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Trade Spend: The Consumer Goods $35 Billion "Elephant in the Parlor"

Trade spend exists at the intersection of brand and customer strategies, and every promotion must be linked directly back to these two drivers. However, too often performance and compliance are neither well defined, nor well measured. Studies show it often has a negative ripple effect on the entire supply chain, resulting in substantial indirect costs that are estimated to be $30 billion annually for the U.S. food industry. Here's a perspective on how trade spend can be used to increase profits across the supply chain.

by Peruvembra Ravi and Nicholas Seiersen

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Trade spend was once a brilliant idea to get special placement and/or pricing for manufacturers' consumer goods in mass retail stores, while giving the retailers a way to monetize prime store "real estate". It has grown into a multi-billion dollar monster that is out of control; trade spend is the consumer goods' "elephant in the parlor". Estimated at $26 billion in the United States, it consumes 13 percent of sales, 61 percent of Consumer Product Goods (CPG) manufacturers' marketing dollars, and it is growing faster than sales, making it the second largest expense line, after Cost of Goods Sold (COGS). Manufacturers and retailers agree it is an important issue: trade spend management is inefficient (thought to cost the industry a further $10 billion annually to manage and administer) and the return on trade spend is questionable at best. It also has a negative ripple effect on the entire supply chain, resulting in substantial indirect costs that are estimated to be about $30 billion per year for the U.S. food industry. In addition, trade spend deals involving temporary price reductions are usually unprofitable, and that the level of profitability declines with an increase in the frequency and the magnitude of the price reduction, according to Researchers Blattberg and Levin. Other studies have shown that 85 percent of trade spend deals are unprofitable. These studies do not account for the effect of increased logistics costs; thus, the actual proportion of profitable trade deals is likely to be even lower.

Legal and regulatory changes in the United States are also targeting the obscurity of trade spend deals. Section 404 of the Sarbanes-Oxley Act requires CEOs, CFOs and external auditors to attest to the adequacy of internal controls and systems for financial reporting, including the reporting of trade spend programs. Ruling 01-9 of the Financial Accounting Standards Board in the United States requires all trade spend items to be classified as revenue reductions rather than as COGS expenses, with the exception of payments made for services rendered by another member of the supply chain that satisfy a set of restrictive conditions. Trade spend programs that do not satisfy these conditions could result in a reduction in revenues, thus defeating the very purpose for which these programs were developed.

Given the marketing, logistics and legal complexities associated with trade spend programs, identifying the most effective trade spend strategies is an important determinant of the success or failure of consumer goods manufacturers. To be workable, a trade spend strategy must be successfully "sold" to all members of a supply chain. This article will identify strategies that benefit not merely manufacturers but the entire supply chain.

Trade Spending is rarely examined very closely on a customer-by-customer basis, under the assumption that it is the result of a strategic corporate decision applied equally to all customers, according to a very clearly laid out set of company guidelines and policies. The truth is that although such policies are in place, the execution in the marketplace is rarely uniform across the customer-base. In fact, looking at trade spend only through the aggregated line items of the company's P&L will mask significant proportional cost differences between customers. The underlying cause of trade spending inequality among customers is the multitude of spend buckets that have evolved and been made available to the revenue-motivated sales force competing for the customers' share of business. In reality, this translates into battles between the sales staff in your company to get the lion's share of your trade spend for their customer.

The large number of spending options (see sidebar) is required to achieve different objectives with customers. For example, merchandising and co-op advertising allowances are intended to increase lift through promotional activity; performance spending and listing allowances aim to improve positioning on the customer's shelves. There are also claims and returns meant to decrease the customer's risk in carrying the company's products and distribution allowances to offset the customer's logistics costs. Some trade spend is in place in response to continuing pressures on prices. Bonus or extra goods and deductions give the sales force the flexibility to negotiate on price. Terms of sale also offer flexibility around price to some extent, but are primarily intended to modify the customer's ordering and payment behaviour. Each customer will pressure the organization differently for spending dollars as their preferences and demands are influenced by their unique strategies, policies, systems and even individual personalities.

