IDEAS home Printed from https://ideas.repec.org/a/inm/ormksc/v20y2001i4p382-404.html
   My bibliography  Save this article

Effectiveness of Trade Promotions: Analyzing the Determinants of Retail Pass Through

Author

Listed:
  • Nanda Kumar

    (School of Management, University of Texas at Dallas)

  • Surendra Rajiv

    (Graduate School of Business, University of Chicago)

  • Abel Jeuland

    (Graduate School of Business, University of Chicago)

Abstract

Trade promotions are temporary price cuts that manufacturers offer retailers to encourage them to reduce retail prices. While trade promotion spending as a percentage of marketing budget has increased dramatically, the inefficiency of trade promotion represents the “number-one concern” among manufacturers, as indicated by recent trade surveys. At the heart of this dissatisfaction lies manufacturers' concern regarding widespread retailer opportunism with low retail pass through. Our objective is to develop a simple game-theoretic framework to examine the strategic considerations that underlie a retailer's decision to pass through a trade deal. In particular, we are interested in answering the following questions: (I) What and how do product-market characteristics impact the extent of retail opportunism? (II) How can the manufacturer alleviate the retail pass-through problem by strategically supplementing trade promotions with advertising trade deals directly to consumers? To address these issues, we consider a stylized channel with a single manufacturer who serves two customer segments through a single (focal) retailer. We implicitly capture the essence of retail competition by allowing customers to have an outside option: other retailers that customers might search if they deem the price at the focal retailers to be “too high.” Customers differ in their valuation for the manufacturer's product and in the costs they incur when searching for a better price at other retailers. While customers are unaware of the existence of a trade deal in any particular time period, through prior experience they know the frequency of such deals and, furthermore, they update their beliefs about the occurrence of a deal by observing the posted retail price. The retailer decides whether to pass through a deal or not, recognizing the impact of his pass-through policy on customers' search propensity, and hence, their willingness to pay. The main message of the paper is that in an environment where manufacturer offers trade promotions, a retailer may not have the incentive to pass a low wholesale price onto consumers because consumers do not have perfect information about ongoing trade promotions. When consumers observe a high price at the focal retailer and yet are not sure if a trade promotion is on, they may not look around for a low price. Therefore, the retailer can price opportunistically to gain a higher margin by not passing a low price to consumers. However, if the retailer never passes savings on, consumers can infer opportunistic pricing based on prior knowledge of trade promotion frequency and have a higher tendency to shop elsewhere, thus reducing sales volume. The retailer resolves the conflicting incentives by occasionally charging a low price when a trade promotion is on, while posting a high price on other occasions. We find that the extent of retail opportunism depends on product-market characteristics, such as the retailer's clientele and the heterogeneity in consumer search costs, as well as on the characteristics of the manufacturer's trade promotion policy, such as the frequency of trade promotion and the depth of discount offered. When the low-valuation consumers have search costs that make them exit the market when the focal retailer posts a high price, the manufacturer will intervene by advertising his trade promotion directly to consumers, thus performing a channel coordination function. We consider several extensions of the base model—explicit retail competition, differentiated retailers, and heterogeneity in consumers' knowledge about the frequency of trade deals—and show that our results still hold.

Suggested Citation

  • Nanda Kumar & Surendra Rajiv & Abel Jeuland, 2001. "Effectiveness of Trade Promotions: Analyzing the Determinants of Retail Pass Through," Marketing Science, INFORMS, vol. 20(4), pages 382-404, August.
  • Handle: RePEc:inm:ormksc:v:20:y:2001:i:4:p:382-404
    DOI: 10.1287/mksc.20.4.382.9757
    as

    Download full text from publisher

    File URL: http://dx.doi.org/10.1287/mksc.20.4.382.9757
    Download Restriction: no

