The relationship between a retailer and a manufacturer can be quite dynamic. A fruitful relationship can lead to increased distribution and brand awareness for the manufacturer, greater consumer purchases for the retailer, and of course, better financial returns for both. One of the biggest aspects to a better relationship is effective promotional strategy. Let’s take a look at both sides of this relationship and how it translates to effective trade spend management.
Background
The Buyer (Retailer)
The buyer, as a representative of the retailer, must balance three main objectives:
- Thousands of products offered from hundreds of manufacturers competing within a limited retail footprint and shelf space
- The overall vision of the retailer (e.g., Trader Joe’s would not buy Hershey’s candy bars to sell in their stores as it does not fit their retail strategy)
- Meeting their consumers’ shopping needs (e.g., not having potato chips in your stores during Super Bowl week could significantly impact your business)
The optimal goal for the category would be to maximize gross margin while also delivering greater depth and frequency of promotions for consumers. The category’s overall sales and, in some cases, overall gross margin are key objectives. Effective promotional strategy with the brand can lead to higher in-store foot traffic, and increased sales.
The Manufacturer
The manufacturer owns all aspects related to the brand. Primary objectives are to:
- Be at the forefront of consumer demand. The brands and products they represent should meet consumer demands. Many manufacturers invest in consumer insights in order to determine whether they should discontinue, divest or expand a product portfolio.
- Evaluate impact on brand or overall company (i.e., is it accretive or dilutive long term). Aspects to consider are expected future demand, logistics and supply chain, plant capacity, raw materials, and of course retail price point.
- Determine the route-to-market. How do we get our products to consumers? This can be direct to consumer, online, distributor or wholesaler, or retailer.
By building an effective promotional strategy with the retailer, the manufacturer can drive consumer awareness, trial, and demand with the brand. As these increase, retailers are more likely to provide a greater footprint for the brand, thereby potentially driving higher share %.
There are many other critical objectives for buyers and manufacturers. For the purposes of this article, we will focus on the manufacturers objective when it comes to promotional return on investment within their total trade spend management process.
What is trade spend?
Trade spend is the amount of money that the manufacturer provides to the retailer for the purposes of selling the product to consumers… known as allowances. This is typically measured as a % of sales. The most common type of allowance is promotional allowance, which was referenced above. This is the discount on the list price of the product in order to sell at a given promotional price. For example, let’s say that a product is going to be “on sale” for a week at $2 instead of regular price at $3. Traditionally, the manufacturer and the retailer would share in the discounting of this item. Though, both the manufacturer and the retailer would take a margin dilution, the purpose is to ultimately drive volume (consumer purchases). Promotional allowance typically makes up about 90% of total trade spend.
Other types of allowances include slotting fees for new items, “bad goods” allowance, or an allowance on payment terms. Bad goods allowance is a small discount the manufacturer provides to the retailer to allow them to manage goods that become damaged or expire. Payment terms allowance is a credit the retailer receives for paying the manufacturer within a certain timeframe (ex. 2% / 10 net 30).
All of these allowances are typically subtracted from the manufacturer’s gross sales in order to arrive at net sales or net sales margin (net sales divided by gross sales).
Trade Spend Management
Commercial teams (inclusive of sales and finance business partners) have trade spend management targets (usually in % of sales) by product, brand, category, and/or overall. Essentially, there are three ways to drive efficient, productive trade spend.
1. Review Historical Promotion Performance
Reviewing historical promotional performance is the most common way of delivering the best return on trade investment. For example, when reviewing historical performance, if an item promoted at $2.50 delivers the same lift in sales as when promoted at $2, then why promote at $2? The best option is to promote at $2.50 and re-invest the savings in an activity that is more price elastic. Also, understanding promotional “overlap” (promotional strategy and sales results in the same period prior year) helps drive more informed decisions for current year strategy. Key factors here include but are not limited to:
- Seasonality: Do some brands / products lift better at different times of the year?
- Category Trends: Is share increasing, decreasing, or something else?
- Customer and Shopper Insights: How is the retailer doing? Are the consumer’s preferences changing?
2. Forensically Manage Fixed Funds
Most promotional allowances are variable in that they are represented as a discount to list price per unit. However, there are some fixed components to promotional allowances. These are funds that are paid to the retailer for activities such as advertising space in the local circular, and space payments for incremental display units. As with all other trade spend, these funds are contractual obligations between the retailer and the manufacturer. If any of the obligations of the fixed payments are not met or not activated, these should be credited back to the financials within the current year.
3. Deliver Accretive, Incremental Promotional Activities
As mentioned, commercial teams have spend % and growth targets. However, it’s very common for incremental promotions to be requested due to retailer request, or growth opportunity. In this case, it’s very important to understand the financial impact of this request. Let’s look at a couple of examples.
- Suppose the trade spend target is 20%, and the incremental promotion, not only drives incremental sales, but also has a projected spend of 15%. Unless there are strategic reasons for not doing so, all teams should engage in this activity. This activity will benefit your current spend, and your net sales. Moreover, since the weighted average trade spend will come down, this “productivity” will allow for additional funds to be re-invested in other activities, or saved to benefit the bottom line.
- On the flip side, suppose in the same example above, that the trade spend on the incremental activity is 25%. Clearly this is dilutive to the target, but the activity will drive high incremental growth. Unless this can be managed through a reduction of trade spend on another activity, the decision should be aligned with finance and leadership teams. This is a case where the overall big picture should be viewed. Let’s dive into this a bit and look at the overall P&L of the manufacturer and see if it makes sense.
In this example, the full-year forecasted trade is 20%, the incremental opportunity costs 25% trade. We assume the variable expenses (COGS, freight, etc.) remain at 30%. Fixed expenses (SG&A, building, etc.) are $0 in the incremental opportunity since those costs most likely won’t change.
After putting this together, the revised full-year forecast shows the net sales margin declines from 80% to 79.5%, but the operating profit as a % of net sales (in order to include the impact of increased allowances) increases from 20% to 28%. This is due to the leverage opportunity on the fixed costs.
Effective trade spend management is critical to both retailers and manufacturers. Both are looking for the best return on investment. For a manufacturer, it may be as significant a line item on the P&L as COGS. Mismanagement of trade spend can lead to, not only to suboptimal financial performance, but also poor strategic decisions. Strong trade management practices will lead to better margins and sales, as well as better decisions on a brand’s go-forward strategy.
Learn More
To get more insight into financial forecasting process, download our free guide. You can also learn more about the work we do for our clients by visiting our services page, which covers the financial consulting services that we offer clients throughout Los Angeles.
About the Author
Amish comes to 8020 with strong financial leadership experience in a variety of roles with Pepsico (Frito-Lay), Nestle, and Princess Cruises. This included everything from logistics and distribution finance to brand finance to commercial/retail finance. Specific areas of financial expertise centered around full P&L management, financial strategy, FP&A, financial modeling, planning / budgeting / forecasting, integration, pricing, and negotiation. Moreover, along with his financial background, Amish also has extensive operational experience in Sales, Supply Chain, and Business Development. This has allowed him to be a tremendous finance business partner to his operational peers. Amish holds a Bachelor of Business Administration and an MBA in Finance and Management from The University of Texas, McCombs School of Business.
