Once an expectation of promotions is established, retailers are motivated to buy as much of their turnover as possible during promotions, often to be resold later at regular prices, this being known as the bull-whip effect. In simple terms, the trade start buying the product on discount to hold in stock for future sale at a higher margin rather than sell imme- diately. They make money by taking advantage of contradicting dis- counts and promotional schedules and then selling the product for a higher price at a later date.
This is not uncommon. At the extreme, forward buying necessitates special warehousing capacity, and the stop—go purchasing creates inventory inefficiencies both for the manufacturer and for the retailer: the average FMCG product spends more than days in inventory supply. Freelance warehousing companies can generate a separate, parasitic business. In October , John DeJesus, president of Foodmaster, explained that this is due to recent changes in the relationship between retailers and manufacturers We used to be able to take a [forward buying] position but manu- facturers are getting smart now and saying no.
Retailers in a selling war sometimes ask manufacturers to create artificial differences in a product sold through competing chains e. They responded by demanding exclusive presentations of products from the main manufacturers. But this approach added extra costs to the manufacturers, who soon began to regret agreeing to the idea.
Manufacturers and selling strategies Selling strategies by retailers are not all bad news for manufacturers. Meanwhile, since these popular brands are so essen- tial to selling-oriented retailers, the manufacturers can hold out for high margins in their negotiations.
In the long term it is a disadvantage to the manufacturer for big brands to be sold at a loss, because the retailer loses the incentive to merchandise the brands in favourable, high-traffic locations.
The retailer features them in advertising to generate store traffic, but once the shopper is in the store the retailer has every incentive via promi- nent merchandising to sell that person a competitive brand, one on which they will make a profit. Manufacturers who cultivate high added- value, brand-building strategies are undermined when the retail trade promotes their brands with aggressive price promotion. This is because the exaggerated importance attached to price overwhelms the other attributes, encouraging brand switching and substitutability.
Their customers do not mind which brand is stocked as the scale of the price discount trumps any brand preference. Selling-oriented retailers can be tough to deal with because they are determined to secure better terms than their quasi-identical competi- tors. However, during negotiations, retailers can sometimes focus on their competition so much that they are often less astute when buying i.
In these circumstances it is not unusual for a manufacturer to find that it is possible to raise the list price offered to all retailers without being criticised. The retailers are focusing on the discount from the given list price, as the list price is known to be common to all retailers. Thus, the objective for retailers in the negotiations is to win greater discounts, bonuses, promotions support, delays of payment and so on than other retailers, but not primarily to compete for profit with the manufacturer.
The winners of the selling phase and the quest for market orientation Retailer selling strategies can dominate for a long time, but not indefi- nitely. Eventually, all the weaker competitors get squeezed out or bought up. The United States, while being by far the largest national grocery market, is still a series of regional markets, which accounts for the relatively low percentage of sales held by the top four grocery chains Figure 1.
In the smaller European markets a greater degree of retail concen- tration has occurred. While Sweden has the highest level of concentration among the top five grocery retailers, it is interesting to note that the concentration among those five is intense.
The information revolution The biggest change that enabled the transfer of power from manufac- turers to retailers was the introduction of UPC scanning and its uni- versal adoption across FMCG. Originally developed as a cost-saving efficiency tool, once all product categories adopted UPCs and computing became powerful and cheap enough to handle the unimaginable quantity of data, the benefits of retail information dwarfed the anticipated cost benefits from efficien- cies.
Real-time knowledge of sales at the item level dramatically illus- trated the truism of knowledge equating to power, especially when the data could be measured at the individual shopper level through loyalty cards. Whereas the utility of UPC codes is confined to retailers and manufacturers, QR codes can be used by end consumers, who scan them with their smart phones and can be directed to anything: a website, a promotional video, even an in-store coupon.
This opens up a direct channel of communication with the consumer that can be used by both manufacturer and retailer. The concept is in its infancy, but will undoubtedly have a huge effect on the retail market.
