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An old adage says you have to spend money to make money. Whether this is still true when it comes to promotional spending is no longer clear, as the industry rethinks its promotional toolkit and cuts back on inefficient spends.
The impetus for this potentially massive shift is not just dissatisfaction with inefficient promotional strategies. Rather, it's being forced by new rulings from the Financial Accounting Standards Board's Emerging Issues Task Force in the wake of questionable accounting practices by many public companies—practices that have led to restated P&Ls, corporate resignations, and a nervous stock market that is focusing on accounting instead of encouraging economic signs.
The consumer packaged goods and retail industries are not being singled out, but their sales and marketing functions will be irrevocably changed. Advertising and promotional expenditures ranging from slotting fees to market development funds are being reclassified to reflect lower revenues and growth. The result will be 2002 net sales reductions of up to 18 percent, with the average falling in the area of 8.5 percent.
An even more devastating post-FASB reality will be a double-digit reduction of growth rates. Cannondale's studies of CPG sales between 1997 and 2001 indicate that the average growth rate was 2.9 percent. During this period, trade spending as a percent of gross sales grew from 13.5 percent to 16.9 percent. Restated net sales will show a 31-percent drop in growth. This measure of real revenue could have a profound impact on price/earnings ratios and stock price valuations.
One could argue that the CPG industry has only itself to blame, that, faced with an increasingly competitive pricing environment, companies used inconsistent and unrealistic accounting practices to buoy sales results. This is true to some degree, and the industry must now make amends to shareholders and the investment community by lowering net sales. On the other hand, some companies beat FASB to the punch by restating revenues before the rulings. For them, further adjustments should be minimal.
The chief issue is how the FASB changes will affect trade promotion spending practices going forward and what effect these changes will have on collaborative efforts between manufacturers and retailers. A recent Cannondale study clearly shows that the vast majority of manufacturers and retailers—92 percent and 88 percent, respectively—know that current trade promotion practices are highly inefficient. How are the changes most likely to play out?
The first, and most obvious, change will be elimination of the most grossly inefficient practices. Chief among these is the quarterly or year-end load, in which manufacturers flood the market with inefficient spending in order to make sales targets. Companies know that they are often spending more to generate these sales than the sales are worth, but they continue the practice in order to fulfill top line sales commitments made to investors. Under the new rulings, the sales gains from this spending will be much smaller and could, in fact, be negative in some cases.
Beyond eliminating the worst spending practices, manufacturers will be more aggressive in developing new types of retail marketing programs that build short-term business but do not offset sales based on the FASB rulings. Expect to see companies undergoing major revisions of their entire promotional portfolios. Also look for a period of intense experimentation with new marketing vehicles such as targeted marketing and customer relationship management (CRM), as well as variations on more established practices such as co-marketing. Not all experiments will succeed—in fact, most will probably fail—but those who are out in front in identifying the winners will reap rich rewards for their efforts in terms of spending effectiveness and efficiency, as well as competitive advantage.
Tense times ahead
How will this play out between manufacturers and retailers in their ongoing quest for "win-win" programs and "collaborative efforts?" Expect the road to be rocky and anything but straight. For example, what happens when "loading" is reduced or eliminated? This will mean a major reduction in trade funds going to retailers. While senior managers may recognize that there will be some offsetting savings in supply chain efficiencies, the category managers and buyers who are in the trenches will only see fewer dollars. With bonuses on the line based on these types of revenues, tensions will run high, and collaborative efforts across the board—including not just promotion planning, but shelf/aisle initiatives, new product authorization, and joint consumer research—could be derailed, at least temporarily.
Longer-term, manufacturers that successfully weather this storm will settle into new patterns. We foresee the advent of several practices that are already being utilized or tested by leading companies, including:
•Emphasis on customer-specific programs and P&Ls.
•Allocation of expenditures based on execution and profitability.
•Empowering and incenting sales forces to be responsible for sales and profits, not just units.
Given the dramatic changes under way, what is the winning strategy for manufacturers and retailers? Our research shows that the answers are clear.
Manufacturers will be divided into two camps. Marketers in the first camp have traditionally viewed trade dollars as "bad" and advertising dollars as "good." For them, the FASB changes just mean everyone is coming around to their point of view. If these managers have their way, trade will be cut dramatically and the dollars shifted elsewhere in the marketing mix. Inevitably, these companies will find that they have swung the pendulum too far away from trade and their businesses will suffer. Why? Because our work shows that trade can build brand equity. Even used ineffectively, some part of it is building equity right now.
Seeking the benefits
The other manufacturer camp is led by marketers who accept that trade has some real benefits as a marketing tool, but that these benefits have not been maximized by past practices. They understand that trade is a "missile used as a club" and they recognize that their current understanding of trade promotion is woefully inadequate. For these marketers, the answer lies in understanding the effects of trade promotion on consumer behavior, answering questions such as:
•What type of buyer responds to trade promotion?
•Do deals encourage pantry-
loading, and does that lead to expanded consumption?
•Which types of promotion support drive which behaviors?
•How do trade deals affect brand loyalty and equity?
Clearly, the road to success and competitive advantage starts with a complete change of mindset regarding trade promotion. No longer can trade be viewed as "a cost of doing business." Rather, winning marketers will begin to view trade as the strategic foundation of a more effective overall marketing plan.
Retailers see vast sums of money on the line as the new order works its way in. For them, the winning strategy is to become part of the solution for manufacturers, rather than part of the problem. Again, we foresee two camps. The "old school" retailers will continue to leverage their scale to attempt to extract maximum promotion dollars from manufacturers. As more manufacturers change their sales incentive systems to align with accounting practices, these retailers will find their tactics increasingly ineffective. In the end, they will suffer dramatic competitive losses as vendor dollars migrate to more progressive retailers.
Those in the other retailer camp will accept that the world is changing and seek to become leaders in the new environment. They will collaborate with manufacturers to experiment on new programs, and will be rewarded with disproportionate shares of spending. They will also take advantage of this process to find new and better ways to market their own private label brands, and will leverage their collaboration to push programs that grow categories while they build brands.
One of the most effective tools for achieving success in these efforts lies right beneath the noses of retailers and manufacturers alike—frequent shopper data. Cannondale's ShopperGenetics work, which uses this rich resource to "map the DNA of consumer behavior," has yielded tremendous and actionable insights for both parties. We see more and more retailers making data available (without specific consumer identification) to manufacturers or third parties in an effort to win the race up the learning curve. And for vendors ready to take up the challenge, the rewards in terms of trade efficiency, effectiveness, and equity are huge.
The bottom line is that both manufacturers and retailers need to pull their heads from the sand and accept that the world of trade promotion is changing and that all revenue must be real. Those ready to take advantage of this change will profit and win. Those that refuse will end up the real victims.
Don Stuart and John Carlson are partners with Wilton, Conn.-based Cannondale Associates, a consulting firm with long experience in trade promotion strategy and analysis.