Technical Paper

TRADE PROMOTION DECISIONS

UNDER DEMAND UNCERTAINTY :
A MARKET EXPERIMENT
APPROACH
GROUP V :

Arnold M10601803
Panca M10601806
Dee M10601808
Bram M10601809
INTRODUCTION
THEORITICAL ANALYSIS
BASIC MODEL
WHOLESALE & RETAIL PRICES

RETAILER ORDER QUANTITIES

MANUFACTURER & RETAILER PROFITS

MODEL EXTENSION : MARKET EXPANSION

IMPLEMENTATION OF THE LAB. MARKET EXPERIMENT
EXPERIMENTAL DESIGN & PROCEDURE

PARAMETER SELECTION & POINT ESTIMATES

RESULT FROM THE EXPERIMENTS

CONCLUSION & DISCUSSION

AGENDA
 INTRODUCTION

TRADE PROMOTION
INCENTIVES DIRECTED TO :
input UNCERTAINTY DEMAND FROM CONSUMER

MFG. &
DESIGNED TO INFLUENCE SALES & PRICES RETAILER

COMPARISON
Wholesale & retailer prices
TWO TYPES OF MARKETS WHERE OFF- SCAN-
TRADE OF PROMOTION DISCOUNTS Retailer order quantities
OFFERED INVOICES BACKS
Profit givens

GENERATE OPTIMAL DISCOUNT LEVEL BASIC

(FORMULATION) MODEL

TESTING TO MARKET (EXPERIMENTS) MARKET

EXPERIMENTS

DECISION
 INTRODUCTION II

MANUFACTURERS OF CONSUMER PACKAGED GOODS

INCREASING (CPG)
CONFLICT TRADE PROMOTION Fourfold $71 to
? $312 1996-2004
(Joyce 2005)

(Ailawadi et al.2009)

Trade promotion budget

DISTRIBUTION
Decide budget allocation (Disc/Performance based)
CHANNEL

FACTORS AFFECT
PROFIT MAX ( OFFER SMALLER TRADE PROMOTION)
DESIGN & IMPL.

RETAILER = OFF-INVOICES TO SCAN-BACKS

MFG = SCANBACKS TO OFF-INVOICES
INTRODUCTION III

LARGER ANNUAL SALES

RETAILER FORMAL T.P POLICIES

STRONGER BRAND HIGH OFF-INVOICES
POSITIONING LOW SCANBACKS

(AILAWADI ET AL.2009) WHAT IS THE IMPACT TO TRADE PROMOTION

WHILE WE HAVE THIS FACTOR ?
OFF-INVOICES

ALLOWS RETAILERS TO UNCERTAINTY DEMAND FROM CONSUMER

D BUILD STOCKS FOR
FUTURE
OR
NOT GIVING ANY DISC.
TO CONSUMER Wholesale & retailer prices
COMPARISON
Retailer order quantities
Profit givens

EXPERIMENTS
 THEORITICAL ANALYSIS

ECONOMIC MODEL OF TRADE PROMOTIONS 15 MARCH 2010

VARIABLES FOR MFG.:
C = CONSTANT MARIGNAL COST
W = WHOLESALE PRICE
VARIABLES FOR SUPPLIERS.:
Q = HOW MANY UNITS
P = RETAILER PRICE
ASSUME RETAILER FACES
A STOCHASTIC DEMAND FUNCTION
a downward sloping, concave,
deterministic function of the
unit retail price p . a>0 , b>0
(INTV SAMPLE SUPERMARKET : 15)
(INTV SAMPLE BUYERS : 7)
(INTV SAMPLE MANAGER: 8)
1. WHO DETERMINES THE TRADE PROMOTION BUDGET ?
INTERVIEWING
2. WHO DECIDES THE ALLOCATION ACROSS TRADE PROMOTION TYPE?
90%
MFG.
OUR MODEL
1. MFG. FIRST DECIDES THE WHOLESALE PRICE &
TRADE PROMOTION BUDGET BASIC
2. DECIDE EITHER BY MFG. & RETAILER WITH MODEL
RETAILERS ORDER QUANTITY AND RETAIL PRICE
DECISIONS
 OFF-INVOICES CONDITION
BASIC MODEL

The trade promotion is offered by the manufacturer as a price reduction in the

normal price of goods and is subtracted from the initial invoice on all units ordered.

