Modeling the Impact of Sales Promotion on Store Profits

TABLE OF CONTENTS
1. INTRODUCTION
1.1. The Problem 1 1.2. What is Sales Promotion? l 1.2.1. Defining Sales Promotion 1 1.2.2. Types of Sales Pron10tion 2 1.3. Why is there Sales Proll10tion? 4 1.3.1. Sales Promotion Objectives 4 1.3.2. Economic Rationale for Sales Promotion 5 1.4. Planning Sales Promotion 7 1.4.1. Sales Promotion Planning Process 8 1.4.2. Store Level Promotional Strategy 9 1.4.3. Selecting Items to Promote 11 1.4.4. Deciding the Promotion Frequency 12 1.5. Importance and Growth of Sales Promotion 14 1.6. Complex Planning Problem 15 1.6.1. Unknown Profit Impact 15 1.6.2. Easy in Principle 16 1.6.3. Impossible in Practice 17 1.7. Purpose and Delimitations 18 1.7.1. Research Purpose 19 1.7.2. Delimitations 19 1.7.3. Steps to Achieve the Purpose 20 1.8. Organization and Overview of the Report 21

2. SALES PROMOTIONAND THE CONSUMER

2.1. Introduction 25 2.2. Implicit Decisions in Grocery Shopping 26 2.3. Sales Promotion and the Store Choice 27 2.4. Sales Promotion and the Category Choice 31 2.5. Sales Promotion and the Purchase Quantity Choice 33 2.6. Sales Promotion and the Brand Choice 34 2.7. Combining the Decisions 36 2.8. Dynamic Effects of Sales Promotion 38 2.9. Summary 40

3. PROMOTIONAL SALES RESPONSE

3.1. Introduction 41 3.2. Sources of Retailer's Incremental Item Sales 41 3.2.1. Other Brands 42 3.2.2. Other Categories 43 3.2.3. Other Stores 44 3.2.4. Other Periods 45 3.3. Response Modeling: Direct and Indirect Approach 46 3.4. Brand Sales Response Models 47

3.4.1. Linear Models of Brand Sales 48 3.4.2. Multiplicative Models of Brand Sales 48 3.4.3. Exponential Models of Brand Sales 49 3.4.4. Time-Series Models of Brand Sales 50 3.5. Market-Share Models 51 3.5.1. Attraction Models 52 3.5.2. Examples of Attraction Models 53 3.6. Category Sales Models 56 3.7. Store Sales and Store Traffic 58 3.8. Sllmming Up 61

4. PROMOTION PROFITS
4.1. Introduction 63 4.2. Profit Impact of Sales Promotion 63 4.2.1. Manufacturer Profits 63 4.2.2. Retailer Profits 65 4.3. Manufacturer Induced Promotions 67 4.3.1. A Normative Framework 67 4.3.2. Trade Promotion Profits 68 4.3.3. Couponing Profits 70 4.4. Retailer Promotions 72 4.4.1. Item Profits 72 4.4.2. Category Profits 74 4.4.3. Store Profits 76 4.5. Sllmming Up 78

5. MODELDEVELOPMENT
5.1. Introduction 79 5.2. Decomposing Retailer Sales 79 5.2.1. General Considerations and Modeling Approach 79 5.2.2. Selecting the Quantity Measure 80 5.2.3. Decomposing Retailer Item Sales 81 5.2.4. Degree of Cannibalization Defined 84 5.3. Specifying the Response Models 86 5.3.1. Model Assumptions and Constraints 86 5.3.2. Specification of Response Models 89 5.4. Modeling Retailer Promotion Profits 92 5.4.1. Retailer Promotion Profits 92 5.4.2. A Sin1plified Promotion-Profit Model 95 5.4.3. Three Promotion Profit Measurement Levels 97 5.4.4. The Profit Impact of Cannibalization 99 5.5. Maximizing Promotion Profits 101 5.5.1. Profit Maximization and Optimal Deal Discount 102 5.5.2. Display Profits 104 5.5.3. Myopic Optimization 104 5.5.4. Determinants of Optimal Deal Discount. 106 5.5.5. Determinants of the Deviation from Optimal Deal Discount 107 5.6. Summary 109 Appendix 111 5.A.1. Relationship between Cannibalization and Model Parameters 111

6. SIMULATING PROMOTION PROFITS

6.1. Introduction 113 6.2. Definition of the Promotional Response Models 113

6.2.1. Model Structure and Parameters 113 6.2.2. Sales Response 115 6.2.3. Basket Response 118 6.3. Promotion Profits Measured at Three Levels 122 6.3.1. Level of Analysis, Deal Discount, and Special Display 122 6.3.2. The Effect of a Deal Requirement 126 6.4. Promotion Profits of Four other Response Patterns 129 6.4.1. Scenario 2: Moderate Cannibalization 130 6.4.2. Scenario 3: Store Traffic Generation 133 6.4.3. Scenario 4: Intra-Category Cannibalization and Store Traffic Generation 135 6.4.4. Scenario 5: More Cannibalization 137 6.5. Determinants of the Size of the Deal Discount 139 6.5.1. Level of Analysis, Trade Deal Discount, and Response Pattern 139 6.5.2. The Cost of Myopic Optimization 144 6.5.3. The Effects of a Deal Requirement. 149 6.5.4. Margins and Optimal Deal Discount 150 6.6. Meta Analysis of the Deal Discount and the Cost of Myopia 152 6.6.1. Procedure 152 6.6.2. The Impact of the Level of Analysis 152 6.6.3. Scenarios, Trade Deals, Deal Requirements, and Margins 154 6.7. Conclusions 155 Appendix 157 6.A.1. Gross margins, Trade Deals, and Optimal Deal discount 157 6.A.2. Simulation Results 159