For example, in , AaramShop, an Indian online retail platform for small independent stores, added another dimension to what can be done with a QR code. Consumers can now scan the code on the product when they are running low, and it will be ordered and delivered within hours to their home, completely side-lining all the tools and techniques of competing manufacturers who would wish to get the consumer to brand switch. The goal of the campaign was to help Homeplus compete with the number-one retailer, E-MART, without increasing their store numbers.
The shopper could use the QR code to record a personalised gift message that could be heard by the recipient when they scanned the code after receiving it with the gift. The commercial uses of QR technology continue to evolve, illustrating that the battle between retailers and manufacturers is never static. All other things being equal, the retailer will have an advantage because of their direct contact with the shopper. In order to develop new, more effective approaches, a much deeper understanding of the modern retailer is needed than has hitherto been the case.
While much has changed over time in the relationship between retailers and manufacturers, one thing that has not changed is that they are very different kinds of businesses. They are structured differ- ently, operate differently and are financed differently, all of which are at the root of much of the tension that exists between the two.
In the next chapter, we will explore these differences and how a better under- standing of them can lead to more productive retailer—manufacturer interactions and relationships. Notes 1. Accessed 27 July Accessed 29 July Accessed 30 March Harvard Business School Press, Boston, p.
Harvard University Press, Boston, p. Basic Books Inc. Accessed 30 October Tony Seideman; Barcodes Sweep the World, www. Accessed 31 March Accessed 3 August They view and act upon the same situations differently, many times at odds with each other. This creates friction in their relationships. Historically, manufacturers and retailers have known little about each other.
For most of the twentieth century, what little knowledge there was about how the other operated was confined to specialists who interacted with each other: sales operatives and buyers. The differing realities of retailing and manufacturing are driven by four fundamental factors: financial structure, cost structure, physical network and the role of price.
Financial structure differences The biggest difference between manufacturers and retailers is how they generate their profits. Table 2. Manufacturers, in general, have a higher ROE than retailers do, which retailers partially compensate for in the eyes of investors by having higher growth rates. But the more relevant fact is that ROE is derived quite differently across the two groups.
Despite the complaints from manufacturers about the rising power of the retailers, manufac- turers still have a large share of the value-chain profits, as demon- strated by the huge difference in net profit margins.
Retailers rely on a higher asset turn and leverage to compensate for their much smaller profit margins. Retailers also have large property portfolios, which add immense value to their businesses, as shown in Table 2. As can be seen by comparing Tables 2. However, this could very well change as retailers are developing their own brand equities via impressive private label strategies see Chapter 9 and will begin seeing brand premiums being factored into their profit margins. These fundamental differences in financial structure affect the way retailers think and operate, which is a source of friction between them and manufacturers.
Volume Sensitivity Retailers are more vulnerable than manufacturers to small changes in volume because it adversely affects their asset turnover, which is a much bigger driver of their profits.
When a manufacturer has supply issues and leaves a retailer out of stock, the impact on the retailer is greater than it is on the manufacturer because of the difference in the importance of asset turnover combined with their lower overall profit- ability.
Consequently, it is not unusual for retailers to get more upset than the manufacturer anticipated. While a manufacturer may be tempted to fund price reductions demanded by a hard discounter as the increased volume would cover their reduced margins, retailers who felt compelled to match the lower price would be outraged because of the cataclysmic impact on their profit margin.
Operating Costs With such thin margins, profits turn to losses if the retailer loses control of costs by even one or two percentage points. There is little chance the product will be listed if it is more costly for the retailer to handle. Equally, any manufacturer who does not immediately jump through hoops to instigate packaging or handling changes required by a retailer for efficiency reasons will find the temperature in negotiations rapidly dropping.
Cost-structure differences Modern retailing is no different from most other industries in terms of the benefits of size, which provides economies of scale and competi- tive strength. The difference for retailers compared to manufacturers is the level at which scale advantages accrue: at the company, chain or store level.
