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A Holistic Approach to Trade Spending

Trade Spending Euro 10/15/04 9:57 AM

A Holistic Approach to Trade Spending

Trade spending—the financial deals that manufactur-ers offer retailers to market their products—stands atan all-time high for consumer goods companies, de-spite their lack of satisfaction with its effectiveness.1

On average, more than 30 percent of the price thatconsumers pay for a product goes to retailers in theform of trade deals, with wide variation across cate-gories. That gives retailers considerable leeway in dis-counting prices—cutting into manufacturers’ profits,not to mention their own. Such discounting can alsoundermine the brand premium if prices fall belowwhat consumers are willing to pay.

In recent years, manufacturers have tried to bolsterprofits by reducing overhead, but those savings—along with productivity improvements—have been off-set by the trade-spending increases retailers have won.Because such spending is among the fastest-growingcosts for manufacturers, optimizing the entire trade-spending system will boost bottom- and top-linegrowth. Moreover, because the European currencyhas brought greater transparency to differences inconsumer prices and trade deals across countries, nowis a particularly opportune time to focus on this cost.

Where Does All the Money Go?

The rise in trade spending in Europe has been fueledprimarily by retailer consolidation, the displacement

1. Because trade-spending practices vary from region to region, we are publishing a slightly different version of this article forNorth American readers, titled “Converting Trade Spending intoInvestment.”

Trade Spending Euro 10/15/04 9:57 AM Page 3

of smaller, independent stores by larger formats, thecompetition for shelf space from private labels, andan advertising environment that has become increas-ingly cluttered, making it harder to create direct con-sumer demand. More and more of the spending isaimed at push efforts (deep discounts, such as pricepromotions, that push consumers to purchase a par-ticular product) and less and less at pull efforts (ser-vices and marketing, such as cooperative advertis-ing, that pull consumers into the store to ask for theproduct).

Push tactics not only cut into profits but also, if poorlyplanned, encourage consumers to take care of theirfuture needs at discount prices—a behavior known as“pantry loading.” Promotions that merely shift shareon a weekly basis fail to boost consumption and resultin lower margins for both the manufacturer and theretailer. Sporadic discounts also drain back-officeresources. Stable prices and margins are importantnot just because they allow for investments in R&D,product improvements, and advertising, but also be-cause they help establish a consistent brand image forthe consumer.

Many companies have tried to optimize one or anoth-er aspect of their trade-spending system, but few havetaken a comprehensive approach to the entire “pricewaterfall” as it flows from the consumer to the retailerto the manufacturer. Rather than view trade spendingas central to the go-to-market process (the full rangeof actions that promote a product’s success in themarketplace), many companies focus on incremental-ly modifying just one or two elements of the systemwithout taking into account the effect on the wholeprogram. Such an approach precludes long-lastingimprovements.


Advantages of a Holistic Framework

In its work with consumer companies, The BostonConsulting Group has been using a holistic frame-work that puts trade spending at the center of abroad go-to-market strategy and helps companiesreassess its effectiveness. (See Exhibit 1.) We recog-nize trade spending as the linchpin connecting themanufacturer and the retailer to all the strategic ele-ments involved in taking a product to market. Theseinclude:

• Channel and Trade Partner Strategy. Which channelsand trade partners have priority? How do you man-age different channels and formats? Which tradepartners are open to brand-building activities andwhich are not?

Channeland

trade partnerstrategy

Tradespending

Brandstrategy

Executioneffectiveness

Productstrategy

SOURCE: BCG analysis.

Exhibit 1. Trade Spending Links All Parts of a Go-to-Market Strategy


• Brand Strategy. How are your brands valued in the retailer’s brand portfolio? Which brands doyou want to promote? How much of a premium—if any—is the consumer willing to pay for your brand?

• Product Strategy. How do you manage the productportfolio across channels and trade partners? Howdo you structure the product lineup to ensure thata consistent brand message and price-value equa-tion can be communicated reliably by the sales staff to consumers?

