Home > Business, Cost Reduction, ERP, Process Improvement, Supply Chain > The Cost of Promotional Sales

The Cost of Promotional Sales

Grocery retailers frequently use promotional sales to lure customers into stores.  Retailers hope customers will purchase higher margin products while they shop for the promoted items.  Chicago grocers Jewel-Osco, subsidiary of SUPERVALU, and Dominick’s, subsidiary of Safeway, both follow use this marketing strategy, changing promotions twice a week.  The promotional sales may increase customer traffic, but they may also lead to the demise of the store.  I suspect, retailers that use promotional sales, on every day products sold year round, increase the cost of doing business and decrease supply chain efficiency.

Used by many grocers, promotional sales are the activities, materials, devices, and techniques used in the advertising and marketing of products.  I separated their cost into two different categories; direct costs and indirect costs.  I see the money spent on the processes and material to implement the promotional sale as direct costs, and the money lost due of the effects of the promotional sales are considered indirect costs.  From my point of view, both of these costs are significantly high, high enough to possibly outweigh any benefit of the promotional sales.  If I were managing a retail grocery operation, these are the items I would consider when deciding whether or not to continue utilizing promotional sales.

Direct Costs

Promotional sales have many components, each having a cost associated with it. Planning, marketing, inventory builds, and store preparations all take time to complete and consume valuable company resources.

Planning

Planning a promotional sale must be time consuming and costly.  Stores need to decide what products to put on sale, when to put them on sale, and at which price to sell them during the sale.  They must also decide how they will market the promotion, design the promotion, and distribute the promotion. It takes time for the retailer to manage, and it takes time for suppliers to manage.  That being said, it is possible that retailers who promote frequently can manage this process relatively efficiently.  However, managing a promotional sales still requires resources; resources that do nothing other than manage and execute promotions. The planning process is only the beginning.

Marketing

Promotions need to be communicated to the public, using any number of methods, all of which cost money.  From my experience, grocers seem to prefer some form of print media, like news papers or local ad circulars. Designing, printing, and delivering these advertisements must add significantly to a retailers cost. Some grocers even compliment the print media with radio and TV commercials, all of which take additional resources to produce and distribute.

Inventory Builds

Before the promotional sale starts, retailers must increase inventory of the items being promoted. Vendors, transporters, distribution centers, and storefronts all need to take special measures to guarantee extra inventory is delivered, on time.  Not only on time, but just in time; fresh produce spoils quickly and it’s vital the delivery process be planned and executed without error.  Early or late delivery can lead to costly spoiled inventory. In addition to any spoiled inventory losses; inventory builds take significant amounts of working capital.

Store Preparations

At the start of the promotional sale, costly store preparations must occur.  I have witnessed employees rearranging store shelving to accommodate shifts in inventory in anticipation of an increase in demand for some products, and decrease in demand for others.  Price tags throughout the store need to be updated, reprinted, and reapplied.  Finally, if displays are being used, they must be built and placed.

Each activity and consumable is temporary.  As promotions end and new ones begin, I expect these four processes repeat endlessly, adding cost during each cycle.

Indirect Costs

Along with any direct costs mentioned above, I predict promotional sales also have indirect costs aswell. Indirect costs caused by poor forecast accuracy, inadequate supply chain communication, and large inventory swings.

Forecast Accuracy

As part the planning and execution phases, I suspect most vendors and retailers use Enterprise Resource Planning systems, or ERP systems, to manage the supply chain.  ERP systems use a multitude of variables, including, but not limited to forecasts, past orders, current orders, and current inventory levels, to track, plan, and manage inventory.  Recommendations to create purchase orders or manufacturing requirements are created on a regular basis. Recommendations may be edited manually and released by planners, or  they may be released automatically as purchase orders to suppliers.

Because forecasts are the foundation of ERP system demand calculations, I know the data must be clean and accurate for the systems to operate efficiently.  But, from my point of view, promotional sales cause forecast data to be dirty or inaccurate for two reasons: lack of predictability, and manual data entry.

