Series Introduction
When sitting down with new clients, TABS guides them through the six essential elements of managing trade promotion. Each successive step builds on the one before it, and they are all critical for managing and optimizing your trade spending.
- Correct Metrics
- Correct Measurement
- Correct Data Harmonization
- Tactics
- Planning
- Execution
This set of best practice information is unique in the consumer packaged goods (CPG) industry. It has come from analyzing twenty-plus years’ worth of trade promotions, over 200,000 of them in all.
TABS Analytics has refined this process over a period of many years, in the comprehensive study of trade promotion of packaged goods companies in nearly every category and mass market retailer. Over the next few weeks, we’ll be visiting these elements in detail. Each new post will cover just one of these elements.
The Trade Promotion Problem
Before we get into specifics about correct metrics, let us first take a moment to clear up current thinking about trade promotion, and how we propose to revise it.
Presently, the conventional wisdom in the CPG industry separates trade promotion practices into two distinct branches:
- Trade Promotion Management (or TPM), the day-to-day implementation of trade promotion practices, and
- Trade Promotion Optimization (or TPO), which is the process of refining those practices. (we wrote a post on this last year which you can find here.)
We propose that splitting TPO actions into four different tiers is a more effective and comprehensible approach. Obviously, the tactical side remains:
- Trade Promotion Implementation (or TPI, formerly TPM), the standard day-to-day execution of promotion practices.
But then we have the following four steps encompassing optimization:
- Trade Promotion Measurement (the “new” TPM, if you will) is the periodic testing of those practices, and figuring out what works vs. what doesn’t.
- Trade Promotion Best Practices (TPB), where we take that knowledge and refine it into a set of theoretical best practices.
- Trade Promotion Planning (TPP), where we take those best practices and incorporate them into our workflow. This can include customized software design and new general processes.
- Trade Promotion Optimization (TPO), where we work to create an optimization model, and actually automate those new processes as best we can.
This is an iterative process, where we’re constantly executing, measuring results, refining practices, automating them, and on and on.
The 4 Metrics - What Is Being Measured?
In our client relationships, we’ve seen various companies attempting to measure different aspects of their business, from retail dollars, to shipment dollars, to equivalized volume (rolls/sheets for paper, pounds for candy etc.). This is where things start to get sticky. In fact, we covered this issue in a recent blog post on ship-to-consumption analysis.
Quality trade promotion analysis is impossible without the correct metrics. If you start by measuring the wrong things, all analysis falls apart. The four metrics you need are: Consumer Units, Revenue, The Incremental Factor and Spend Ratio.
1. Consumer Units
The key to keeping measurement simple and accurate is to measure exclusively in Consumer Units. If you want to be consumer-centric, then you need to measure the same way that the consumer buys.
If we need to equivalize later on to analyze certain things, then we do it later on. But the most important thing is to convert those consumer units to pounds, cases, rolls, whatever. This is a downstream process.
2. Revenue
We then take that unit count and create a measurement called Revenue. This is going to serve as the foundation of how we evaluate our incremental (promotional) sales vs. our base sales. This not Revenue in the way it is typically used, which is total Net Sales shipped. Rather our Revenue definition is the shipment value of the consumer units sold at retail. You get ZERO credit for loading inventory at your customers.
Here’s an example of ten weeks’ worth of weekly POS data:
In the three weeks where there’s obvious promotional activity, we’ll concentrate on Week 9, the one that shows the largest spike.
The way we define Revenue is as follows:
Net Wholesale Price x Retail Units
As an example, if the net cost was $3.50, and we sold 600 units, our Revenue would be $2,100 (3.50 x 600).
3. The Incremental Factor
We’ll come back to Revenue in just a few moments, but first, let’s talk about another important metric, the Incremental Factor.
This is probably the single most strategically important measure in trade promotion analytics…and almost nobody uses it!
The Incremental Factor is the incremental Revenue divided by the total Revenue. It can also be calculated as Incremental Units divided by Total Units. Revenue is better to use because it reflects differences in Net Pricing across a brand’s product portfolio. Incremental Factor effectively answers the question,
“What percentage of my business goes away if I stop promoting entirely?”
Let’s return to our example (here we are using Units):
Those spikes of 400, 350, 600 represent the number of units we sold over and above our day-to-day base sales. In this example, let’s say our base sales constitute 100 units per week.
Let’s calculate our total units. We’ve got seven weeks without any appreciable spikes:
7 x 100 = 700
We then add the three weeks of promotional activity:
700 + 400 + 350 + 600 = 2,050 total units.
Now, let’s compute our base units exclusively:
100 base units per week x 10 weeks = 1,000 base units.
Clearly, our incremental units constitute total units minus the base:
2,050 – 1,000 = 1,050
Remember, our incremental factor is comprised of the incremental units divided by the total units:
1,050 / 2,050 = .51, or 51%
The result is clear. If I stop promoting tomorrow, slightly more than half my total business disappears. (Note: this statement leads to many readers likely saying, “How do we know it goes away entirely? Won’t it just be made up on other brands or in future weeks?” The answer is no. It’s lost entirely, and we will address that question in more detail in later blog posts. For now you can review the actual academic research that proves the incrementality of these sales here.)
In short, Incremental Factor is the simplest way to tell just how dependent your business is on promotion. Let’s look at pasta sauce as an example.
As you can see, the entire category is highly dependent on their promotional activities. Even Prego, the brand with the lowest Incremental Factor of the top five brands, still depends on incremental sales for nearly half of their business.
4. Spend Ratio
The final metric that’s vital to assess is your profit, which we will measure using Spend Ratio. Spend Ratio is computed by taking your Incremental Revenue and dividing by total Spend. This can be done for a single event or any aggregated period, such as a quarter or year. Our goal is to simplify here, so we’re not going to mess around with manufacturing costs, logistical costs and other variable costs. Our break-even Spend Ratio (SR) is the reciprocal of your internal Margin Percentage per unit (1/m).
In addition to simplicity, this measure also has the benefit of being able to be shared with retailers because no sensitive internal costing information is being revealed. It can be easily communicated: “Look Mr./Ms. Buyer, I need to generate $x for every dollar I spend, and the current deal structure isn’t doing that. If you can help me get to that objective by shaving some of your margin I can go back and get more money from my management.”
As an example, let’s say that the total cost of three events is $1,500.
You’ll recall that our total incremental units were 1,050. We’ll multiply that by the net wholesale price of $3.50 to get $3,675. So, here’s the equation:
$3,675 (IR) / $1,500 (IS) = 2.4 Spend Ratio
Put another way, if the internal margin is greater than 42% (1/2.4), then the event is profitable.
Conclusion
- Consumer Units
- Revenue
- Incremental Factor
- Spend Ratio
Of course, you won’t be able to compute most of these accurately unless you can precisely calculate your base sales. Our next blog post takes you into the specifics of correct measurement, where you’ll be able to establish an accurate baseline.
Later on, we'll also dive into the world of data harmonization, where you’ll learn to improve the accuracy of results by standardizing on core units of measurement and integrating different sources of information.