• Execution Effectiveness. Does the sales force have theright incentives? Is the manufacturer clear on whois responsible for pricing and margins? Are all ofthe elements in the price waterfall transparent?

To understand how a holistic approach to tradespending affects all aspects of the go-to-market strate-gy, consider the price waterfall illustrated in Exhibit 2.It shows the cascading effect of a typical trade-spend-ing program, starting with the suggested consumerlist price and flowing through the regular discounts,temporary discounts, and off-invoice discounts that goto the retailer. Because cost-to-serve is also part of aproduct’s total profitability, it too is represented,although it is neither an element of trade spendingnor part of the retailer’s margin. A well-designedtrade-spending program, however, can reduce thatcost as well.

Determining the Suggested Consumer List Price

The best place to begin a comprehensive optimizationof the trade-spending system is the suggested price


the consumer pays for the product.2 That priceshould drive all of the subsequent discounts to theretailer along the waterfall. Manufacturers should(but often don’t) determine the suggested list priceaccording to the value of the product or brand fromthe consumer’s perspective—an approach that maylead to a different price than one derived from apure “cost-plus” approach (cost to produce the prod-uct plus desired margin).

One advantage of a consumer-oriented approach topricing is that it provides a clear picture of a prod-

Suggestedconsumerlist price

Regulardiscounts

Temporarydiscounts

Invoiceprice

Off-invoice

discounts

Net-netprice

Cost-to-serve

Net-net-net price

realized bymanufacturers

NOTE: Cost-to-serve is not an element of trade spending.

Exhibit 2. The Price Waterfall Provides a Frameworkfor Restructuring Trade Spending

A Typical Price Waterfall

2. In the United States and European Union, manufacturers arerestricted from specifying resale prices to their customers and fromrequiring customers to pass on to consumers promotional or otherdiscounts. Consequently, a manufacturer cannot monitor the dis-counting practices of a wholesaler or retailer with a view to enforc-ing its own discount policy.


uct’s profitability. A good example comes from a con-sumer electronics manufacturer we worked with. Thecompany had always determined its suggested con-sumer list prices by coming as close as possible to thecompetitor’s price and then building in a margin forthe retailer. When we helped this manufacturer insti-tute consumer-oriented pricing (basing the suggestedlist price on the product’s consumer value proposi-tion and allowing for an adequate trade margin), thecompany discovered that an entire subset of productshad been unprofitable.

Because the former approach to pricing didn’taccount for how consumers valued the product, themanufacturer had failed to recognize that some ofthe SKUs in its assortment wouldn’t sell as well as oth-ers. The retailer responded to the poor performanceof those SKUs by lowering the price until consumersstarted buying them and then going back to the man-ufacturer for substantial promotional discounts,which the manufacturer gave but did not track sys-tematically. Both the retailer and the manufacturerwere dissatisfied with the margins those SKUs generat-ed. Furthermore, the erratic pricing that resultedfrom significant discounting detracted from thebrand’s overall image. After instituting consumer-ori-ented pricing, the manufacturer finally had the con-sumer data it needed to reevaluate unsuccessful prod-ucts. It could then either remove those products fromthe assortment or change their specifications to makethem profitable again.

Determining Regular Discounts

Regular discounts—those that are determined inannual agreements for every order, regardless ofother deals—should provide the retailer with the base


margin it needs.3 The calculation the manufactureruses to determine those discounts should reflect boththe manufacturer’s strategic priorities and the eco-nomics of the channel and the trade partner. Thisexercise requires a close look at the format in whichthe retailer operates. Real estate costs for hypermar-kets, for example, are considerably different fromthose for small independent retailers. Manufacturersshould also consider the product’s role in the retail-er’s portfolio, which is a function of the absolute mar-gin (realized price, relative margin, and inventoryturns) and the cost to sell (the cost of maintainingthe retail space and sales staff, for example).

