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Creating Win-Win Trade Promotions
Theory and Empirical Analysis of Scan-back Trade Deals

Authors:

Xavier Drèze
David R. Bell

Publisher:

Marketing Science
Winter 2003, Vol. 22 (1), 16-39

Abstract:

By 1996, average manufacturer trade promotion spending had risen to around 13% of net sales (from 5% in 1978) and was second only to cost of goods sold as a profit and loss item. It has nowb ecome common for manufacturers to lose money on trade deals as retailers often subvert the profitability of the promotion by forward-buying merchandise. The search for more effective forms of trade promotion and the availability of scanners at cash registers has led to the emergence of a newt ype of trade deal called scan-back which gives retailers a discount on units sold during the promotion rather than on units bought.

We develop a theory to compare retailer pricing decisions and profitability under scan-back and traditional off-invoice trade deals and showho wscan -backs can change trade promotion practices. The theory assumes only downward-sloping demand (i.e., no particular functional form), and makes use of the following result: Retailer prices and profits depend only on average costs during promotion and non-promotion periods and the price elasticity of demand.

We showtha t when the terms of the trade deal are identical, retailers prefer off- invoice trade deals and manufacturers prefer scan-backs. Manufacturers can, however, redesign the scan-back to leave the retailer weakly better off and leave themselves strictly better off. While there are many ways to redesign the scan-back, there is at least one solution in which retailer behavior (in terms of prices) and therefore consumer behavior (in terms of quantities purchased) remains identical to the off-invoice case. From the retailer's point of view, the redesigned scan-back generates identical revenues, but eliminates inventory costs and increases cost of goods sold, such that total costs are the same. The increase in cost of goods sold, (i.e., manufacturer revenues) leads to the increase in manufacturer profits.

Using proprietary data from the beverage category, we conduct an empirical analysis and found that during the promotion period, scan-back trade deals, relative to off-invoice deals: (1) do not cause excess ordering, and (2) generate higher retail sales through lower retail prices. Implications for researchers and managers are discussed.