EXPERT COLUMN: The Promotion ROI Myth
Madge Smithy shops weekly at TPR-Mart. As she's about to pick up her usual Land’s Buttermilk Biscuits for $3 per unit, she notices that the Land’s Southern Style Biscuits are being promoted at a reduced price of $2 per unit. Realizing what a good deal that is, Smithy decides she'll buy the promoted Land’s Southern Style Biscuits instead of her usual Buttermilk Biscuits. And since it’s such a good deal, she buys enough for a month rather than one week’s supply -- 20 units instead of her usual five. All told, for the month she will spend $40 on Land’s Biscuits instead of $60. Many other shoppers do likewise.
The TPR-Mart and Land’s both think the promotion was a success because the units sold of Land’s Southern Style Biscuits skyrocketed. They believe the promotion had a positive ROI because sales on Southern Style Biscuits was up 300 percent that week.
In reality, the ROI was negative -- very negative. Here’s why:
- Sales of Buttermilk biscuits went down for the month.
- Many people who really preferred Buttermilk Biscuits bought Southern Style Biscuits, skewing demand.
- Due to the promotion and spike in demand, many stores had out-of-stocks on Southern Style Biscuits.
- The increase in point of sale (POS) on Southern Style Biscuits misled store replenishment systems to increase safety stock because the promotion increased forecast error.
- The increase in POS on Southern Style Biscuits in turn increased the forecasted demand to an unrealistic level.
- The increase in both safety stock and forecasted demand of Southern Style Biscuits caused an excessive supply to be delivered at all 550 stores on the next order.
- The unexpected increase in store orders for Southern Style Biscuits from all 550 stores caused the retailer distribution centers (DC) to stock out and to increase safety stock as well as forecasted demand.
- The increase in forecasted demand and safety stock at the retailer DC caused the retailer to order an unexpectedly large amount of product from the supplier.
- The supplier’s replenishment system then increased safety stock and forecasted demand as a result of the unexpected orders from the retailer.
- The supplier produced way more Southern Style Biscuits than it should have.
- Later, with the excess inventory in the entire supply chain, the amount of unsellable product skyrocketed.
- Transportation costs increased as the excess inventory in the supply chain also resulted in more transshipments between locations to balance inventory needs.
- The unexpected reduction in sales of Buttermilk Biscuits caused the demand forecasts in the stores to go down which resulted in decreased orders to the DCs and therefore the factories, causing the supplier to be misled into producing less.
- A month later Buttermilk Biscuits were stocking out in the stores, the DCs and at the supplier.
- The stockouts of Buttermilk Biscuits throughout the supply chain caused forecasts of Buttermilk Biscuits to be reduced, generating even more stockouts.
- The stockouts throughout the supply chain resulted in more emergency transshipments increasing transportation costs, again.
- Several people switched from Land's Buttermilk Biscuits to a competitive brand when they couldn’t find their regular product due to the large number of stockouts.
- As a result, sales of Buttermilk Biscuits continue to decline and many stores drop the SKU from the assortment in order to make room for an assortment addition in the category.
Although this is a highly stylized scenario, it actually occurs, either in part or in a similar scenario, and it shows the ripple effect that can happen from just one promotional event if there is a lack of transparency throughout the supply chain. Unfortunately, no one individual has visibility to or knowledge of all of these ramifications throughout the supply chain. If this were the case, these scenarios might happen less frequently or, at the very least, the ROI would be calculated accurately. Such a myopic view of promotions cause retailers and suppliers to blame one another for poor execution when in reality both are making poor decisions due to misinterpreted demand signals.
There are several approaches that are worth pursuing to improve the situation. However, remember to consider the fundamentals of managing the whole supply chain. Don’t be too quick to interpret an analysis that suggests a promotion has a positive ROI.
Here are a few ways retailers and suppliers can improve the ROI of a promotion:
- Clearly communicate to all nodes and links in the supply chain about the promotion and its expected impacts.
- Be sure to consider how the promotion will affect automated replenishment systems throughout the supply chain.
- In calculating the ROI, capture the impact on demand for substitute products (cannibalization).
- All calculations of the ROI should include impact on supply chain costs including inventory, stockouts, labor, transportation and others associated with uncertainty introduced into the forecasting system.
Technology plays a critical role in the success and ROI of promotions. In order to avoid a scenario similar to Land's Biscuits, incorporate the following capabilities:
- A demand signal repository that can handle daily POS data
- Sophisticated promotional forecasting capabilities
- Ability to estimate the impact on shelf availability
Dr. Matt Waller is currently the chief data scientist at Orchestro, Garrison Endowed Chair of Supply Chain Management at the University of Arkansas' Sam Walton College of Business and co-editor of the Journal of Business Logistics. He can be reached at [email protected]