Optimizing trade promotion ROI in the CPG industry

Executive summary

Trade spend is a huge investment for consumer packaged goods (CPG) manufacturers around the world – yet most trade promotions fail to generate a profit. To be successful, manufacturers must determine their trade promotion return on investment (ROI), which can be difficult to calculate accurately due to common industry challenges. TELUS Trade Promotion Management (TPM) software can enable more accurate calculations, facilitate predictive planning, provide real-time execution monitoring and result in continuous, profit-driven improvement.

This guide will provide frameworks, formulas and best practices to help you understand trade promotion ROI, how to calculate it and ways to optimize your calculations.

What is trade promotion ROI?

Trade promotions are incentives for retailers to drive sales for your products. In the CPG industry, trade promotions drive sales, secure shelf space and help manufacturers gain a competitive edge. As more Canadians begin shopping with intention, retailers need to focus on promotions and price more than ever. But the cost for these programs can be high and the returns are not always clear cut.

Globally, CPG companies worldwide invest about 20 percent of their revenue annually in trade promotions. Despite this strong investment, studies have indicated that most promotions – 59% worldwide – don’t turn a profit. 

When you invest  in trade promotions, it’s likely costing you a pretty penny, but is it profitable? To ensure every dollar you spend on trade promotions is maximized, you need to accurately calculate trade promotion ROI. 

Trade promotion ROI is key to determining profitability

Trade promotion ROI is a key performance indicator (KPI) that measures the effectiveness of promotional spending by comparing a promotion’s cost to its incremental profit. It helps you determine if your discounts, displays and advertising are working.

Trade spend is typically the second-largest expense for CPG manufacturers, with cost of goods sold (COGS) taking the prime spot. Because this spend can account for 15% to 25% of gross revenue, every dollar must be scrutinized. Without a reliable method of measuring trade promotion ROI, manufacturers risk losing money and time. For these reasons, trade promotions must be built with a data-driven approach. Sound ROI measurements reveal:

Profit drivers

These identify which promotions are leading to profitable sales, versus those that are only shifting existing sales (cannibalization) and those that are breaking even.

Retailer partnership effectiveness

This isolates the retail partners and channels that are the most effective in your promotional investments.

Tactical success

This indicates which promotion formats (discount, display, feature etc.) are working for your specific products.

When organizations don't accurately calculate trade promotion ROI, they risk wasting money and missing opportunities to reinvest in future high-ROI activities. This also hinders the team's ability to negotiate effectively with retail partners, due to a lack of reliable data that demonstrates how promotions will be profitable.

Challenges for measuring trade promotion ROI

Measuring trade promotion ROI can be quite complex. It involves data, attribution and operational challenges. To calculate it accurately, you have to isolate the impact of a promotion from all other influencing factors. This is challenging because of:

Data complexity

Accurate data analysis requires harmonization from multiple, often disconnected, sources like point-of-sale (POS) data, shipment data, syndicated data and retailer portals. Reconciling fragmented data into a single source of truth using manual spreadsheets can be incredibly time consuming, error prone and nearly impossible at scale.

Attribution uncertainty 

Your sales can be impacted by several factors like seasonality and holidays when demand peaks, baseline erosion when demand gradually declines, your competitor’s actions which lure customers away and even the weather. So how can you tell if your promotion really drove the sale? To know for sure, you need to establish a reliable baseline of what sales would have been like if the promotion never ran.

Cannibalization

Promotions can influence more than just the featured product. Cannibalization can occur when a promotion increases sales of one item at the expense of another in the same portfolio, reducing the true incremental gain. In other cases, promotions may generate halo effects, where they drive additional sales of non-promoted products, providing an unmeasured positive benefit.

Operational disconnects

No matter how carefully you plan a promotion, sometimes plans won’t be followed perfectly by retail partners. When this happens it can undermine your promotion's ROI. POS data can also take weeks to gather, making it very challenging to optimize a promotion while it’s still running.

Factoring in all of these challenges can quickly become overwhelming, especially for those who conduct manual calculations and promotion planning. Without an accurate and detailed trade promotion ROI calculation, it’s hard to effectively negotiate with your retail partners who want to see granular, accurate data that demonstrates that their promotions will likely be profitable. But, with the right strategy and tools, you can carefully calculate the ROI figures you need. 

