change matters. Competitive rivalries and fear of being charged with illegal price fixing have inhibited them. Forward buying, diversion, higher manufacturing expenses, and inflated selling and administrative expenses for manufacturers as well as distributors are costing consumers billions each year. And all indications are that the problem is becoming worse. Trade promotions cannot be wished away.

But surely there must be a means to execute them at lower cost.

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This book is the result of twelve years' experience in teaching university students to write special feature articles for newspapers and popular magazines. By applying the methods outlined in the following pages, young men and women have been able to prepare articles that have been accepted by many newspaper and magazine editors. The success that these students have achieved leads the author to believe that others who desire to write special articles may be aided by the suggestions given in this book. Although innumerable books on short-story writing have been published, no attempt has hitherto been made to discuss in detail the writing of special feature articles.

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Publication does not signify that the contents neces- sarily reflect the views and policies of the U. Environ- mental Protection Agency, nor does mention of commercial products constitute endorsement by the US. An environmental protection publication CSW in the solid waste management series. Recycling programs can be and have been success- ful. Those which have oftentimes proven the most beneficial to the public and have been responsible for recycling the largest volumes of materials have suc- ceeded because of organization members' determina- tion'and willingness to implement any of a number of recycling options available to them as the need and opportunities arose. In the following pages of this guide you will discover an assortment of recycling program alternatives, an assortment of procedures for handling and marketing recyclables, and suggestions for financing and publi- cizing the program you choose to develop. By no means is this booklet able to discuss any of these topics in depth. Its intent, rather, is to give you solid information at your project's outset, to give you encouragement and advise of possible pitfalls, and to provide you with names of organizations which will be of further use to you as new circumstances present themselves. EPA recommends that the first activity of a new community recycling program be to determine and locate the area's available markets for recyclable materials. The program may then be planned accord- ing to what materials these markets will and will not buy.

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An inventory is the entirety of those things owned by a company and intended for resale or the raw materials and parts to be used in producing salable goods and products. Inventories are time-sensitive storage systems that can be divided into three categories. First are cycle stocks: the order quantity or lot size received from the plant or vendor.

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One of the most valuable projects that a logistics and supply chain management professional can undertake is a distribution network redesign using one of the many powerful applications developed over the past two decades. For those manufacturers, distributors and third-party logistics providers 3PLs that have seen the service and cost improvements that a well executed network design project can yield know well that these projects need our best people, processes and technology. Some past project teams found themselves spending a small fortune on building models to run on powerful optimization platforms. The projects are much more satisfying if the ratio of data collection vs. Cloud-based solutions, the longer-term value is in the ability to include key variables and the ease of importing data. More variables will give you the flexibility to consider more than transportation data such as labor, tax and productivity costs. Ease of importing various types of data—assuming you have the right clean, usable data—will reduce the set up time for iterations of your model. With a selected tool in mind, map the needed data to a source, and keep in mind there may be a combination of internal and external sources that will be required. Large firms with multiple 3PL partners and perhaps multiple ERP systems and data centers will need to do some investigating to determine the most reliable data warehouses for modeling purposes.

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One of the most significant phenomena in retailing in recent years has been the shift in power from manufacturers to the trade. Partly as a […].

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Designed to gauge activities and trends in warehouse and DC management, our annual survey offers a first-hand look into how U. Most participating companies came from manufacturing 38 percent , followed by distributors 31 percent , third-party logistics providers 9 percent , and retailers 8 percent.

I normally only do the top five developments for the biosimilar industry in this annual column. But it turned out, upon reflection, that was an even more eventful year than it may have seemed as we were making our way through. Tough competition for traditional funding has led creative biotech entrepreneurs to seek alternative and diversified sources. Here's what that might look like, and why it's unlikely to happen in short order.

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