7. EMPIRICAL DATA AND ESTIMATIONMETHOD

7.1. Illtroduction 161 7.1.1. Purpose of Empirical Illustrations 161 7.1.2. Selection of Cases 161 7.2. Data Sources 162 7.2.1. Managerial Judgment, Historical Data and Experiments 162 7.2.2. Information Technology 164 7.2.3. Scanner Data in General 165 7.3. The Scanner Data Project 167 7.3.1. Data Collection History and Procedures 167 7.3.2. Problems in Data 168 7.3.3. The Database 169 7.4. Description of the Store-Level Data 169 7.4.1. Definition of Variables 170 7.4.2. Data Frequency and Temporal Aggregation 170 7.4.3. Description of Store-Level Variables 171 7.5. Parameterization of the Response Models 175 7.5.1. Selection of Independent Variables 175 7.5.2. Linearizing Transformations before Estimation 176 7.5.3. Estimation Procedure 177 7.4.4. Regression Diagnostics 178 7.5.5. Parameter Significance 179 7.5.6. Modeling Approach and the Null Hypothesis 180

8. EMPIRICAL ILLUSTRATION 1: COFFEE

8. 1. Introduction............................................................................................................ 181 8.2. Description of the Coffee Category 181 8.3. Building the Promotional Response Models 182 8.3.1. Model Building Procedure 182 8.3.2. Initial Tests of the Model 183

8.3.3. Store-Level Response Models 184 8.3.4. Category-Level Response Models 186 8.3.5. Item-Level Response Models 189 8.3.6. Overview of the Regression Results 193 8.4. Deal Discount, Sales Response, and Profit Impact. 195 8.4.1. Item A 196 8.4.2. Item B 198 8.4.3. Item C 200 8.5. Determinants of the Size of the Deal Discount. 202 8.5.1. Level of Analysis 202 8.5.2. Trade Deal and Margins 203 8.6. Conclusions 207 Appendix 208 8.A.1. Summary Statistics 208 8.A.2. Store and Category-Level Time-Series 209 8.A.3. Item-Level Time-Series 211

9. EMPIRICAL ILLUSTRATION 2: CEREALS

9.1. Introduction 213 9.2. Description of the Cereals Category 213 9.2.1. Selection of Items for Analysis 215 9.3. Building the Promotion Response Models 217 9.3.1. Data Manipulations 217 9.3.2. Initial Tests of the Model 217 9.3.3 Store-Level Response Models 218 9.3.4 Category-Level Response Models 219 9.3.5 Item-Level Response Models 222 9.3.6. Overview of the Regression Results 228 9.4. Deal Discount, Sales Response, and Profit Impact. 229 9.4.1. Item A 230 9.4.2. Item B 232 9.4.3. Item C 234 9.4.4. Item D 236 9.4.5. Item E 238 9.4.6. Item F 240 9.4.7. Summing Up 242 9.5. Determinants of the Size of the Deal Discount 243 9.5.1. Level of Analysis 243 9.5.2. Trade Deal and Margin 245 9.5. Conclusions 250

10. EMPIRICAL ILLUSTRATION 3: PASTA

10.1. Introduction 251 10.2. Description of the Pasta Category 251 10.2.1. Selection of Items for Analysis 253 10.3. Building the Response Models 253 10.3.1. Data Manipulations 253 10.3.2. Initial Tests of the Model 254 10.3.3. Store-Level Response Models 255 10.3.4. Category-Level Response Models 256 10.3.5. Item-Level Response Models 258 10.3.6. Overview of the Regression Results 264 10.4. Deal Discount, Sales Response, and Profit Impact. 265 10.4.1. ItemA 266 10.4.2. Item B 268 10.4.3. Item C 270 10.4.4. Item D 272

10.4.5. Item E 274 10.4.6. Item F 276 10.4.7. Summing Up 278 10.5. Determinants of the Size of the Deal Discount 279 10.5.1. Level of Analysis 279 10.5.2. Trade Deal and Margins 281 10.5. Conclusion 285

11. CONCLUSION
11.1. Summary 287 11.1.1. Promotion Profit as Change in Gross Profits 287 11.1.2. The Sales Model 288 11.1.3. The Profit Model 289 11.1.4. Myopic Measures and Myopic Optin1ization 291 11.2. What is New? 292 11.3. Generalizations 293 11.4. Limitations 293 11.5. Suggestions for Further Research 294 11.6. Managerial Implications ' 295

REFERENCES 299