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

Author

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  • 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
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    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.
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    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. 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.
    6. 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.
    7. 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).
    8. 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.
    9. 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.
    10. 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.
    11. 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.
    12. 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.
    13. 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.
    14. 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.
    15. 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.
    16. 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.
    17. 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.
    18. Steven M. Shugan, 2003. "Editorial: Defining Interesting Research Problems," Marketing Science, INFORMS, vol. 22(1), pages 1-15.
    19. 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.
    20. 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.
    21. 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.
    22. Desheng Wu, 2017. "Pass-through decision analysis in a supply chain," Annals of Operations Research, Springer, vol. 257(1), pages 297-316, October.
    23. 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.
    24. Metin Çakır, 2022. "Retail pass‐through of package downsizing," Agribusiness, John Wiley & Sons, Ltd., vol. 38(2), pages 259-278, April.
    25. 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.

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