How to Calculate Promotional ROI – Start With 5 Key Building Blocks

Business Processes
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This is Part 1 of UpClear’s Series on Promotional ROI and Optimizing Trade Spend. In future posts, we will discuss the areas such as cannibalization, promotional effects, and the ROI formula. Before that, though, we need to make sure the foundations are in place…

“60% of trade promotions have a negative ROI!” is a commonly quoted statistic: alarming enough for FMCG (CPG) companies if they have the tools and capability to calculate the “Return on Investment” (ROI) of their trade spend. What about those businesses that cannot, though? The term “wooden dollars” is often used, even in big corporations, to refer to promotional investment that is naively, or blindly spent. Below is a summary of the building blocks you need to calculate whether your organization’s dollars are wooden or within the 40% spent wisely…

1 It’s all about the Base

If you didn’t promote how much would you sell to brand loyalists? This is your base demand and it is a relevant question for both sales to a distributor (“shipment base”) and for sales from a retailer or wholesaler (“consumption base”). Without knowing this number, you can’t begin to understand how much of your total volume is being driven by trade spend.

The simplest way to calculate base is to chart your volume over a proceeding period for a customer / SKU combination. For this, weeks is generally better than months, and if the information is available, also overlay base and promoted volume data from a syndicated provider. This will probably give you a spiked line, with the ‘peaks’ corresponding to promotions or known events, such as Christmas, Valentines, or Easter: ignore these and draw a line connecting the ‘valleys’. You should be aiming for a standard deviation (sigma) of +/-3… This is approximately your base. From here all your other calculations can begin…

2 Understand the power of price

Most companies exist to make a profit which only three levers can deliver: volume, costs, and price.  Price, particularly on-going pricing, is the least discussed but the most important of the three as it affects everything a business can do with the other two. A 1% increase in price for example delivers straight to the bottom line more than a 1% increase in volume or a 1% decrease in COGs. Essentially, there are four elements to setting and understanding pricing:

  • Defining a strategy: Identify targets and goals, understanding how you can (legally!) influence the price in the market and establish boundaries, particularly for promotions.
  • Setting prices: Both on-going and promotional, based around the questions “are we worth it?” and “are we delivering value?”
  • Allocating spend to “buckets”: Define your investment clearly, right down the pricing ladder and especially around what any discounts or promotional investment is “paying” for.
  • Implementing: Decide how to manage price – with what tools, reports, controls, and training? Understand how to keep the business (and particularly “Sales”) delivering the strategy and prevent value leaking from each “bucket”

Once you have completed these two steps you can begin to understand the Volume on Deal (VOD)element of your sales and the proportion of your total “price”, i.e. the trade spend element, that is funding it.

3 Label those ‘Buckets’

… But which bit of your trade spend and what is it for? When the second biggest line on most FMCGs’ P&L is usually trade spend, understanding this is quite important. Only by having a clear pricing model, including “buckets” for promotional spend, with the ability to allocate and report investment against these, will you be able to measure ROI. Put simply, there are two types of trade spend:

  • Fixed spend: this can be thought of as the money spent to get your brand noticed by shoppers when it’s on promotion. Normally, this is paid to retailers and customers as a lump sum to cover feature and display costs, either in-store or online.
  • Variable spend: Whether an amount taken off your customer’s invoice or claimed retrospectively, if it is passed onto the end shopper, this investment either rewards your loyalists or drives promotional uplift. It’s variable because although the rate per unit (jar, case, can, etc.) normally remains the same, the volume sold on promotion will determine how much the activity will cost.

If necessary, as a minimum, start simple with a “bucket” for variable spend and one for “fixed” spend.  The more “buckets” you have – to a point! – the more you can understand your investments.

4 Ship or Shop

Retailers do not require a straight 10,000 cases from a supplier one week before a promotion starts. They have warehouses where they may already be sitting on 2,000 cases, plus another 1,000 cases at the back of their stores. For a three-week promotion, they may need to frontload their ordering across a two-week “buying in” period before the deal starts on shelf, then depending on the uplift, require additional stock in weeks one and two, once the activity is running.

Confusing? Yes, and that’s before you start thinking about how the variable spend element of an activity is going to work, especially if the claim for per unit funding is retrospectively submitted by the retailer based on sales-out data. All of this, however, needs to be factored in when trying to calculate the volume sold “on deal” and so the ROI  of an activity.

5 Show me the money!

If you’re funding on ‘sales-in’, when do you start applying the promotional discount: order date, ship date, on receipt? For retro funded activity, can the retailer claim only on the volume ordered during the promotion dates, or, as in the case above, also on the 3,000 cases they already had in stock?

Finally, when reconciling the retailers claim, so you are not over or under funding, is it accepted at face value or do you align it against EPOs numbers or third party data, from Nielsen for example? What if the retailer sends in multiple invoices against one promotion, or conversely combines several promotions onto one invoice? Only by having the ability to correctly allocate these claims, first to the correct promotion, and second to the correct bucket in the P&L, will you be able to determine the ROI.

So, in summary…

  • Understand the difference between base and promotional volume
  • Be clear about pricing both on and off promotion
  • Allocate investment to different ‘buckets’
  • Manage the volume
  • Appreciate what you’re paying for

It is complicated, particularly as promotion management touches pretty much every department across a business, from marketing or RGM in the conception, through sales execution, to supply chain in the delivery. Understanding your volume drivers and related spend gives you insight into which promotions “work” and which don’t, the ability to make decisions and the opportunity to take the appropriate action as a business, plugging holes in any leaking value buckets.

And, yes, you can manage all this in spreadsheets, but there are considerably better ways of doing so …

Understanding which of your dollars are ‘wooden’ allows you to identify and eliminate, for example, the worst 10% performing trade activities, investing this money instead to make the best performing 10% even more profitable. We will discuss this more in future posts, along with “All-in” / “Extended” ROI, but if you have any other areas you would like us to discuss, or indeed any comments on this piece, please do not hesitate to contact us at: info@upclear.com.