We instituted this approach with a food manufacturerthat had been negotiating trade discounts with indi-vidual retailers without considering their economicsor its own go-to-market strategy. First we segmentedthe company’s brands and products to determine thecompany’s ambitions for them. One segment, for

3. The use of discounts and bonuses is highly regulated in both theUnited States and the European Union, and it is important to seeklegal review of your channel strategy. This article should be readwith the following considerations in mind: U.S. law prohibits pricediscrimination among competing resellers, regardless of marketshare, and requires price differences to be justified by differencesin the seller’s cost. In the European Union, a manufacturer with asignificant market position, which might render it dominant, mustexercise caution in devising its bonus schemes. In this regard, amanufacturer with a market share in excess of 40 percent in theEuropean Union should be particularly wary. Discounts and bonus-es offered by such a manufacturer must be based on demonstrablecost savings or efficiencies benefiting the manufacturer’s econom-ics, as opposed to the customer’s economics; must be offered to allcustomers in a similar position (in other words, discounts shouldnot be discriminatory); must not be in return for any exclusivity orfidelity requirement; and must be based on purchases over a shortreference period (not normally in excess of a quarter). In addition,any scaling of volumes required for discounts must be proportion-ately tiered and linear.


example, consisted of “innovators”—new brands thatgenerated traffic in the store. Retailers would receivecomparatively lower regular discounts for thosebrands but higher off-invoice discounts to supportadvertising and other pull strategies. Another seg-ment belonged to “defenders”—established brandsthat faced intense competition for shelf space. A highshare of the trade spending on these products wouldgo for regular discounts to make the margin suffi-ciently attractive to retailers.

Then we examined the roles that the company’sbrands were playing in retailers’ portfolios. Thatincluded calculating sales per square meter, salesgrowth, the size of the category, and the average pricerealized. The data were gathered for each distributionchannel, which allowed the company to base tradeterms on the product’s economics for the retailers ineach of the channels.

An appliance manufacturer also adopted this ap-proach to calculating regular discounts. The manufac-turer’s trade spending had depended primarily on itssales reps’ negotiating skills—a practice that hadresulted in erratic consumer prices across channelsand some prices that stretched beyond a reasonablebandwidth. (A reasonable bandwidth would cover anarrow range of prices on either side of average, withlarger, more efficient retail formats at the low end—given their favorable economics—and smaller inde-pendents at the upper end.) In following the newapproach, the company grouped its customers intocategories on the basis of sales channel and volumesold, and then adjusted trade spending accordingly.

The new system took into account the economics andmargin requirements of the various channels, as wellas the company’s desired bandwidth. As a result ofthese segmentations and adjustments, prices were sta-


bilized within the desired range to the advantage ofall parties. The approach also preserved the purposeof trade spending as a payment for service, not as afee to keep retailers in business.

Making the Best Use of Temporary Discounts

Temporary discounts are granted to retailers on anorder-by-order basis. We often hear consumer goodscompanies say that if they could, they would eradicatethem. We believe, however, that temporary discountscan be a powerful weapon for specific situations—tocounter the effects of seasonality or short-term com-petitive moves, for instance. They can also correcttemporary differences between regional markets andsupport promotions or products that need a tempo-rary boost. Once again, companies must consult their product and brand strategy to determine theirpriorities.

Creating the right organizational processes to ensurethe effective execution of trade deals is particularlyimportant for temporary discounts. If a manufacturermanages the discounts through its central marketingfunction, it must set clearly defined rules for promo-tional effectiveness and monitor sales uplift andpantry loading.4 If it decentralizes temporary dis-counts by empowering sales reps and managers todetermine who gets what, the company will needclear budgets and rules to avoid an imbalance inaccounts. In either case, the company should trackthe discounts carefully with the appropriate informa-tion technology.

