Outlook dims on trade promotion

Will new accounting rules, SEC probes, Wal-Mart exorcise the ghost of Nixon?

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Call it the ghost of Richard Nixon.

 

Trade promotion as the food industry knows it was born in the aftermath of price controls imposed by President Nixon amid rampant inflation in the 1970s. Food companies, fearing they could get stuck with another price freeze, started hiking list prices at double-digit rates and dealing back the increases in the form of trade allowances.

 

Trade promotion kept snowballing right through the 1980s on largely the same terms, even though the threat of price controls had long since abated. Then the 1990s brought an even more unfortunate phenomenon for the industry. A combination of recession early in the decade and retail consolidation thereafter made it harder to raise prices, yet also harder to resist demands from retailers to spend more on trade deals.

 

Efforts to reform the system in the 1990s -- such as everyday low pricing, value pricing and Efficient Consumer Response -- met with limited success at best. Mass merchandisers and club stores didn't play by the old deal rules, but most supermarket operators who tried everyday low pricing soon scurried back to their high-low ways.

 

Now a new form of 21st century regulation, combined with accounting scandals and the evolving structure of the food industry, may finally be putting a dent in the marketing tool food marketers have grown to hate.

 

New accounting rules that most food companies implemented in 2002 did what some marketers felt was impossible , made trade promotion even less attractive than it already was. Spending that once could be counted as a marketing expense now must generally be accounted for as a deduction against sales. While the change means no impact on profits, it has trimmed billions off the top lines of major food players and shaved points off of top lines in an industry already struggling to show sales growth.

 

The spectre of the ,'70s

 

The impact of the new rules on the package-goods industry shows just how large the spectre of the ,'70s still looms. Gartner Group estimates trade promotion is now a $25 billion annual enterprise. Research by Wilton, Conn.-based Cannondale Associates shows restatements necessitated by the new accounting standards will reduce industry revenue by 8.5 percent and result in an average reduction in sales growth of 30 percent for most companies as numbers are restated for the 10 prior years.

 

The steady climb in trade spending has made it the industry's second leading expense after cost of goods sold. The impact is even bigger for food companies, where trade spending has been heavier, than for non-food package goods players. The average reduction in 2002 revenue for food companies from the rules is 9.9 percent, Cannondale estimates, compared to 6.1 percent for health and beauty care players.

 

The changes reduce the package-goods industry's average annual growth rate from 2.9 percent to 2 percent for the years 1997 to 2001, and the impact is even greater for food companies, which spend 59 percent of their marketing budget on trade promotion and another 11 percent on account-specific marketing, for a total of 70 percent of marketing dollars spent on the trade. By contrast, HBC marketers spend 40 percent of marketing dollars on trade promotion and 19 percent on account-specific plans , a total of 59 percent.


Most manufacturers still struggling

 

"The new rules certainly have gotten everyone's attention," says Ken Harris, partner with Cannondale. But he believes most manufacturers are still struggling with exactly what they're going to do in response to the new rules. The waste involved in trade spending has long been a major issue for manufacturers, Cannondale research shows. The problem has always been doing anything about it.

 

But the financial impact may be inspiring more manufacturers to try harder. Cannondale's 2002 study showed that for the first time in five years, the share of marketing budgets earmarked for trade promotion and account-specific programs actually declined , from 61 percent to 59 percent. The move helped partially reverse the long slide in spending on consumer promotion, primarily couponing, but left advertising unchanged. More retailers apparently left the table feeling short-changed as a result, since the share who said they receive their fair share of trade dollars declined to 54 percent from 63 percent. Still, trade promotion as a share of manufacturers' gross sales increased to 16.9 percent, up 0.5 points from 2001, as overall marketing budgets increased.

 

Harris believes the new scrutiny on trade spending already has figured into the recent move by Philip Morris Co.'s Kraft Foods to get bang for its trade bucks, unilaterally changing the terms of its slotting fees by paying only half of the slotting money up front and the other half when new products actually reach store shelves.