    File URL: https://libkey.io/10.1287/mksc.20.4.382.9757?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Bester, Helmut & Petrakis, Emmanuel, 1995. "Price competition and advertising in oligopoly," European Economic Review, Elsevier, vol. 39(6), pages 1075-1088, June.
    2. Gerstner, Eitan & Hess, James D, 1991. "A Theory of Channel Price Promotions," American Economic Review, American Economic Association, vol. 81(4), pages 872-886, September.
    3. Rajiv Lal & J. Miguel Villas-Boas, 1998. "Price Promotions and Trade Deals with Multiproduct Retailers," Management Science, INFORMS, vol. 44(7), pages 935-949, July.
    4. Eitan Gerstner & James D. Hess, 1995. "Pull Promotions and Channel Coordination," Marketing Science, INFORMS, vol. 14(1), pages 43-60.
    5. Diamond, Peter A., 1971. "A model of price adjustment," Journal of Economic Theory, Elsevier, vol. 3(2), pages 156-168, June.
    6. Rajiv Lal & John D. C. Little & J. Miguel Villas-Boas, 1996. "A Theory of Forward Buying, Merchandising, and Trade Deals," Marketing Science, INFORMS, vol. 15(1), pages 21-37.
    7. K. Sridhar Moorthy, 1988. "Product and Price Competition in a Duopoly," Marketing Science, INFORMS, vol. 7(2), pages 141-168.
    8. Joel Sobel, 1984. "The Timing of Sales," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 51(3), pages 353-368.
    9. Sang Yong Kim & Richard Staelin, 1999. "Manufacturer Allowances and Retailer Pass-Through Rates in a Competitive Environment," Marketing Science, INFORMS, vol. 18(1), pages 59-76.
    10. K. Sridhar Moorthy & I. P. L. Png, 1992. "Market Segmentation, Cannibalization, and the Timing of Product Introductions," Management Science, INFORMS, vol. 38(3), pages 345-359, March.
    11. Jagmohan S. Raju & V. Srinivasan & Rajiv Lal, 1990. "The Effects of Brand Loyalty on Competitive Price Promotional Strategies," Management Science, INFORMS, vol. 36(3), pages 276-304, March.
    12. Preyas S. Desai & Kannan Srinivasan, 1995. "Demand Signalling Under Unobservable Effort in Franchising: Linear and Nonlinear Price Contracts," Management Science, INFORMS, vol. 41(10), pages 1608-1623, October.
    13. Ram C. Rao, 1991. "Pricing and Promotions in Asymmetric Duopolies," Marketing Science, INFORMS, vol. 10(2), pages 131-144.
    14. Narasimhan, Chakravarthi, 1988. "Competitive Promotional Strategies," The Journal of Business, University of Chicago Press, vol. 61(4), pages 427-449, October.
    15. Abel P. Jeuland, 1979. "Brand Choice Inertia as One Aspect of the Notion of Brand Loyalty," Management Science, INFORMS, vol. 25(7), pages 671-682, July.
    16. K. Sridhar Moorthy, 1987. "Comment—Managing Channel Profits: Comment," Marketing Science, INFORMS, vol. 6(4), pages 375-379.
    17. Eric T. Anderson & Duncan I. Simester, 1998. "The Role of Sale Signs," Marketing Science, INFORMS, vol. 17(2), pages 139-155.
    18. Benoit, Jean-Pierre & Krishna, Vijay, 1985. "Finitely Repeated Games," Econometrica, Econometric Society, vol. 53(4), pages 905-922, July.
    19. Rajiv Lal, 1990. "Price Promotions: Limiting Competitive Encroachment," Marketing Science, INFORMS, vol. 9(3), pages 247-262.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. F. J. Arcelus & G. Srinivasan, 2006. "Marketing|inventory interactions in the characterization of retailer response to manufacturer trade deals," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 27(7), pages 537-547.
    2. Jie Wu & Zhixin Chen & Xiang Ji, 2020. "Sustainable trade promotion decisions under demand disruption in manufacturer-retailer supply chains," Annals of Operations Research, Springer, vol. 290(1), pages 115-143, July.
    3. Maratou, Laoura & Gomez, Miguel I. & Just, David R., 2004. "Market Power And Off-Invoice Trade Promotions In The Us: An Empirical Investigation," 2004 Annual meeting, August 1-4, Denver, CO 20280, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
    4. Chadwick J. Miller & Daniel C. Brannon & Jim Salas & Martha Troncoza, 2021. "Advertising, incentives, and the upsell: how advertising differentially moderates customer- vs. retailer-directed price incentives’ impact on consumers’ preferences for premium products," Journal of the Academy of Marketing Science, Springer, vol. 49(6), pages 1043-1064, November.
    5. Hellerstein, Rebecca, 2008. "Who bears the cost of a change in the exchange rate? Pass-through accounting for the case of beer," Journal of International Economics, Elsevier, vol. 76(1), pages 14-32, September.