Range and Assortment The size and breadth of product range affects profit margins differently for retailers than for manufacturers. In retailing, more is mostly seen as better. Competition is fiercest on the most basic grocery items: some lines, which in many cases are still sold at Michael Cullen- type margins. If a store stocks only lines, only a maximum of can be sold at a higher margin. A store with several thousand lines has more scope for making good margins for the vast majority of its lines in particular fresh foods and non-food.
Thus, a larger retail unit, all other things being equal, will make better margins than a smaller one. In contrast, a manufacturer will usually make better margins on its biggest products and be constantly looking to rational- ise its tail of lower-volume lines. This difference can cause much conflict when a manufacturer wants to discontinue a low-volume product because of poor profitability, whereas those retailers who sell it see no reason why it should go as it will be one of their higher- margin lines.
Fixed-Costs Inflexibility As retailing becomes more sophisticated, the fixed costs in property and technology at each location increase.
For the large retailers, the value tied up in their stores is enormous Table 2. The lower the ratio of sales to fixed tangible assets, the more the retailer is exposed to these capital assets and needs to find ways to make them work harder.
Retailers have to generate increased sales in each location to justify the investment, and every manufacturer has to demonstrate how their brands help to achieve this versus competitive brands, either through increasing store traffic or increasing basket size, or both.
Pricing and price perception differences Price plays a larger role in the positioning of stores than it does in the positioning of brands. Price rarely provides a differential advantage for product brands: indeed, the more expensive brands are often category leaders, like Tropicana in chilled fruit juice, Pampers in disposable nappies diapers and Danone in Greek yogurt.
In contrast, the price perception of a large retailing chain is a cornerstone of its image. This is the case not just for hard discounters with an unambiguous price positioning but also for those who aim at a mainstream compromise between price, quality and assortment. Their messaging is focused on providing service at the best prices, and they have regular deals on their website to help maintain a price-conscious image. Suppose a supermarket decides to invest in giving wide choice, and reflects the costs incurred via generally higher prices.
Nearby, a competitor develops a low-choice, low-cost strategy. The more expensive store finds shoppers develop the habit of visiting the cheaper store to stock up on basics e.
When retailers stock directly comparable national brands, it is easy for shoppers to cherry pick, buying from the retailers that have the lowest price that week. Differences Between Manufacturers and Retailers 31 Breaking the Price—Quality Relationship In product marketing the price of a brand usually has an influence on its perceived quality. When stores that have different price positionings sell the same brands, this price—quality relationship can be broken. A store can position itself credibly as selling good-quality products and, through its own efficiency and good faith, delivering those products or brands at lower prices.
Managing Price Perceptions Retail price perception is much more open to influence through advertising than it is from shoppers comparing actual prices between chains. Even a research company trying to make an objective compari- son between pricing in two chains has to pick an arbitrary basket of goods and a particular date, and then as soon as it is published the retailers who compare unfavourably point out that it is out of date or unrepresentative.
Thus Aldi, the retail brand with the cheapest positioning, has an almost universal penetration among the richest population in Europe who are unwavering in their support of premium brands such as Mercedes, BMW and Audi.
There are very few upscale grocery chains. While it is possible for a grocery company to operate different chains that have different actual and perceived prices, for example the Loblaws Group in Canada own Fortinos at the higher end, Loblaws in the middle and No Frills at the cheaper end, the price dif- ferentials between them are small compared to the price differentials between product brands. FMCG retailing is generally a low-added-value activity.
Shoppers seek neither prestige nor pleasure from the experience. Manufacturers need to be extremely sensitive to this. Physical differences Location is of the highest importance to retailers. Report by Amarach Research. It depends on the number of stores, the population density, traffic flows and transport infrastructure.
For example, one store may be in an affluent area and another in a poor area. Some will be in urban areas; others, in rural areas. Thus, a chain of stores is forced to service a widely heterogeneous target: the people for whom the set of stores is convenient. Manufac- turers create perceptual maps of brands that suggest how their brand should be positioned to gain users, whereas stores are positioned on a real map.
