Executive Summary

Sales promotions are a particularly important marketing activity for fast moving consumer goods, representing the majority of manufacturers’ marketing budgets, amounting to 16% of their revenues (Canondale Associates 2001). However, manufacturers question the long-term effectiveness of this practice as (1) the retailer may fail to pass-through and support price cuts over time (Armstrong 1991; Chevalier and Curhan 1976), (2) competitors may retaliate with their own promotions (e.g. Leeflang and Wittink 1996), and (3) consumers may ‘lie-in-wait’ for promotions (Kopalle et al. 1999; Mela et al. 1998). Moreover, the move towards category management (Progressive Grocer 2001) implies that retailers may respond to wholesale price promotions with changes in prices (and feature and display activity) for competing brands (Zenor 1994; Hall, Kopalle and Krishna 2002); a practice referred to as ‘cross-brand pass-through’ (Besanko et al. 2005; Moorthy 2005). In light of these practices and the resulting mutual suspicion, it is not surprising that both manufacturers and retailers are unhappy with their own and their collaborative efforts on improving promotional effectiveness (Jones 2004). Therefore, it is important for all market players to empirically assess the extent of consumer, retailer and manufacturer reactions to sales promotions, and to calculate their impact on long-term promotional effectiveness.

This paper estimates restricted impulse response functions, based on Vector Autoregression models for 75 brands in 25 categories, to answer three related research questions. First, to what extent are manufacturer promotions passed through by the retailer, and induce reaction by competing manufacturers? Second, how do these retailer and competitor reactions drive the long-term sales response to the initiating wholesale price promotion? Third, do these reactions and sales effects depend on category characteristics and the brand’s competitive position? In particular, are smaller brands in jeopardy compared to leading brands in the category?

The analysis is based on weekly scanner data from a large mid-western supermarket chain, Dominick's Finer Foods, for the top 3 brands in analgesics, bathroom tissue, beer, canned soup, canned tuna, cereal (cold, hot), cheese, cookies, crackers, dish detergent, fabric softeners, front-end candies, frozen dinners, fabric softener, juice (bottled, frozen, refrigerated), laundry detergent, paper towels, shampoos, snack crackers, soaps, soft drinks, toothbrushes and toothpastes. The data period runs from September 1989 till May 1997. This extended time period also enables comparison of the early-90s period in which manufacturer promotions mostly took the form of off-invoice allowances, with the late-90s period during which scan-back deals became more prominent (Ailawadi 2001; Drèze and Bell 2003).

The results show that the long-term retailer pass-through of promotions is 65% on average, yielding a long-run wholesale promotional elasticity of 1.78 before competitive response. However, competitors partially match the wholesale price reduction by 15%, which decreases promotional elasticity by 10%.  The range of retailer and competitor response across the analyzed cases is very wide, and is affected by category and brand characteristics. As to the former, large categories yield stronger retailer response, while concentrated categories yield stronger competitor response.As to the latter, smaller brands face a fourfold disadvantage compared to leading brands: they obtain lower retail pass-through, lower retail support, and lower benefits from competing brand’s promotions, while their promotions generate higher benefits to competitors. Interestingly, the mid-90s move from off-invoice allowances towards scan-back deals only partially improves their promotional effectiveness compared to that of leading brands. As a result, it is crucial for these smaller brands to engage retailer cooperation and create innovative sales promotions that benefit both parties and are hard to imitate by the leading brands. In particular, managers should focus on initiatives that enlarge the brand’s consumer base, such as product sampling and integrated communications. The more consumers are familiar with the brand, the larger the retailer support for and the effectiveness of future price promotions (Bronnenberg and Mahajan 2001). Finally, smaller brands may benefit more than leading brands from increased collaboration with retailers in the form of “proportional discount sharing arrangements” (Wierenga and Soethoudt 2004); in which each party contributes to the consumer price discount in proportion to its original margin.