    6. Meghan Busse & Florian Zettelmeyer & Jorge Silva-Risso, 2004. "$1000 Cash Back: Asymmetric Information in Auto Manufaturer Promotions," NBER Working Papers 10887, National Bureau of Economic Research, Inc.
    7. Tsao, Yu-Chung & Lu, Jye-Chyi, 2016. "Trade promotion policies in manufacturer-retailer supply chains," Transportation Research Part E: Logistics and Transportation Review, Elsevier, vol. 96(C), pages 20-39.
    8. Corstjens, Marcel & Steele, Richard, 2008. "An international empirical analysis of the performance of manufacturers and retailers," Journal of Retailing and Consumer Services, Elsevier, vol. 15(3), pages 224-236.
    9. Mohammad Jahangir Alam & Andrew M. McKenzie & Ismat Ara Begum & Jeroen Buysse & Eric J. Wailes & Guido Huylenbroeck, 2016. "Asymmetry Price Transmission in the Deregulated Rice Markets in Bangladesh: Asymmetric Error Correction Model," Agribusiness, John Wiley & Sons, Ltd., vol. 32(4), pages 498-511, November.
    10. Arcelus, F.J. & Kumar, Satyendra & Srinivasan, G., 2008. "Pricing and rebate policies in the two-echelon supply chain with asymmetric information under price-dependent, stochastic demand," International Journal of Production Economics, Elsevier, vol. 113(2), pages 598-618, June.
    11. Kusum L. Ailawadi & Bari A. Harlam, 2009. "—Retailer Promotion Pass-Through: A Measure, Its Magnitude, and Its Determinants," Marketing Science, INFORMS, vol. 28(4), pages 782-791, 07-08.
    12. Steven M. Shugan, 2003. "Editorial: Defining Interesting Research Problems," Marketing Science, INFORMS, vol. 22(1), pages 1-15.
    13. Sridhar Moorthy, 2005. "A General Theory of Pass-Through in Channels with Category Management and Retail Competition," Marketing Science, INFORMS, vol. 24(1), pages 110-122, August.
    14. Joost Rietveld & Melissa A. Schilling & Cristiano Bellavitis, 2019. "Platform Strategy: Managing Ecosystem Value Through Selective Promotion of Complements," Organization Science, INFORMS, vol. 30(6), pages 1232-1251, November.
    15. Metin Çakır, 2022. "Retail pass‐through of package downsizing," Agribusiness, John Wiley & Sons, Ltd., vol. 38(2), pages 259-278, April.
    16. Xiaolong Guo & Shengming Zheng & Yugang Yu & Fuqiang Zhang, 2021. "Optimal Bundling Strategy for a Retail Platform Under Agency Selling," Production and Operations Management, Production and Operations Management Society, vol. 30(7), pages 2273-2284, July.
    17. Mohammad J Alam & Raghbendra Jha, 2016. "Asymmetric threshold vertical price transmission in wheat and flour markets in Dhaka (Bangladesh): seemingly unrelated regression analysis," ASARC Working Papers 2016-03, The Australian National University, Australia South Asia Research Centre.
    18. Hall, Joseph M. & Kopalle, Praveen K. & Krishna, Aradhna, 2010. "Retailer Dynamic Pricing and Ordering Decisions: Category Management versus Brand-by-Brand Approaches," Journal of Retailing, Elsevier, vol. 86(2), pages 172-183.
    19. Gomez, Miguel I. & Rao, Vithala R. & Yuan, Hong, 2008. "Effects of Horizontal and Vertical Market Power on Trade Promotion Budget and Allocation in the US Supermarket Industry: An Experimental and Empirical Analysis," 2008 Annual Meeting, July 27-29, 2008, Orlando, Florida 6247, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
    20. Limon Deb & Yoonsuk Lee & Sang Hyeon Lee, 2020. "Market Integration and Price Transmission in the Vertical Supply Chain of Rice: An Evidence from Bangladesh," Agriculture, MDPI, vol. 10(7), pages 1-21, July.
    21. Abhijit Banerjee & Sharon Barnhardt & Esther Duflo, 2015. "Movies, Margins, and Marketing: Encouraging the Adoption of Iron-Fortified Salt," NBER Chapters, in: Insights in the Economics of Aging, pages 285-306, National Bureau of Economic Research, Inc.
    22. Cao, Qingning & Geng, Xianjun & Zhang, Jun, 2015. "Strategic Role of Retailer Bundling in a Distribution Channel," Journal of Retailing, Elsevier, vol. 91(1), pages 50-67.
    23. Arcelus, F.J. & Kumar, Satyendra & Srinivasan, G., 2007. "Pricing and rebate policies for the newsvendor problem in the presence of a stochastic redemption rate," International Journal of Production Economics, Elsevier, vol. 107(2), pages 467-482, June.
    24. Tsao, Yu-Chung & Lu, Jye-Chyi & An, Na & Al-Khayyal, Faiz & Lu, Richard W. & Han, Guanghua, 2014. "Retailer shelf-space management with trade allowance: A Stackelberg game between retailer and manufacturers," International Journal of Production Economics, Elsevier, vol. 148(C), pages 133-144.