How to calculate trade promotion ROI

There is a defined, simple formula used to calculate trade promotion ROI. But don’t let its simplicity fool you – accurately defining and isolating the components of the formula is the real challenge.

The basic trade promotion ROI formula

The basic trade promotion ROI formula is:

Trade promotion ROI = (incremental revenue - promotion costs) / promotion costs x 100

Once calculated, the ROI result is a percentage. A positive number means you had a profitable promotion and a negative number shows a loss.

How to calculate each component of the formula

There are two main components to define within the formula – incremental revenue and promotion costs.  

Incremental revenue

Incremental revenue is the extra money a promotion earns. You calculate it by subtracting baseline sales (your anticipated sales) from your actual sales during the promotion period, like this:

Incremental revenue = (promoted units - baseline units) x price per unit

Your baseline should be calculated using statistical models that analyze your historical sales, factoring out variables like seasonality, holidays and previous promotions. An inaccurate baseline estimate will result in a misleading ROI calculation. For the price per unit, it's important to use your own unit price – not your retailer partner's selling price. This is because the baseline units would have been sold at the standard CPG unit price.

Promotion costs

Promotion costs are all of the financial expenditures tied to the promotion. They may include trade spending (discount per case, slotting fees, feature ad allowances etc.), execution costs (display materials, in-store labour and merchandising costs etc.) and opportunity costs (potential cost of running out of stock or diverting resources etc.).

How to calculate trade promotion ROI most accurately

To calculate accurate trade promotion ROI, you’ll need to factor in profit and margin analysis. This involves incorporating cannibalization, halo effects and the product's margin. You’re essentially moving from incremental revenue to incremental margin. This involves subtracting the COGS for the incremental units. This gives CPG companies a more high definition picture of a promotion's profitability, not just its sales lift, enabling them to make better-informed decisions.

What is a good trade promotion ROI?

There is no single "good" ROI number. Benchmarks vary across product categories, retailer channels, promotion mechanics and strategic objectives. A 50% ROI might be ideal in one scenario and less than in another.

Benchmarks and variations

While you might not know what ROI percentage to shoot for in your promotions, benchmark ranges can help. High-margin products (like premium bottled water), for example, may have lower ROI than low-margin, high-volume products (like soda). The type of promotion you run will also affect the ROI. For example, certain promotion mechanics (discounts, contests, or special offers etc.) may drive higher ROI than others.

What defines good ROI

When evaluating if your trade promotion ROI percentage is good, you must factor in the strategic objective(s) of the promotion. If, for example, your goal was to make the most profit possible, your ROI should be high. If you ran a sale to raise awareness for a new product, your ROI could be moderate. If your goal was to defend your market share, your ROI could be low. Good ROI should be higher than your minimum desired percentage while still achieving its strategic objective.

How to optimize promotions for maximum ROI

To optimize your promotions for maximum ROI, you’ll need to assess what’s already worked and failed for your business.

If you’ve always worked manually with spreadsheets or on paper, you’ll likely struggle to optimize your promotions for maximum ROI. There are too many variables and things tend to get far too complicated pretty quickly. 

The right software solution can make all the difference. New SaaS solutions offer predictive analytics that can forecast ROI before trade spend investment, enabling the user to design ideal promotion strategies in advance. The forecasting tools provide visibility into how each promotion may perform, allowing opportunity to pivot should potential promotional activity look as though it will underperform. Post-event analysis empowers teams to make continuous improvements, utilizing historical performance for iterative improvements.

How TELUS can help with your trade promotions

Without the right software solution, optimizing trade promotion ROI is nearly impossible. TELUS Trade Promotion Management software helps you calculate accurate trade promotion ROI by integrating and harmonizing all your relevant data sources into a single source of truth.

At TELUS Consumer Goods, we bring more to the table than just transformative software solutions. Our expert team provides invaluable support, helping you achieve more profitable promotions. 

Key takeaways for optimizing your trade promotion ROI