Suboptimality of Sales Promotions and Improvement Through Channel Coordination

This paper deals with sales promotions in the form of consumer price discounts in fast-moving consumer goods. First, we show analytically that suboptimality is to be expected with respect to the size of the consumer price discount. This is due to the separate decision making of the retailer and the manufacturer. We then compute the impact of this suboptimality for a database of eighty-six sale promotions, and we find that it is substantial. On average, the actual profitability of the sales promotions is only about one fourth of its potential profitability. The suboptimality problem can be solved through specific arrangements between retailer and manufacturer, which have the purpose of better channel coordination. One of these is a proportional discount sharing arrangement, in which each party contributes to the consumer price discount in proportion to its original margin (without sales promotion). Several other winwin arrangements are possible also.