Trade promotions drive the marketing strategies of packaged goods manufacturers. Roughly 60 percent of the marketing budget of major packaged goods manufacturers goes to offering wholesale discounts to retail partners. Not surprisingly then, manufacturers are concerned with how much of their promotional pricing gets passed through to the end-users of their products. Discrepancies between manufacturer and retailer estimates of pass-through often occur. Retailers claim to pass-through $7.5 billion more in trade promotions than manufacturers believe they do. Recent research published in Marketing Science explores this gap and offers insights into retailer behavior with regard to these promotions.
David Besanko, a professor at the Kellogg School of Management, Jean-Pierre Dubé, a professor at the University of Chicago Graduate School of Business, and Sachin Gupta, a professor at the Johnson Graduate School of Management studied pass-through behavior in eleven key product categories of a major Chicago supermarket chain. They explored two types of pass-through behavior: own-brand pass-through (i.e., when retailers adjust shelf prices of the discounted brand) and cross-brand pass-through (i.e., when retailers adjust the shelf prices of the discounted brand as well as other brands competing in their category). The data collected allowed the researchers to observe a large number of retail price adjustments in response to manufacturer price changes across a variety of geographic sub-regions served by the retailer.
The research shows that 60 percent of every trade promotion dollar is passed on to the consumer in the form of lower prices. This result is far closer to retailer claims that they pass through 62 percent of trade promotions than it is to the 52 percent claimed by manufacturers. In addition, the research reveals some surprising insights into retailer pass-through decisions that should help manufacturers improve their pricing strategies.
Table 1 provides estimates of own-brand pass-through rates across the eleven categories of products included in this study. The pass-through rate is a percentage measure. For example, if a product’s pass-through rate were 0.50, then the retail price of that item would decrease by $0.50 for every $1.00 decrease in its wholesale cost. There is significant variation across product categories: the pass-through rate for toothpaste is only 0.22, while the pass-through rate for beer is 5.58. Pass-through rates that are higher than one run counter to the commonly held belief that most brands receive far less than 100 percent pass-through. Nevertheless, this study found that 14 percent of all observed pass-through rates were greater than one at a statistically-significant level.
Table 1: Estimated own-brand pass-through rates
Many conclusions can be drawn from these variations in pass-through. In general, one would expect there to be a high correlation between the price elasticity of a product and the rate of pass-through evident within that category. However, there are many additional strategic factors to consider on the part of the retailer when examining these cross-category differences. For example, the notably high pass-through rate of beer was affected by the high pass-through rates for the Budweiser 12-pack and the Miller 12- and 24-packs. There is a strong likelihood that these products are used as loss leaders by the retailers, leading to discounts that far exceed what would be expected or hoped for by the manufacturer. These extenuating circumstances merit attention from the manufacturer on a case-by-case basis.
Within Category Variation in Own-Brand Pass-Through
Discounts on higher-profile brands are more likely to expand overall category sales than to lead to the cannibalization of the sales of other brands within that category.While categorical variation in pass-through can be informative, this study indicates that 75 percent of pass-through variation occurs between products within a single category. Generally, it has been found that the brands with the largest market share have the highest pass-through rates.
The study shatters several widely held assumptions regarding store brands (i.e. private labels). Despite the popular belief that store brands receive 100 percent pass-through because of their importance to retailers, results suggest that the opposite is true: national brands receive greater pass-through than store brands. Moreover, when national brands (or larger brands) are trade-promoted, the store brands (or smaller brands) do not receive any price reductions. In addition, when store brands are trade-promoted, the retailer reduces prices of larger competing brands in the category.
Table 2 provides pass-through rates across detergent brands. Significant variation occurs across the category and even across products from single manufacturers. All, Wisk, and Surf are all Unilever products. Surf’s pass-through rate is by far the lowest. This variation reflects the common retail practice of passing through trade promotions on the highest-profile brands and withholding the promotions on lesser brands for the sake of maintaining the retailer’s targeted per-category profit levels.
Table 2: Estimated own-brand pass-through rates for laundry detergents
Other explanations for the greater pass-through rate of national brands include the greater bargaining power that the manufacturers of larger brands often possess. In addition, discounts on higher-profile brands are more likely to expand overall category sales than to lead to the cannibalization of the sales of other brands within that category. These high-profile discounts may also play a greater role in terms of retailer competitiveness.
Table 1 also suggests that two-thirds of estimated cross-brand pass-through rates are significant, implying that retailers change prices of multiple products in a category in response to trade promotions for a competing brand. Of this two-thirds, 28 percent are positive and 35 percent are negative. A positive effect means that a trade promotion on one brand leads to a shelf price reduction on another brand in the category. This may suggest that retailers are trying to protect other brands by reducing their prices as well. On the other hand, a negative effect that leads to a price increase may suggest that retailers are purposefully driving customers to the trade-promoted brand.
These findings are significantly different from the findings in previous studies that assume that cross-brand pass-through rates are zero. Additionally, these findings reinforce some of the conclusions made regarding own-brand pass-through. For example, a negative coefficient for “relative market share” was established in cross-brand pass-through statistical analysis. It indicates that when a brand has a large market share, it is more likely to have its price reduced when competing brands have their prices reduced. However, discounts of these major brands will not lead to price reductions for its smaller competitors.
By behaving in this way, retailers continue to protect their sales margins, maintain good relationships with their most important suppliers and prevent cannibalization of their most important brands. However, these results represent more cause for concern among manufacturers of smaller brands. Not only do manufacturers of smaller brands receive a lower pass-through percentage on their own brands, but they may also find that retailers take measures to dilute the efficacy of their trade promotion efforts with cross-brand pass through.
Implications for the Real World
The research underscores the pitfalls manufacturers can experience if they blindly issue trade promotions without a clear understanding of retailer behavior and goals. While manufacturers are concerned with specific discounts on specific brands, retailers ultimately seek to maximize their share of category profits. This misalignment of goals can threaten the value of trade promotions for manufacturers. Therefore, when manufacturers design trade promotions for their brands, they should be mindful of the economics within each category and the pass-through rates for individual products. Manufacturers must consider that retailers pass through only some of their trade promotion spending, and that retailers may also change pricing on other brands in a category. In light of these trends, trade promotion on smaller brands may be counterproductive for a manufacturer if it is expected that the retailers will respond by discounting competitor products.
Overall, packaged goods manufacturers should carefully consider the expected response of retailers to their promotional efforts in order to ensure that their marketing budgets are well spent.
Prasanthi Gandhi, Kellogg MBA Class of 2008
David Besanko, Jean-Pierre Dubé, Sachin Gupta, (2005), “Own-Brand and Cross-Brand Retail Pass-Through,” Marketing Science, Winter, 24(1): 123-137.
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