How Zero-Based Budgeting Can Transform Consumer Trade Promotions
Zero-based budgeting (ZBB) is lately all the rage in consumer goods. It’s a remarkably simple thing to explain: instead of assuming every department’s budget should be exactly the same as it was last period plus or minus some incremental adjustments, the default assumption is that each department should budget for everything that they invest in from a zero base. It’s not just an accounting technique, it’s a philosophy that costs should be justified based on a business purpose and not assumed to be a “given.” It’s not new thinking -- Jimmy Carter used it as governor to budget the state of Georgia.
One example of where a ZBB philosophy should most definitely be applied is in trade promotions. Currently, the typical CPG spends 25 percent of net revenue on discounts and promotions, and a slew of analysts have already proven that these discounts have a negative ROI. It's easy to understand why; most consumer goods categories are highly cross-price elastic on deal but category inelastic every day. Also, consumers don’t become more loyal to brands because of perceived sales (at least not once that sale is over), and discounts are quickly countered by competition. All of which serves to escalate trade funding each year, which in turn increases supply chain and retail performance volatility. This commoditizes brands and leads to increased consumer store switching and other value-destructive behavior for the entire industry. If promotions were budgeted from a ZBB approach, we wouldn’t be in this collective mess. So why don’t more companies do it?
The most obvious answer is “my retail partners would never let me allocate trade from a zero-based budget.” Anyone who says this is right. A typical retailer in the U.S. market is lucky to eke out 4-6 percent EBITDA margins. Trade spend often dramatically exceeds to the total profitability of a retailer, and if those funds are taken away, their entire business could be wiped out overnight. It’s a hot button issue that causes debate in every top-to-top meeting I’ve ever sat in. However, that doesn’t mean the retailers like having to rely on those trade dollars for their businesses to stay afloat.
As a merchant, the time and stress of constantly looking over your shoulder, worrying about what your competition is about to run and doubting whether your trusted supplier is really giving you the same terms, is exhausting. This trust isn’t usually enhanced by common benchmarking from consultants, or access to price files after a major acquisition, that often reveal the "consistent" trade terms offered to everyone aren’t quite as consistent as that trusted supplier had been telling them.
Why do these trade rates end up being so disparate across retailers? Part of it stems from avoiding a ZBB approach to budgeting. Every retailer asks to “anniversary” the trade events from the previous year, nervous about losing out. Manufacturers, meanwhile, comp their sales teams on sales vs. the prior year, and there’s no way to sustain the addiction of that rented market share without keeping the trade levels flat and working slowly from there to close new gaps. As a result, even the events themselves get copied over, so the battle for market share gets as specific as making sure your team is competitive on every single week in every single banner vs. your market share last year. The result? A “sea of sameness” where the same deals run on the same weeks every year, except the weeks where you lost last year… those weeks get an even lower price. As a result, trade rates go up every year, consumers get less loyal every year, and more and more of the supply chain gets distorted with heavy peaks and valleys.
So, what might it look like if a ZBB approach to trade was used? For starters, it's time to get rid of false frontlines on products. If you’re on deal 40 weeks a year, and out of business the other 12 weeks, the new lower price should just be the reality in the market, and those savings should be passed on to retailers from day 1.
Promoted events should be based on what consumers want to buy (not just what the manufacturer wants to sell), and there should be some reason for them. Is the shopping behavior of your category split between loyalists who regularly buy large supplies, and occasional users who tend to sample on impulse? Heavy vs. light users? Occasional vs. frequent? What about investing those extra dollars in a seasonal category that consumers love, but only engage with around certain holidays? Or perhaps the trade budgets should be lowered on the core transaction packages (with a corresponding drop in price), and trade funds be redirected to drive impulse behavior for those you can still surprise and delight with a deal?
