Modelling Retail Price Promotions
The following example explains how we help retailers understand demand due to price promotions on their products and also how to predict promotional sales in advance.
Many FMCG manufacturers are under margin pressure. This is due to a consolidation of retailers around the world, rising input commodity prices and the growth of high quality private label brands. One of the important management levers left to manufacturers are short term trade incentives (price promotions) offered to retailers. According to Neilsen “Trade promotions are the 800 pound gorilla of marketing spending, representing 60% of the marketing budget and accounting for more than $100 billion per year”. Although sales promotions generally tend to “spike” volumes, it is not always clear what the financial benefits are. The financial picture is muddied if one considers that the promotional sales spike is derived from the following sources:
Category expansion. This is generally the most desirable source of sales and refers to increased consumption or an increase in market share for the focal category.
Purchase timing. This is sometimes referred to as a pre or post promotion “dip” and comes about because of delayed purchases in anticipation of a promotion or stockpiling behaviour by consumers.
Cross-brand cannibalisation. This is when sales of other brands in the same category decrease and move to the brand being promoted.
In-brand cannibalisation. This is where a promotion on one SKU leads to a drop in sales on another SKU of the same brand. For example 2 litre Coke sales may dip if cans of Coke are promoted.
Category substitution. This is where sales in another closely related category dip as customers rather purchase an item in the category being promoted.
Considering these sources of sales, it is clear that promotions can have both positive and negative effects on manufacturer and store profitability. For example, it is possible to offer a 15% price discount on say, a brand of baked beans, experience a 30% increase in sales during the promotion and actually lose money! The following example illustrates the principle. In the example, a promotion on a particular SKU results in a net volume increase of 5000 units (as compared to regular sales of 1000 units). The promotion was manufacturer funded at a 35% discount, with a profit per unit of $1.00.
Regular accounting suggests that a gross profit of $6,000 less the profit that would have resulted from normal sales leaves an apparent promotion profit of $4,462. However, if one considers that 25% of the promotion uplift of 5000 units was sourced from other higher priced SKU’s within the same brand and a further 35% was cannibalised from other higher priced time periods (before and after the promotion), there is a significant opportunity cost associated with each of these. Once these costs are brought into the accounting, the promotion goes from making an apparent profit of $4,462 to making a net loss of $154. If this had beenknown upfront, it is unlikely that the manufacturer would have offered this trade incentive.
After reviewing over 20 years of published literature on the topic, Quantalytic has developed a cutting edge decomposition model that allows manufacturers and retailers to quantify exactly where each promotion draws its sales from and to accurately forecast future sales as a function of price discount. This calculation engine allows managers to unravel the financial impact of promotions; to understand in great detail, the effectiveness of each campaign; to forecast demand and to design more financially effective promotions. It also allows for very accurate estimation of sales volumes ahead of a promotion. Contact us to explore how we can help you understand your promotions better.