Whatever shopper segments a chain would like to choose, it has to serve the shoppers who live or work nearby. Hence, any one chain is unlikely to find a homogeneous socio-economic or lifestyle sub-group across all its stores. Retailers do not sit side by side on a shelf. They do not have an entire population from which to target their users; for their part, shop- pers do not select stores from the complete range of retail chains on offer in the country.
These differences drive many of the contrasting perceptions and behaviours of the two parties and are at the root of much of the friction: they see and respond to the same events in very different ways.
Manufacturers who offer better deals to some retailers and not others take a huge risk. Note 1. Accessed 16 January New entrants, both manufacturers and private label, are able to jump quality learning curves by using outsourced manu- facturing, which just further increases the pressure on the market leaders. As far as shoppers can judge, brands become mostly indis- tinguishable. This leads to substitutability, a death sentence for profits in any industry.
There is no longer blind loyalty to brands in more than a small minority of consumers. This overcapacity eventually destroys profits as manufactur- ers are more likely to make marginal cost-based decisions to regain volume. Retailers play a role in both these phenomena. In addition, to facilitate the ease with which retailers can switch listings, they are committed to the commoditisation of brands.
Retailers want brands to be interchange- able and thus substitutable; otherwise, they are weakened in negotia- tions if the brand is so unique and popular it must be listed at all costs.
In mature markets, where overcapacity and brand substitutability have become prevalent, selling strategies seem much more attractive than stagnation, but selling-oriented manufacturers can all but destroy each other. Selling orientation and hustle strategies When overcapacity occurs in industries with high fixed costs, price cutting by one or two competitors often leads to a price war. Price wars are bloodiest in markets where volume is key to competitiveness and high fixed costs are involved e.
Selling-oriented strategies work for the first competitors to use them, but they elicit a mirror response from the competition and often spiral out of control. The bailouts of GM and Chrysler in North America were in part precipitated by the price war initiated in by GM, and rapidly copied by Ford and Chrysler, to extend their employee pricing to all buyers. The offer was repeated in subsequent years despite falling sales volumes, which dragged down prices and profits for all.
The airlines felt their only resort was to make massive price cuts to retain volume. High fixed costs mean that high volumes are an ever-essential objective. One of the big strategic advan- tages of manufacturers outsourcing production is that they are not as vulnerable to fixed-cost pressures to fill the factories at any cost.
Market orientation The key to profitability for manufacturers is to make their brands non- substitutable in the eyes of consumers, and the best way of achieving that is through segmentation. While the potential of segmentation to grow volume and profit is widely understood, it comes as a surprise to many to learn that segmentation was originally developed to negate price wars, a lesson that seems to have become neglected, so it is worth revisiting the origins of segmentation to remind ourselves of its origi- nal purpose, which is of critical importance today.
New brands had been launched by all to fill capacity, not unmet consumer needs. With so many brands available, each claiming to address the whole range of washing needs, prices were falling as shoppers were choosing on the basis of price alone — the brands were completely substitutable.
Thus initially evolved separate brands for the washing of clothes, skin and hair, which further evolved over time into separate brands for work-clothes, delicates, colours, whites, oily skin, dry skin, sensitive skin, dry hair, oily hair, dandruff-laden hair, blonde hair, coloured hair ad infinitum.
This segmentation not only addressed the downward pressure on prices but also became a major engine for volume growth. Segmenta- tion encouraged the consumer to buy not just one large slab of generic soap at a rock-bottom price but also a whole range of higher-priced offerings that performed different tasks or were targeted at different water conditions, usages or users.
And once all that soap was in the house, washing frequency increased. Now differentiated, the brands could coexist on the shelf without being seen as substitutes for each other, each being able to maintain its appropriate price point. Segmentation of usage occasion can be used within the same brand via differentiated packaging formats. Coca-Cola introduced the first six-pack carrier in to create a new place to enjoy their product — the home — and consumption rapidly increased.