4. Any monitoring should not be used as a means of enforcing apassing on of the discount. See footnote 3.


Because of a lack of controls, the sales force foranother appliance company we worked with had beenmisusing temporary discounts to meet day-to-day pric-ing requirements, often succumbing to its customers’better negotiating skills. (In one country, for exam-ple, retailers demanded unusually high levels of“delivery damage” discounts.) The new trade-spend-ing system the company established allowed for“smart” temporary discounts and removed the vari-able of poor negotiating skills by instituting a specificbudget for each level of the sales force, calculated togive each sales rep enough room for negotiation onthe basis of his or her trade-partner portfolio. Thecompany also adapted its IT system for better controland linked successful use of discounts to sales reps’compensation, which made it possible for reps todetermine the right tradeoff between volume andmargin.

Another company had handled its temporary dis-counts centrally but lacked a rigorous system forselecting the products to be promoted and for calcu-lating the discount levels and trade support the retail-er required. As a result, many of the promotions weredestroying value because the increase in volume did-n’t compensate for the price reduction. We helpedthe company set new guidelines to determine promo-tions and the optimal level of discounts, frequency,and support in the store. The terms given to retailerswere linked externally to promotional effectivenessand internally to the compensation of account managers.

Improving Performance with Off-Invoice Discounts

Off-invoice discounts (rebates) are usually granted ona quarterly or an annual basis and should be paid out


to retailers as a reward for performance.5 Many com-panies have greatly increased their off-invoice spend-ing in recent years. Most of the time, however, thisspending is not linked to specific performance crite-ria. Ideally, such spending should be curtailed, butthat’s not always easy to do.

A more practical solution is to spend strategically. Off-invoice discounts can be a useful tool for rewardingperformance, but they must be structured so that thedesired behavior is clear and easy to measure. Thebest practice is to link performance objectives to somemeasure of shareholder value (growth, profitability, orcash-flow improvement). The objectives should also be consistent with trade-partner, brand, and productstrategy. Although this is true for all elements of tradespending, it is most important for off-invoice dis-counts, which are designed as a reward for perfor-mance, not as a lump-sum payment to retailers. Wehave found that off-invoice discounts are easier tomanage if their number is limited to one discount perperformance objective.

A packaged goods company we worked with provides aclear example of the strategic benefits of off-invoicediscounting. The company’s logistics costs were muchhigher than competitors’, partly because it had agreedto a 48-hour order-to-delivery guarantee for retailers.To correct the situation, the company announced aprogram that would reward the retailer with an off-invoice discount in exchange for a slightly longerorder-to-delivery schedule. It was a win-win proposi-tion for both parties. The new discount made up forthe additional working-capital cost to the retailer. Andthe manufacturer was able to increase its direct deliv-eries (factory to retailer), thereby cutting warehouselogistics costs in half for relevant orders.

5. See footnote 3.


Another example, which also demonstrates the effec-tiveness of flawless execution, comes from a beveragemanufacturer. The company’s off-invoice discountsdidn’t reward well-managed shelf space, because thecompany felt that push efforts didn’t improve sales.But under a new trade-spending agreement, the man-ufacturer and retailer worked jointly to manage theshelf space, and both parties benefited. The retailergot a higher gross margin per square meter of space,and the manufacturer got increased sales volume.

A final example shows how a holistic approach totrade spending connects trade-partner strategy withbrand strategy. The manufacturer had a high share ofunconditional off-invoice discounts, which increasedevery year, with no additional performance improve-ment from the retailer. The company adopted atrade-spending system that linked off-invoice dis-counts to shareholder value. It offered trade partnersin economically attractive channels (those with lowcost-to-serve) a rebate for sales growth.6 That gaveretailers an incentive to increase their business withthe manufacturer, and the increase in these channelsadded to overall profitability. Another discount re-warded the retailer for providing more shelf space forspecific brands, which improved brand mix as well assales growth and supported the entire brand strategy.

Guidelines for Implementing a Holistic Policy

Trade-spending optimization is more like a marathonthan a sprint. That said, it is well worth the effort.Here are the most important lessons we’ve learned

6. See footnote 3.


while helping companies across a range of categoriesimprove their trade spending:

• Before beginning to redesign your program, beclear about your goals. Do you want to lower totalspending or increase the efficiency of your currentlevels by, for example, changing the product mixto improve margins?