    25. Desheng Wu, 2017. "Pass-through decision analysis in a supply chain," Annals of Operations Research, Springer, vol. 257(1), pages 297-316, October.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Hao Lan & Tim Lloyd & Wyn Morgan & Paul W. Dobson, 2022. "Are food price promotions predictable? The hazard function of supermarket discounts," Journal of Agricultural Economics, Wiley Blackwell, vol. 73(1), pages 64-85, February.
    2. Bing Jing, 2007. "Product differentiation under imperfect information: When does offering a lower quality pay?," Quantitative Marketing and Economics (QME), Springer, vol. 5(1), pages 35-61, March.
    3. Surendra Rajiv & Shantanu Dutta & Sanjay K. Dhar, 2002. "Asymmetric Store Positioning and Promotional Advertising Strategies: Theory and Evidence," Marketing Science, INFORMS, vol. 21(1), pages 74-96, October.
    4. Mathur, Sameer & Sinitsyn, Maxim, 2013. "Price promotions in emerging markets," International Journal of Industrial Organization, Elsevier, vol. 31(5), pages 404-416.
    5. Villas-Boas, Sofia B & Villas-Boas, Miguel, 2006. "Learning, Forgetting, and Sales," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt7td275hv, Department of Agricultural & Resource Economics, UC Berkeley.
    6. Villas-Boas, Sofia B & Villas-Boas, J Miguel, 2008. "Learning, Forgetting, and Sales," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt01v2r04t, Department of Agricultural & Resource Economics, UC Berkeley.
    7. Raju, Jagmohan S., 1995. "Theoretical models of sales promotions: Contributions, limitations, and a future research agenda," European Journal of Operational Research, Elsevier, vol. 85(1), pages 1-17, August.
    8. Rajiv Lal & J. Miguel Villas-Boas, 1998. "Price Promotions and Trade Deals with Multiproduct Retailers," Management Science, INFORMS, vol. 44(7), pages 935-949, July.
    9. Sofia Berto Villas-Boas & J. Miguel Villas-Boas, 2008. "Learning, Forgetting, and Sales," Management Science, INFORMS, vol. 54(11), pages 1951-1960, November.
    10. Eric Anderson & Nanda Kumar, 2007. "Price competition with repeat, loyal buyers," Quantitative Marketing and Economics (QME), Springer, vol. 5(4), pages 333-359, December.
    11. Zheyin (Jane) Gu & Yunchuan Liu, 2013. "Consumer Fit Search, Retailer Shelf Layout, and Channel Interaction," Marketing Science, INFORMS, vol. 32(4), pages 652-668, July.
    12. Liang, Donghan & Li, Gang & Sun, Linyan & Chen, Yubao, 2013. "The role of rebates in the hybrid competition between a national brand and a private label with present-biased consumers," International Journal of Production Economics, Elsevier, vol. 145(1), pages 208-219.
    13. Holzer, Patrick Sebastian, 2020. "The effect of time-varying factors on promotional activity in the German milk market," Journal of Retailing and Consumer Services, Elsevier, vol. 55(C).
    14. Berck, Peter & Brown, Jennifer & Perloff, Jeffrey M & Villas-Boas, Sofia B., 2007. "Sales: Tests of Theories on Causality and Timing," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt2g56n1jk, Department of Agricultural & Resource Economics, UC Berkeley.
    15. Kutsal Dogan & Ernan Haruvy & Ram Rao, 2010. "Who should practice price discrimination using rebates in an asymmetric duopoly?," Quantitative Marketing and Economics (QME), Springer, vol. 8(1), pages 61-90, March.
    16. Villas-Boas, Sofia B & Perloff, Jeff & Berck, Peter & Brown, Jen, 2008. "Sales: Tests of Theories on Causality and Timing," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt0076k5r6, Department of Agricultural & Resource Economics, UC Berkeley.
    17. Dmitri Kuksov & Kangkang Wang, 2014. "The Bright Side of Loss Aversion in Dynamic and Competitive Markets," Marketing Science, INFORMS, vol. 33(5), pages 693-711, September.
    18. Marshall Freimer & Dan Horsky, 2008. "Try It, You Will Like It—Does Consumer Learning Lead to Competitive Price Promotions?," Marketing Science, INFORMS, vol. 27(5), pages 796-810, 09-10.
    19. Kusum L. Ailawadi & Praveen K. Kopalle & Scott A. Neslin, 2005. "Predicting Competitive Response to a Major Policy Change: Combining Game-Theoretic and Empirical Analyses," Marketing Science, INFORMS, vol. 24(1), pages 12-24, September.
    20. Sigué, Simon Pierre, 2008. "Consumer and Retailer Promotions: Who is Better Off?," Journal of Retailing, Elsevier, vol. 84(4), pages 449-460.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:inm:ormksc:v:20:y:2001:i:4:p:382-404. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Chris Asher (email available below). General contact details of provider: https://edirc.repec.org/data/inforea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.