When does a business truly gain from promotions?
First let’s clarify the definition for this post:
A promotion is a stated period of time in which a certain product mix is sold for reduced prices.
Thus, reducing prices to get rid of unsold inventory is not a promotion. A promotion requires a clear date where the prices are going back to their original level.
The end-date of a promotion puts a pressure on the customer to buy now and buy more. However, that pressure also pushes the customer to wait for promotions and refrain from buying after the promotion. This is what makes promotions different from price wars.
There are four reasons for using promotions:
- Introduction of new products, where the intent is gaining as many first customers as possible hoping that they will become regular customers. Sometimes this kind of promotions makes sense.
- Fixing a state of lower than expected sales or against a marketing campaign of a competitor. The objective is selling high volume. This is a key cause for going into the vicious cycle where the vast majority of the sales are in reduced prices.
- Retailers and distribution channels use promotions to bring customers into the store, where they buy additional items. The problem here is that all the direct competitors use this scheme and by this vastly reduces the added-value.
- Being forced by a distribution channel to participate in their ongoing promotions. The distribution channels are the Gorilla dictating the business rules. Their poor suppliers need to find good-enough ways to live under that tyranny or rebel against it.
There are four different negative branches to promotions, without considering the relationships within the supply chain.
- The total T might go down because the increase in volume does not cover the reduced T per product-unit.
- The capacity of at least one resource is exhausted because of the sudden increased volume, causing loss of sales, usually of other products sold at premium price. Promotions cause a peak of load that often turns the weakest-link into a temporary constraint, cost goes up because of overtime and quality problems, and everybody in the organization feels the waves of that peak.
- The lower prices steal sales of other products that are sold at premium price!
- A critical effect is the reduction of sales after the promotion.
The result of the above is high probability that the promotion causes a loss rather than profit, most of the potential damage is currently unknown. In TOC terms the loss is expressed by:
Delta(T) – Delta(OE) < 0.
So, the first mission when a proposal for a promotion is on the table is to assess the true impact of the negative effects relative to the positive of selling higher volume of items. The biggest mistake is to consider Revenues instead of Throughput. Reducing prices reduces T-per-unit much more than revenue-per-unit. Then, extra costs have to be included in the analysis.
The main difficulty to calculate the net impact of a promotion on the bottom line is to assess the demand during the promotion and also after the promotion!
Building two what-if scenarios, the reasonable pessimistic and the reasonable optimistic, is a tool to check the full impact of the negatives and guide the required actions.
Promotions are typical moves that impact both sales and operations. The end-date of a promotion impacts the behavior of customers. Operations are hit by a huge peak, creating waves of shifting priorities that would take long time to calm down. The crazy run after volumes of sales, expressed by either revenues or quantities sold, blocks the sight of the true economic impact.
However, being aware to the damage of most promotions would not automatically solve the basic two conflicts that involve promotions.
One conflict is generated when a competitor launches a promotion, which would reduce sales. Should we respond with our own promotion? Preserving the market-share is a flawed argument because the worthy objectives are high and stable profits and it is not obvious that preserving market-share is the mean to achieve them. But, does it mean that ignoring the reduced prices of a competitor is the right action? When you don’t have truly superior products directed at specific market segments then you pay the price of being depended on the rational of your competitors.
The other conflict is whether to accept the demand of your distributors to carry a promotion or insist on your own interests, which might cause them to give up your products. Again, this could happen only when your products, viewed by the end customers, are practically the same as your competitors.
When you have to have a promotion how should your operations behave during the promotion?
The high demand starts at the first day of the promotion. The resulting demand is highly uncertain, meaning the range of the potential demand is pretty wide. Only after the first day or two it is possible to assess a narrower range. The length of the promotion is critical to the ability to respond by fast replenishments. The shorter is the promotion more stock is required at the beginning of the promotion, both at the central warehouse and in the stores.
A short promotion poses a dilemma regarding the stock buffers. The optimistic forecast leads to very high buffers, but the actual demand might be according to the pessimistic forecast. Sizing the buffers according to the pessimistic forecast might cause shortages. Starting with low buffers and increasing them within the promotion requires considerable amount of excess capacity.
My recommendation is to prepare enough stock in the central location to cover the pessimistic forecast for the whole promotion period!!!
Every store has to hold enough stock for at least two days based on the optimistic forecast for that store. After the first day or two of the promotion re-adjusting all the buffers in the stores could be done more sensibly. The central warehouse, starting with overstock, should also calculate the target-levels after the first two days, and replenish only when the inventory goes below the target.
Like in handling seasonality, it is imperative to reduce all the buffers to their original size sometime before the end of the promotion.
The damage of promotions is high and its most critical element is fixation of an end-date. This is a kind of dynamic pricing, a topic I mentioned in a post about yield-management, which pushes customers to change their natural behavior.
The true remedy is to be able to deliver unique value to many loyal customers, creating a decisive competitive edge (DCE). Is it always possible? Unless you truly think hard about the possibilities you cannot claim it is impossible.