GIVEN THE WHOLESALE PRICE AND THE STOCHASTIC DEMAND, THE RETAILERS PROFIT :
2
OPTIMAL ORDER QUANTITY AND RETAIL PRICE
1 3
 OFF-INVOICES CONDITION
BASIC MODEL

BY FIRST EQUATING (2) AND (3) TO OBTAIN THE OPTIMAL PRICE AND THEN SUBSTITUTE
THE OPTIMAL RETAILER PRICE INTO EITHER (2) OR (3), IT WAS FOUND THAT

THE MANUFACTURERS PROFIT MAXIMIZATION PROBLEM CAN BE REPRESENTED BY

WHERE M IS MANUFACTURERS PROFIT. SOLVING FOR THE OPTIMAL WHOLESALE PRICE, WE FIND THAT
 BASIC MODEL SCAN-BACK CONDITION

Involve per-unit discount the manufacturer offers to the retailer for each unit sold to consumers
THE RETAILERS PROFIT GIVEN THE WHOLESALE PRICE AND THE TRADE PROMOTION DISCOUNT OFFERED BY THE MANUFACTURER CAN BE WRITTEN AS

SIMILAR TO THE OFF-INVOICES CASE, WE TAKE THE FIRST-

ORDER CONDITION WITH RESPECT TO ORDER QUANTITY AND
RETAIL PRICE:
 BASIC MODEL SCAN-BACK CONDITION

NEXT WE EQUATE (9) AND (10), AND THE SOLUTION IS

THEN, THE SOLUTION OF OPTIMAL WHOLESALE PRICE AS

THE MANUFACTURERS PROFIT MAXIMIZATION PROBLEM FOR THE SCAN-BACKS CASE CAN BE WRITTEN AS
BASIC MODEL Wholesale and Retail Prices

Proposition 1
PREPOSITION
Facing consumer demand uncertainty,
manufacturers charge a higher wholesale
price when the same amount of trade
promotion discount is allocated to scan-
backs versus off-invoices
Proposition 2
Facing consumer demand uncertainty,
retailers charge a higher retail price when
the same amount of trade promotion
discount is allocated to scan-backs versus
off-invoices

Retailer Order Quantities

Proposition 3
Facing consumer demand uncertainty,
retailers order more from the
manufacturer when the same amount of
trade promotion discount is allocated to
off-invoices versus scan-backs

Manufacturer and Retailer Profits Manufacturer and Retailer Profits

Proposition 4 Proposition 5

Facing consumer demand uncertainty,

Facing consumer demand uncertainty,
manufacturer profits are higher when the
retailer profits are higher when the same
same amount of trade promotion
amount of trade promotion discount is
discount is allocated to off-invoices versus
allocated to off-invoices versus scan-back
scan-back
MODEL EXTENSION : Market Expansion

Market Demand New Baseline Demand

Similar to the derivations in the basic model, we first solve for the optimal order quantity and
wholesale and retail prices given the trade promotion discount. Table below is the summary of
authors analysis.
MODEL EXTENSION : Market Expansion

Since the trade promotion affects the market demand, it is important to determine the optimal
value of and

The author lost analytical tractability with these two complicated partial derivatives, so numerical
analysis was conducted
MODEL EXTENSION : Market Expansion

Manufacturer and Retailer Profits Manufacturer and Retailer Profits

Proposition 4 Proposition 5

Facing consumer demand uncertainty,

Facing consumer demand uncertainty,
manufacturer profits are higher when the
retailer profits are higher when the same
same amount of trade promotion
amount of trade promotion discount is
discount is allocated to off-invoices versus
allocated to off-invoices versus scan-back
scan-back

Market Expansion

Proposition 6
When trade promotion discount leads to market expansion,
there exists an optimal level of discount that maximizes a
manufacturers profit under demand uncertainty, and this
optimal trade promotion discount is larger when it is
allocated to off-invoices versus scan back
 IMPLEMENTATION OF THE LAB. MARKET EXPERIMENT

