Channel Pass-Through of Trade Promotions

Abstract

Packaged goods manufacturers spend in excess of $75 billion annually on trade promotions, even though their effectiveness has been hotly debated by academics and practitioners for decades. One reason for this ongoing debate is that empirical research has been limited mostly to case studies, managerial surveys, and data from one or two supermarket chains in a single market. In this paper, we assemble a unique data set containing information on prices, quantities, and promotions throughout the entire channel in a category. Our study extends the empirical literature on pass-through in three important ways. First, we investigate how pass-through varies across more than 1,000 retailers in over 30 states. Second, we study pass-through at multiple levels of the distribution channel. Third, we show how the use of accounting metrics, such as average acquisition cost, rather than transaction cost, yields biased estimates of pass-through and therefore overstates the effectiveness of trade promotions. We find that mean pass-through elasticities are 0.71, 0.59, and 0.41, for the wholesaler, retailer, and total channel, respectively. More importantly, at each level of the channel we observe large variances in pass-through estimates that we explain using various measures of cost and competition. Surprisingly, we find that market structure and competition have a relatively small impact on pass-through. We conclude by showing how the profitability of manufacturer and wholesaler deals can be improved by utilizing detailed effectiveness estimates. For example, a manufacturer using an inclusive trade promotion strategy might offer a 10% off invoice deal to all retailers on every product. This strategy would decrease manufacturer and wholesaler profits for 56% of product/store combinations, whereas retailers experience a profit boost in 96% of cases. Manufacturers and wholesalers can avoid unprofitable trade deals for specific products and retailers by utilizing estimates of pass-through, consumer price elasticity, and margins. Compared to the inclusive strategy, such a selective trade promotion strategy would improve deal profitability by 80% and reduce costs by 40%.