 

Even a giant like Kraft feels the pinch from trade promotion. The company's filings with the U.S. Securities and Exchange Commission show that its trade promotion spending went up $1 billion to $4.7 billion in 2001, the year it consolidated its Nabisco Foods acquisition, even though advertising spending stayed flat at $1.2 billion.

 

Paul Kelly, partner in Westport, Conn.-based Silvermine Consulting Group, believes the new accounting rules will make it harder for manufacturers to shift trade funds around between accounts and between programs. He also believes it will reverse a trend toward lumping all trade funds into one big pot. Instead, manufacturers will want to segment out spending on such things as temporary price reductions and in-store circulars from other account-specific programs, such as co-branded manufacturer-retailer advertising, that still may be treated as a bona fide marketing expense for accounting purposes.

 

"I think in the longer term that if trade spending comes off of your gross revenue and it doesn't add to your bottom line, then accountants push back on that more," Kelly says. So he expects that demands from chief financial officers that trade spending show return on investment will intensify.

 

Promodata, a Chicago-based firm that tracks trade deals nationally, may already be seeing some signs of that. Rich Palesh, president of Promodata, says the size of trade deals has been on the rise in the past year, but that they often cover fewer brands and products than they used to. "Manufacturers aren't necessarily spending more money," he says, "but they're concentrating more money on their bigger brands and products. They may be looking to get more for their money that way."

 

Meanwhile, just accounting for all that money has become an increasing problem for retailers. Bankrupt Kmart, Great Atlantic & Pacific Tea Co. and grocery wholesalers Fleming and Nash Finch all have either restated revenues and earnings or are undergoing internal or SEC probes into how they account for vendor allowances. Of the four, only A&P so far has come out with a clean bill of health, voluntarily disclosing timing errors in accounting for funds that actually understated the retailers' earnings in past periods.

 

Harris believes the growing financial and accounting difficulties in dealing with conventional trade deals may have been among factors that prompted Rochester, N.Y.-based supermarket Wegmans to adopt an EDLP strategy in 2002. Overall, however, he said Cannondale's most recent survey shows EDLP is likewise held in relatively low regard among retailers, and he doubts many others will follow suit.

 

What could make the debate increasingly moot, however, is the continued growth of mass merchandisers Target and Wal-Mart Stores. Both plan aggressive expansion into food retailing and both of which shun most conventional trade deals in favor of the lowest possible negotiated price combined with jointly developed marketing programs designed to move merchandise.

 

Wal-Mart's reach

 

Of the two, Wal-Mart is by far the bigger factor. The company's supercenter expansion already has propelled it to account for more than 10 percent of the annual sales of such food giants as Kraft and General Mills in the past year. Now, Wal-Mart is developing two more prongs in its attack on supermarket retailing. The chain's supermarket-size Neighborhood Markets, which were getting a slow rollout into states surrounding Wal-Mart's Arkansas home base, will get a more aggressive push in 2003, with plans for construction of 25 stores in Florida. And according to retail executives, Wal-Mart has begun quietly approaching independent and small chain retailers about become their wholesaler, which could quickly make it a factor even in stores it doesn't own.

 

Wal-Mart's growth will continue to make conventional trade dealing less of a factor for food companies, Harris and Kelly say. But they're not sure how Wal-Mart as a supermarket wholesaler will affect industry deals. Harris says small chains and independents will still want conventional deals, and refusing to play ball could limit Wal-Mart's prospects as an independent. But Kelly says it may be difficult for independents who buy from Wal-Mart to get in on the same deals they have through conventional wholesalers. 

 

"If Wal-Mart can get them a lower price anyway," he says, "it may not be much of an issue."
        

 

Breakdown of marketing budgets

 

 Year 

1997

1998

1999

2000

2001

2002

 Advertising 

23%

25%

23%

24%

24%

24%

 Consumer  Promotion

24%

19%

17%

16%

15%

17%

 Account specific retailer programs   

9%

9%

7%

11%

10%

10%

 Trade Promotion

44%

47%

53%

49%

51%

49%

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