Dynamic Explanation of Industry Structure and Performance
Cotterill
be a vertical Nash pricing program. Trade promotion
programs on the other hand reduce double
marginalization in the channel.
Consider Figure 3. Assume that the manufacturer is
the channel captain and as much initiates a trade
promotion. The manufacturer can offer product to the
retailer on the condition that it be promoted at price p1
the channel profit-maximizing price. To obtain the
retailers cooperation, the manufacturer need only lower
w to a level that increases the retailer’s profits from the
non-promoted level. Figure 3 illustrates a trade
promotion's impact on prices and profits. At the non-
promoted retail price level, p2, the manufacturer has
profits equal to the area, wbde. The retailer earns profits
equal to area, p2 abw. With promotion the retailer agrees
to sell at p1 and the manufacturer lowers the wholesale
price to w1. The retailer participates in the trade
promotion because its profits, area p1fiw1, are greater
than its non-promotion profits, area p2abw.
Manufacturer profits under promotion are area w2ige,
which is larger than non-promotion profits, wbde.
Under the trade promotion scenario both the
manufacturer and retailer share the increased profits due
to the elimination of double marginalization. Exactly
how much each gets depends on their bargaining ability,
which is a function of their knowledge. The
manufacturer knows its costs, and in the U.S. with
access to IRI or A.C. Neilsen scanner data, knows
demand conditions as well. Manufacturers probably
benefit most from promotions.
Why, one might ask would one not see a permanent
trade promotion, i.e. EDLP, since it improves both
players profits? Technically one should in fact observe
such. One could argue that this is evidence against
successive monopoly, however other factors are clearly
at work.
One other factor is the retailers option to do private
label. That strategy can dominate participation in a trade
promotion. A retailer is not going to participate
permanently in a trade promotion because it kills its
private label program, a program that captures a higher
share of the channel's profits. If the retailer can
introduce a private label product of equal quality and
consumer acceptance, i.e. a product that destroys all
manufacturer brand equity built up due to advertising,
product trademarks, and design, the retailer can
appropriate all of the profits earned at p1q1 in Figures 2
and 3. Private label products, however, rarely are so
successful that they eliminate manufacturer brands.
Nonetheless, they clearly diminish national brand
pricing power (Cotterill et al. 2000). Trade promotion
by manufacturers reduces the incentives for development
of private labels, and the amount of brand equity that
manufacturers have created also affects retailer's ability
to introduce private label products. One cannot analyze
private label pricing or trade promotions in a vacuum.
The rapid growth of private label products in the 1990’s
is in large part due to the problem of successive
monopoly in the food system.
Having dismissed EDLP as a failure due to its
inability to solve channel coordination problems during
the 1990's, looking forward things may be different if
WalMart continues its advance. WalMart does a
permanent trade promotion, i.e. it is EDLP. Research is
needed on WalMart's pricing practices, however it
appears that they assume the channel captain role and
dictate terms to manufacturers. Walmart's EDLP prices
are at or near the single monopoly level on a permanent
basis. Walmart and its suppliers seem able to give up
the merchandising excitement and the communication of
price cuts that stop-go trade promotions offer.
This is due in no small part to Walmart's reputation
as a no frills, no bull (trade puffery) retailer. Their
procurement strategy in meat for example, vertically
forecloses the market in a fashion that reduces the need
for trade and consumer marketing programs (costly
competition) by meat processors and increases processor
margins. Walmart (at least in New England) carries only
Purdue fresh chicken, only Tyson frozen chicken and
only Smithfield fresh pork. These vertically coordinated
meat firms with branded products do not have to
compete with unbranded meats or each other in the case
of chicken.
7. An Out of the Box Solution: Truly National
Supermarket Chains
Moves to improve channel coordination and pricing
efficiency such as trade promotions, ECR, category
management, and copycat private label programs are “in
the box” solutions. They don’t challenge the structure of
the food-marketing channel, essentially leaving the food-
manufacturing firms intact and in control of the content
of the system. Although U.S. supermarket chains are
larger in absolute size than their European markets
counterparts, and they dominate regions of the U.S.
comparable in size to many European countries, unlike
many European supermarket chains they have not
established themselves as channel captains by instituting
strong retail brands via supply chain management
programs.14 In the U.S. this is an “out of the box” move
14 Cotterill (1997) discusses this option and whether developed
nations’ food systems might converge to it. See Wrigley
(1999), a leading British geographer, for a very interesting
Food Marketing Policy Center Research Report No. 53
14