I wanted to write a case study about a company that had implemented trade promotion optimization, so I conducted some secondary research and came across the following claim in analyst reports, trade publications, and comments made by software vendors: “For consumer products companies, trade spend is the second-largest expense item on their Profit and Loss statements right after the Cost of Goods Sold (COGS). For the average consumer products company, trade promotions account for 18 percent of revenues.” Some articles claimed 20 percent, which sounds impressive. Effective trade promotion must be strategic.
But something about these statements struck me as odd. I’m a supply chain guy, not a finance guy, but according to a financial management textbook sitting on my desk, here is how an income statement is organized:
Revenues
– Costs of Goods Sold (All supply chain costs, including procurement, manufacturing, and distribution)
= Gross Margin
– Selling, General and Administrative (SG&A) Costs
– Other Stuff
= Operating Income
So, when you say promotion spend is the second largest item after COGS, what you’re really saying is that it is the largest line item in a consumer products company’s SG&A costs.
But still, if promotion spend is 18 -20% of revenues at the “average” consumer products company, that is significant. But is this true?
I went to the Edgar database and looked up COGS and SG&A data for the publicly-traded consumer goods companies listed below. The table shows COGS and SG&As as a percentage of revenues based on each company’s most recent 10-K filing:
| Company | COGs | SG&A |
| Coca-Cola | 36% | 37% |
| General Mills | 60% | 21% |
| Hormel | 83% | 8% |
| Kellogg | 57% | 27% |
| Kraft | 64% | 24% |
| Mars | 91% | 3% |
| PepsiCo | 46% | 39% |
| Procter & Gamble | 49% | 31% |
So, as I look at this chart, I notice a few things. The “average” consumer products company isn’t very average. That 18-20% of revenues coming from promotions does not look credible or particularly meaningful.
I have nothing against spending money on Trade Promotions Optimization applications. In fact, I think it is a good idea for this industry. But if companies choose to invest in new applications, shouldn’t they make an informed decision?
One question that a consumer goods company might ask is the following: If I break sourcing, manufacturing, warehousing, and transportation costs out of COGS, what are the percentages for each? If I break trade promotions out of SG&A, what is its percentage? What is the rank order from largest to smallest of these different spend buckets? By itself, this type of analysis might not tell you where to spend your IT dollars, but it is a good starting place.
CPG companies report Net Revenue or Net Sales. Net Sales is after they have deducted the Trade Spend. So the Trade Spend does not show up in the income statement, as it would be a top line deduction from Total Sales. As I understand it, CPG companies often spend 15+% on promotions like coupons, rebates to companies like Walmart for product placement, ‘giveaways’, etc. This money is managed by the sales and marketing teams, as a way to drive sales for certain products, to targeted regions or customers, to reduce inventory, to gain market share, and so forth. The next time you are shopping, look around at all of the promotions. There is definite business value in doing a better job of ‘optimizing’ this spend: 1) to get a higher return on sales and 2) in quantifying the ‘lift’ on demand as a result of promotions which impact the supply chain.
I went to my finance text and it says: “to determine net sales, gross sales are reduced by sales returns, allowances (discounts for defective merchandise), and sales discounts.” But would allowances also include slotting fees and other types of promotional spend. My text does not say and I can’t figure it out on the Internet.
It also says “Selling expenses are costs incurred in obtaining the sale of goods or services (e.g., advertising, salesperson salaries) and in distributing the merchandise (e.g., freight paid on shipments).” So would advertising in a specific region in a local newspaper in return for better placement fall under selling expenses? Probably. So in short, I think cyhertz is probably part right and I’m probably part right. It also seems to suggest that outbound transportation spend (and DC costs?) is found in selling expenses rather than COGs for a manufacturer. Understanding total transportation, warehousing, and promotion costs looks complicated. I hate accounting.
Actually, there has historically been inconsistent accounting treatment of trade promotions. Here are some links and quotes for further insight on the topic.
This article discusses treatment of various trade promotion activities.
http://www07.ibm.com/services/pdf/IBM_Consulting_New_rules_bring_consumer_and_trade_promotions_to_harsher_light.pdf
Here are some other references.
http://www.pg.com/annualreport2010/financials/notes-to-consolidated-financial-statements/note-1-summary-of-significant-accounting-policies.shtml
http://www.orghelp.com/pdfsandfiles/Syspro%20electronic%20brochures/TPM_White_Paper.pdf
“Treatment of trade promotion costs
The treatment of trade promotion costs by companies in the FMCG sector is not covered in detail by IFRS, and such costs tend to be treated differently by different companies in Europe.
Unilever’s treatment of trade promotion costs has been as follows:
• Most of these (such as “Buy-one-get-one-free”, or “20% off this purchase”) are already deducted from turnover
• Certain expenses, primarily coupons offering discounts for future purchases and trade communications have been included in advertising and promotions. ”
Under US GAAP, all trade promotion costs, including promotional couponing and trade communications are deducted from turnover. Details of these costs therefore appear in the notes to the Report and Accounts set out in our annual accounts.”
http://www.trade-promotion.com/trade-promotion-fasb-compliant.aspx
“Government scrutiny and regulations regarding accounting practices are at a heightened level in all industries, including the CPG sector. FASB Ruling 01-09 FASB has required that all trade promotion expenditures targeted for price reduction/in-store merchandising support be deducted from the quarterly gross revenue statements. This accounting regulation has resulted in many CPG manufacturers adjusting their revenue downward by 20% and more.”