Experimental Design and Procedure

+ Programmed using Z-tree
+ Using two design Market Expansion (ME) and Non Market Expansion (NME)
+ Subject: 80 MBA students
+Half of the subjects becomes a retailer and the other half pretends as a manufacturer

EXPERIMENTAL PROCEDURES
Stage 1 : Stage 2 : Stage 3 : Stage 4 :
Manufacturer decides Manufacturer or Retailer decides order Transaction and profits
wholesale price retailer decides on quantity and retailer
trade promotion price
allocation
1. The theoretical predictions for key variables are different enough for the off-invoice and scan-back conditions
2. The induced costs and benefits are relatively easy for subjects to understand2
 IMPLEMENTATION OF THE LAB. MARKET EXPERIMENT

No Market Expansion Point Estimation

 IMPLEMENTATION OF THE LAB. MARKET EXPERIMENT

Market Expansion Point Estimation

RESULT FROM THE EXPERIMENT I

Mean Observations Results Overview

W-price Q-unit P-price Discount
NME 7.90 ED 49.47 17.12 ED 2 ED
condition unit

ME 7.28 ED 48.02 17.10 ED 2.43 ED

condition unit

258 NME condition

ME condition
298
Choosing Off-invoices
: 54.38%

: 72.46%
RESULT FROM THE EXPERIMENT II

TESTING THEORITICAL PROPOSITION

: 6.76 : 16.40 : 55.76

: 1.91 : 3.40 : 26.32

: 7.32 : 17.63 : 44.93

: 2.00 : 2.93 : 21.39

T VALUE = 2.43 T VALUE = 3.36 T VALUE = 3.92

P- VALUE =0.016 P- VALUE =0.001 P- VALUE =0.000
RESULT SUPPORT PREPOSITION RESULT SUPPORT PREPOSITION RESULT SUPPORT PREPOSITION
RESULT FROM THE EXPERIMENT III

TESTING THEORITICAL PROPOSITION

: 222.95 : 356.62 : 2.57

: 149.23 : 227.57 : 1.11

: 181.49 : 305.50 : 2.32

: 123.05 : 222.09 :0.88

T VALUE = 2.62 T VALUE = 1.45 T VALUE = 1.99

P- VALUE =0.009 P- VALUE =0.149 P- VALUE =0.048
RESULT SUPPORT PREPOSITION RESULT WEAKLY SUPPORT RESULT SUPPORT PREPOSITION
PREPOSITION
VALIDITY OF EXPERIMENT I

Low Risk
Learning
Wholesale Price (NME)
Wholesale Price (ME)

Retailer Order (NME)

Retail Price (NME)
Retailer Order (ME)
Retail Price (ME)
VALIDITY OF EXPERIMENT II

Wholesale Price (NME)

Wholesale Price (ME)

Retailer Order (NME)

Retail Price (NME)
Retailer Order (ME)
Retail Price (ME)
VALIDITY OF EXPERIMENT III

Wholesale Price (NME)

Wholesale Price (ME)

Retailer Order (NME)

Retail Price (NME)
Retailer Order (ME)
Retail Price (ME)
VALIDITY OF EXPERIMENT IV

Wholesale Price (NME)

Fail to learn
Wholesale Price (ME)

Retailer Order (NME)

Retail Price (NME)
Retailer Order (ME)
Retail Price (ME)
VALIDITY OF EXPERIMENT V

Wholesale Price (NME)

Wholesale Price (ME)

Retailer Order (NME)

Retail Price (NME)
Retailer Order (ME)
Retail Price (ME)
VALIDITY OF EXPERIMENT VI

Wholesale Price (NME)

Wholesale Price (ME)

Text Retailer Order (NME)

Retail Price (NME)
Retailer Order (ME)
Retail Price (ME)
Conclusion
Examine Optimal Behaviour in deciding trade promotion, under the
demand uncertainty
Price higher, quantity lower, profits lower @ scanbacks
Deeper discounts on off-invoice if there is market expansion effect
Support for six propositions
Validity of data by comparing theoretical predictions and behaviour
Evidence that market experiments maybe an useful approach
THANKYOU

GROUP V