I assume it is nearly impossible to precisely predict how inventory will move during and after a promotional sale.  The incredibly high quantity of variables makes it close to impossible to accurately forecast purchasing. Even the most nimble and elaborate forecasting software will likely have difficulty analyzing uneven sales data, not knowing what impact each dip or spike had, or if the dip or spike will happen again. During a promotion, inventory could be wiped out completely or may not be sold at all.  After the promotion, purchasing may likely decrease but it may, instead, increase.  The dip or spike in demand will last an unknown period of time.  I suspect competitors may possibly have a promotion on the same or competing products.  The promotion price may or may not impact purchasing.  Finally, it is also likely a naturally occurring or unpredicted event may also affect demand.

Even if all the variables are correct and accounted for, and the company has perfect knowledge of consumers’ thoughts and competitors’ marketing, forecasts may still be entered or edited incorrectly.  The manual data entry processes is far from six-sigma levels of accuracy and, from my experience in analyzing forecast data, will most likely have errors.  Incorrectly entered or edited data points could flow automatically from the retailer’s ERP system to the vendor’s ERP system without notice.  It is likely systems would be in place to detect erroneous data, but because the data nature of highly volatile forecasts, I would expect the detection systems would miss many errors.

Supply Chain Communications

The ramifications of incorrectly generated and/or entered forecasts could be huge and expensive.  Data often trickles down from retailers to distributors and from distributors to suppliers; Most likely traveling automatically by way of automatic releases of ERP generated purchase order recommendations.  An invalid forecast could be transfered from the retailer to distributor to vendor without anyone knowing its inaccuracy.

Correct, but changed forecasts, could also cause problems.  I expect promotion plans change all the time.  They may get canceled, dates may move, or anticipated purchasing may change.   Regardless of the change, corrections or non-standard changes could get lost, miss communicated, or miss translated when being sent from retailers to vendors.  In some cases, they may not be communicated at all.

The farther away in the supply chain a company is from the retailer, the more difficult planning and communication becomes.  At the front of the chain, retailers have direct knowledge of a promotion, and have the ability to add or edit the details in their ERP system.  As promotions are developed, retailers communicate information to suppliers.  But, as mentioned before, if a promotion changes, it may not be fully communicated to all suppliers.  To add to the confusion, suppliers have suppliers, and those suppliers also have suppliers.  The farther down the chain, the less promotion visibility is seen.

The entire chain is only as good as the weakest link.  If not handled quickly and efficiently, at all levels of the supply chain, one invalid or missed forecast entry, or forecast change, has the ability to trigger massive product spoilage.

Inventory Swings

From my experience at a manufacturing company, huge swings in inventory are nightmares for suppliers.  Inventory builds require increased production, which may require overtime pay and/or auxiliary temporary warehouse space; both impacting the supplier’s profitability.  On the other hand, purchasing reductions that occur after a promotion ends may lead to vast amounts of unused warehouse space, non-moving inventory, or unutilized resources or personnel.  These swings are not only problems for suppliers, they are disruptive to transporters as well.

Trucking is the predominant type of food transportation in the United States.  Trucking is a tough business; just like empty planes, empty or unused trucks are not profitable. To be profitable, trucking companies need to haul loads to and from sources and destinations.  And inventory swings spurred by promotion sales create irregular shipments and increase the possibility of empty trailers for flatbed trucks.  Fortunately, third party logistics companies have become a popular way to mitigate the cost of empty trucks, but I still don’t believe they are still not a perfect solution, nor do they provide free services.

The least tangible costs of inventory swings are their affect on data mining and forecast generation.  As previously discussed, forecast accuracy is crucial.  From my experience as a Supply Planner, large swings in inventory make it very difficult to produce an accurate forecast. Standard deviations for products that regularly go on sale are extremely high, and systematically generated forecasts can be incredibly inaccurate.

Any losses or costs incurred at any point in the supply chain will be passed on to the retailer by way of higher wholesale prices, regardless who is at fault.  The retailer will then pass that cost increase to the consumer via higher retail prices throughout the store, not necessarily on the product being promoted.   Keep in mind, all of these additional costs are being incurred to sell an item at a reduced price, likely a price below wholesale cost.

I believe retailers that use promotional sales as part of their marketing strategy are pregnant with cost saving opportunities.  It only requires retailers to realize how many costs are likely associated with their promotional sales in order for them to analyze their promotional sales strategy.  In a retail world ruled by everyday low prices, the analysis will hopefully come soon.  If not, retailers selling everyday products will likely fail because their promotional sales have a high probability of increasing their cost of doing business and decreasing their supply chain efficiency.


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  1. February 25, 2010 at 9:12 PM

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