Policies and guidelines are designed to control how each available trade dollar is spent. However, rarely do policies control total spend with a given customer. With such a wide array of possible ways to claim money from the organization, customers (often with the help of your company's own sales organization) can be very creative at structuring their business relationship to minimise their 'net net' price by bending or breaking the rules governing your trade spend.

What is wrong with Trade Spending and promotions?

Two large issues exist in CPG trade spend today. First, trade investment is not driven by strategy. Trade spend is the intersection of brand and customer strategies, and every promotion must be linked directly back to these two drivers. Second, performance and compliance are neither well defined nor well measured. It is essential for the execution of the promotion that both the manufacturer and the customer understand the goals and the measures.

What is changing in trade spend?

There are three main changes underway in grocery sector:

What are the supply chain/logistics implications of trade promotions? Trade promotions cause a temporary spike in demand, which increases logistics and manufacturing costs during and after the promotion.

How can we make promotions more effective and profitable?

While these options are valuable tools in the management of trade promotions, it is important to address the fundamental driving forces that lead to unprofitable trade promotions. Improve coordination across all the supply chain organizations to design better trade promotions and that reduce current logistics and manufacturing costs. It may require revamping incentives and key performance metrics.

The approaches to trade spend management outlined in this article can increase profits for the entire supply chain and can thus be readily "sold" to all functional areas within your firm and to your retail partners. They provide a win-win situation for manufacturers, retailers and customers, with a well-coordinated supply chain offering a wider array of products at lower prices, while increasing profits for manufacturers and retailers and keeping a check on logistics and manufacturing costs.

Sidebar

Regular Discounts are typically agreed upon or recommitted annualy. They can include:

  • Volume Rebates: are used to provide incentives for volume growth and retailer preference for your brands over competing brands.
  • Payment Terms: such as longer payment terms to compensate for slower turning products or greater minimum order quantities, or shorter payment terms in the case of consignment inventory or scan-based sell-through.
  • Listing Fees: some large customers, particularly in the grocery industry, require manufacturers to pay a listing fee for each SKU that is put on the retailer's shelves.
  • Claims: allowances are conceded to either warranted or unwarranted claims made by customers. It is not uncommon for retailers to take deductions for discounts that have not been earned. This may be "approved" on a case-by-case basis with the knowledge of the sales representative, however continuous abuse or never meeting the requirements for the discounts taken, must be highlighted and addressed.
  • Returns: most organisations have a Returns policy designed to add a certain level of guarantee to the products being shipped. There may still be a tendency, on occasion, to oversell the customer or for the customer to overbuy to reach certain volume thresholds, before a price increase, at the end of a promotion, or at the end of a quarter.
  • Distribution Allowance: is payment for logistics costs incurred by the customer. Demanding customers may be getting a great deal of logistics support from the logistics function and at the same time claiming distribution allowances. A number of other tools are used to boost sales episodically.
  • Merchandising Allowances: are monies given to customers in return for in-store merchandising performance.
  • Coop Advertising: allowances are paid to participate in customer advertising initiatives. The money is usually in proportion to the number and prominence of the supplier's product(s) in the advertising initiative.
  • Coupons: are typically issued by the manufacturer, and are redeemed by the consumer at the point of sale.
  • Temporary Price Reductions: are created by the manufacturer and are expected to be passed through to the consumers. However, all too often, it is the manufacturer's regular consumers that use these "deals" to load their pantries, and thus they defer their next purchase at the regular price. Many retailers also load their distribution channels at the reduced price, then sell the merchandise at the normal price, pocketing the extra margin.
  • Performance Spending: is payment to the customer in return for specified activity around particular items or brands. This activity can take the form of things such as preferred and/or increased in-store positioning, special display locations, end-aisles etc.
  • Display Allowance: display stands are developed, manufactured and delivered to get front-of-store presentation of merchandise where a manufacturer is able to increase control of the check-out or other key store areas.
  • Bonus or Extra Goods: expenses are in place to cover situations where rather than conceding a price decrease, the customer is given extra merchandise. This merchandise should be valued at dock cost of goods, or if the supply is constrained, at the price the company could realise (opportunity cost).