• Altering the entire price waterfall across all busi-ness units and regions is a highly complex under-taking. Most companies do it in stages. Before youbegin to implement a new trade-spending system,ensure compatibility across units or regions byclearly defining the overall blueprint. Then rollthe program out by element, by country, and byregion.

• Even when you implement a new system in stages,the effort will be massive and rigorously analytical.It will also require several iterations. You will needto run complex quantitative simulations, potential-ly involving many trade partners and products.Each simulation should reflect the impact on indi-vidual trade partners and products.

• The more you involve sales reps, the better. Im-proving trade spending should be a bottom-upeffort that requires knowledge of trade partners’histories, margins, negotiating behavior, and price-setting practices.

• The devil is in the details during the rollout.Senior management must be involved throughoutthe project for many quick but high-impact deci-sions. And don’t “go live” with a new trade-spend-ing program until you are sure every piece of ITreprogramming code is in place.


• You may need to establish new processes andresponsibilities, such as a pricing council to linktrade spending to the other elements of the go-to-market strategy. Pricing—which affects marketing,sales, and finance, as well as production and logis-tics—needs to be managed cross-functionally.

• Remember that a holistic approach is also requiredduring the rollout. If product strategy is affected bythe new trade-spending system, changes to theproduct lineup need to be reflected as a separatemilestone in the implementation.

Questions to Ask

Would our holistic approach to trade spending helpyou get more out of your arrangements with retailers?A number of questions will help you take a fresh lookat how well your trade spending is working for you.

1. What are your most pressing issues? The approachyou take to trade-spending redesign will dependon where the current program hurts the most:

• Net price differences across regions or countries?7

• No control over temporary discounts?

• No pay for performance?

• Trade-spending increases as a percentage of sales?

7. Manufacturers in the European Union must ensure that they donot implement bonus schemes that have as their objective the par-titioning of the national markets of the European Union; notably,they should not discriminate against customers that may export theproducts to, for example, higher-priced countries.


2. Does your trade-spending system reflect the inter-dependencies among all the elements of your go-to-market strategy? Or are you finding that optimiz-ing one element creates difficulties in another?

3. Do you know the price consumers are willing topay for your products? Or are your prices deter-mined on a cost-plus basis or by benchmarkingcompetitors?

4. Do your regular discounts reflect your trade part-ners’ support in selling your products, as well astheir economics and the role your product orbrand plays in their portfolios? Or are your dis-counts based mostly on past negotiations?

5. Do you use temporary discounts as a flexible tool?Or are they out of control?

6. Do your off-invoice discounts improve your perfor-mance and reward your trade partners’ perfor-mance? Or are they largely unconditional?

7. Is trade spending under the leadership of seniormanagement? Is there one person or group who“owns” pricing and trade spending, and does thatperson know how much is spent by whom and forwhat purposes?

A Win for Manufacturers and Retailers

Manufacturers and retailers don’t have to be onopposite sides of the table when it comes to tradespending. Manufacturers want a program that rewardsretailers for growth in shareholder value, is fair andeasy to understand, benefits consumers, and encour-ages efficient spending. Retailers also want profitablecategory growth with top-line increases and gross-mar-


gin expansion. And they want to be rewarded for per-formance. Both manufacturers and retailers benefitwhen they share insights on merchandising andassortment. We are convinced that a holistic approachto trade spending that reflects the interdependenciesamong all elements of the go-to-market strategy willcreate an effective linchpin between retailers andmanufacturers, for the benefit of all.

Rolf BixnerHolger GottsteinJust Schürmann

Rolf Bixner is a senior vice president and director in theAmsterdam office of The Boston Consulting Group. HolgerGottstein is a project leader and Just Schürmann a managerin the firm’s Munich office.

The authors wish to thank Christian Cerda, a manager inBCG’s London office, and Martin Stellmacher, a managerin the Munich office, for their contributions to this article.

You may contact the authors by e-mail at:

[email protected]

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© The Boston Consulting Group, Inc. 2004. All rights reserved.


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