With the rise of digital assets (load-to-card offers, personalized circulars, in-store coupon printers, mobile apps, etc.), these assets can be perfect testing grounds for experimenting on different offer structures that can meet the needs of each group, without spending the funds on the groups that don’t need it. These platforms also serve as a great basis for experimentation for the most compelling deals to the general public. Don’t assume the deal you ran this week last year is the best that can ever be done -- consumer preferences can evolve greatly within the span of a year. Test many different offers to see which consumers respond best to today.
One example of where a ZBB philosophy should most definitely be applied is in trade promotions. Currently, the typical CPG spends 25 percent of net revenue on discounts and promotions, and a slew of analysts have already proven that these discounts have a negative ROI. It's easy to understand why; most consumer goods categories are highly cross-price elastic on deal but category inelastic every day. Also, consumers don’t become more loyal to brands because of perceived sales (at least not once that sale is over), and discounts are quickly countered by competition. All of which serves to escalate trade funding each year, which in turn increases supply chain and retail performance volatility. This commoditizes brands and leads to increased consumer store switching and other value-destructive behavior for the entire industry. If promotions were budgeted from a ZBB approach, we wouldn’t be in this collective mess. So why don’t more companies do it?
The most obvious answer is “my retail partners would never let me allocate trade from a zero-based budget.” Anyone who says this is right. A typical retailer in the U.S. market is lucky to eke out 4-6 percent EBITDA margins. Trade spend often dramatically exceeds to the total profitability of a retailer, and if those funds are taken away, their entire business could be wiped out overnight. It’s a hot button issue that causes debate in every top-to-top meeting I’ve ever sat in. However, that doesn’t mean the retailers like having to rely on those trade dollars for their businesses to stay afloat.
As a merchant, the time and stress of constantly looking over your shoulder, worrying about what your competition is about to run and doubting whether your trusted supplier is really giving you the same terms, is exhausting. This trust isn’t usually enhanced by common benchmarking from consultants, or access to price files after a major acquisition, that often reveal the "consistent" trade terms offered to everyone aren’t quite as consistent as that trusted supplier had been telling them.
Why do these trade rates end up being so disparate across retailers? Part of it stems from avoiding a ZBB approach to budgeting. Every retailer asks to “anniversary” the trade events from the previous year, nervous about losing out. Manufacturers, meanwhile, comp their sales teams on sales vs. the prior year, and there’s no way to sustain the addiction of that rented market share without keeping the trade levels flat and working slowly from there to close new gaps. As a result, even the events themselves get copied over, so the battle for market share gets as specific as making sure your team is competitive on every single week in every single banner vs. your market share last year. The result? A “sea of sameness” where the same deals run on the same weeks every year, except the weeks where you lost last year… those weeks get an even lower price. As a result, trade rates go up every year, consumers get less loyal every year, and more and more of the supply chain gets distorted with heavy peaks and valleys.
So, what might it look like if a ZBB approach to trade was used? For starters, it's time to get rid of false frontlines on products. If you’re on deal 40 weeks a year, and out of business the other 12 weeks, the new lower price should just be the reality in the market, and those savings should be passed on to retailers from day 1.
Promoted events should be based on what consumers want to buy (not just what the manufacturer wants to sell), and there should be some reason for them. Is the shopping behavior of your category split between loyalists who regularly buy large supplies, and occasional users who tend to sample on impulse? Heavy vs. light users? Occasional vs. frequent? What about investing those extra dollars in a seasonal category that consumers love, but only engage with around certain holidays? Or perhaps the trade budgets should be lowered on the core transaction packages (with a corresponding drop in price), and trade funds be redirected to drive impulse behavior for those you can still surprise and delight with a deal?
With the rise of digital assets (load-to-card offers, personalized circulars, in-store coupon printers, mobile apps, etc.), these assets can be perfect testing grounds for experimenting on different offer structures that can meet the needs of each group, without spending the funds on the groups that don’t need it. These platforms also serve as a great basis for experimentation for the most compelling deals to the general public. Don’t assume the deal you ran this week last year is the best that can ever be done -- consumer preferences can evolve greatly within the span of a year. Test many different offers to see which consumers respond best to today.