Channel Pass-Through of Trade Promotions

ConversionNijs, V.; Misra, K.; Anderson, E.; Hansen, K.; Krishnamurthi, L. · 2010Marketing Science

Topicstrade promotion·pass-through·channels·pricing·wholesaler·retailer·cpg·competition

Manufacturers spend heavily on trade promotions, the temporary discounts they give wholesalers and retailers, yet they cannot assume the same discount will pay off across every store and product. Channel pass-through is how much of that discount wholesalers and retailers pass on to shoppers as a lower shelf price. Imagine your packaged goods team is deciding whether to offer every grocery and drug store the same invoice discount across its portfolio. Which product and retailer deals deserve the budget?

Manufacturers can earn more from selective trade deals than from a blanket discount, when they choose products whose shoppers respond to price cuts and retailers that pass more of the discount on.

Data chart

Selective trade deals can raise manufacturer and wholesaler profit while costing less

Percent change from a blanket 10% invoice discount to selective deals in the study's simulation, an upper bound; profit is the combined manufacturer and wholesaler profit from the deals, and cost is the discount times the units sold during the deal.

Choosing by product and area still beats a blanket discount.
These are simulated upper bounds, not forecasts.

Choosing which product and retailer deals to fund, instead of discounting everything, can raise manufacturer and wholesaler profit and cut promotional cost, even where US law requires one deal per product across a wholesaler's area.

Simulated upper bound for a 10% invoice discount in one US packaged goods category; the paper reports manufacturer and wholesaler profit together. The +59% case gives every retailer in a wholesaler's area the same deal on a product, as US price-discrimination law may require.

Action guide

Offer your trade deals selectively instead of as a blanket discount.In a simulation, a blanket 10% invoice discount lowers profit for you and your wholesalers on more than half of product and store combinations. Choose deals by product and retailer, or by product and wholesaler area where US price-discrimination law requires one deal for all retailers there.
Target your deals at products whose shoppers respond enough to make the discount pay.Losing deals trace to shoppers who do not buy enough more at the lower price, given the product's costs and margins, more often than to retailers keeping too much of the discount. Before blaming a retailer, check how strongly that product's shoppers respond to price.
Favor retailers and markets that pass more of your discount on.Pass-through varies widely and local competition barely moves it, so neither a channel average nor a market's competitiveness can show where your discount reaches shoppers. Ask your trade marketing team for pass-through by retailer and by market before you set deal terms.
Measure retailer pass-through against what retailers actually paid during the deal.Accounting averages of retailer cost make retailers appear to pass on more of your discount than they do, which flatters your trade deals. Ask your finance and insights teams to use the price retailers actually paid when they judge whether a deal reached shoppers.

Evidence

In the study's simulation, selecting only the profitable deals instead of a blanket 10% invoice discount raises manufacturer and wholesaler deal profit by up to 80%. It also cuts promotional cost by up to 40%. Where the same deal on a product must go to every retailer in a wholesaler's area, deal profit still rises by up to 59%.
Under the simulated blanket 10% invoice discount, manufacturer and wholesaler profit falls for 56% of product and store combinations, while retailer profit rises for 96%.
Of the manufacturer and wholesaler deals that lose money, 37% involve too little retailer pass-through. The other 63% trace to shoppers who do not buy enough more at the lower price, given the product's costs and margins.
On average, a 10% manufacturer price cut lowers the shelf price by about 4% across the full channel. Yet retailers pass on $0.69 of each $1 of discount from wholesalers, close to the 67% they report and well above the 45% manufacturers believe.
Pass-through varies widely across products and markets. As an example, a retail chain's pass-through might be about 98% in one state and 42% in another. A typical difference in local competition moves pass-through by less than 1%.
Measuring retailer cost with average acquisition cost, an accounting average, instead of the price the retailer actually paid, overstates estimated retailer pass-through by about 31% on average.

Key takeaway

Manufacturers can make trade deals more profitable by offering them selectively, based on shoppers' price response and retailer pass-through.

Limitations

The data cover one US packaged goods category in grocery and drug stores over two years, recording prices and quantities across the channel. The profit gains are a simulated upper bound for a 10% discount and leave out benefits a deal may bring, such as distribution and shelf space.

Source

Nijs, V., Misra, K., Anderson, E., Hansen, K., & Krishnamurthi, L. (2010). Channel Pass-Through of Trade Promotions. Marketing Science, 29(2), 250–267. https://doi.org/10.1287/mksc.1090.0509.

https://doi.org/10.1287/mksc.1090.0509

Exact values behind the rounded figures: a 10% manufacturer price reduction yields a 4.1% consumer price reduction on average.