Not that Coca-Cola ignored the possibilities of seg- menting by product variant. Once you know what consumer preferences depend on, you can adapt your offering to those conditions. A key element of a segmentation strategy is that a market-oriented producer is not jealous of the segments satisfied better by its competi- tors. The producer is pleased to have competitors who follow market- oriented strategies similar to its own, while despising competitors who want to copy its products and then compete on price.
Apple are a terrific example. Instead of following the trend to push products when they opened their retail outlets in , their goal was to create a place for people to gather and celebrate. They provided a great experience by being a hub of information instead of focusing on sales, and in they even replaced their check-out counters with handheld POS systems now iPods to minimise the sales push feel.
For example, many household cleaning brands have shifted their offering to respond to the environmental movement. Aldi Australia linked with Aussies Living Simply, a community focused on sustain- ability, permaculture and organic gardening. New companies have also emerged, including Tri-nature lifestyle products in Australia and Method, a high-end range of natu- rally derived, biodegradable household cleaning products.
In the US cola market, Coca-Cola and Pepsi have long waged a permanent advertising and public relations war. This has encouraged consumers to develop emotional loyalty for either supplier. Meanwhile, regular price promotions, often alternating between the two of them, tend to reduce the scope for smaller brands and private label trying to attract buyers willing to switch on the basis of low price.
Coca-Cola and Pepsi were not competing on price with each other, but using price to minimise further competition. This kind of arrange- ment can still be profitable if the big brands have a group of loyal buyers who still buy at the normal price outside promotions. But when matters are less orderly and the heat is on, the need for speed of response often dictates the types of action in a market. For example, if management is under pressure to deliver profits in the short term, quick-response promotions are a more attractive invest- ment than design improvements.
Short-term actions are also favoured in industries sensitive to changes in volume sales, like retailers. Shop- pers tend to react more quickly to price promotions than to store layout changes. The financial resources of competitors also dictate the choice of weapon.
Retailers, even small ones, can initiate a disruptive price war to which all others must respond, whereas with manufacturers a sales force war, for example, can only be initiated by rich competitors. Only where profitability is high, like pharmaceuticals, can companies afford expensive tools such as large, well-trained sales forces.
The more competitors focus on different reasons for purchase, and on segmenting their offerings, the more orderly the market becomes, and the more the opportunities for individual competitors to be profit- able abound. However, it is hard for a single competitor to move away from a selling mode in isolation. In many cases it has to get to the point where competitors collectively become so tired of ongoing selling wars that they find ways of moving as an industry.
There are three ways for an industry to escape from the selling war: collusion, concentration and signalling. Protectionism to reduce the competition from abroad is similarly attractive. Producers have long been convinced of the benefits of these methods; however, governments generally disapprove. Beyond possible legal problems, there is the risk of falling back into selling strategies if the cartel crumbles. In a cartel, there is a permanent temptation for each member to break ranks and sell more or cheaper than agreed with the other members.
The more producers involved, the more realistic it is that someone will crack, and thus the greater the temptation to be that one. De Beers operated a selling cartel for diamonds by using their control of the central selling organisations to manage prices by manipulating supply and demand. In the past, when a single country, such as Zaire, tried to break away and sell their diamonds independently, De Beers would flood the market with similar diamonds to drive down prices for Zaire, forcing them to return to the cartel.
The cartel could cope with occasional defectors but not such a large number. However, consolidation, coupled with a desire among the survivors to restore normal profit levels, helps to usher in an era of orderly competition based on serving the variety of wants.
In , Carrefour became the first foreign retailer in Brazil. The outcome has been a more orderly market where each is large and successful enough not to have to resort to permanent cut-throat price competition. By making the right signals, they can sometimes collectively withdraw from unwinnable battlegrounds and create a competitive, but orderly, market.
Announcements promising the most competitive prices are an invitation to the industry to start a price war. By Alison Konrad , Ken Mark ,. By Frank V. Cespedes ,. By Sharon Foley ,.
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