What is Return on Trade Investment (ROTI) ?
What are base and incremental volume estimates?
How is ROTI calculated?
How is breakeven calculated for trade investments?
Is there a method to evaluate trade effectiveness across customers?
How would a customer P&L be structured?
What are some meaningful key ratios?
Is all volume sold on a promotion incremental?
Is all volume sold on deal to retailers promoted?
What about Every Day Low Price (EDLP) trade investment?
What if a promotion is run in addition to an EDLP program?
How is slotting profitability evaluated?
Will fund allocation base on profitability cause fair & equitable issue with the trade?
What are the risks of applying ROTI to trade investment decisions?

What is Return on Trade Investment (ROTI) ?    [TOP]

• Much like a stock trader would measure a return, ROTI measures the economic benefit of trade spending by calculating the financial return of money (trade investment) spent with the customer.
• ROTI calculations apply base and incremental volume estimates against trade investments.

What are base and incremental volume estimates?    [TOP]

• Base and incremental volume estimates are key components for measuring the benefit of a trade investment.
• Base expected volume is volume over a period in absence of any in-store activity (price discount, ad, display).
• Incremental volume is volume in excess of base volume and is driven by one or more in-store activities.
• Beware of the "pantry load trough" when calculating incremental volume.
  

How is ROTI calculated?     [TOP]

• First we will establish variables that impact ROTI:
  • B = Base
  • I = Incremental
  • T = Trade investment
  • v = volume
  • m = variable margin before trade expense

• Return on Trade Investment is calculated by dividing Trade Investment by Incremental Margin before Trade:
  • ROTI = T / Im

How is breakeven calculated for trade investments?   [TOP]  

• Bm + Im - T > Bm
• Im - T > 0
• Im > T
• These formulas measure the profitably of doing something (In-store activity) against the profitability of doing nothing (no in-store activity).

Is there a method to evaluate trade effectiveness across customers?    [TOP]

• Yes, On a micro basis, discrete trade promotions can be measured against each other for: 1) % ROTI & 2) Incremental profit.
• On a macro basis, customer P&L's can be created.

How would a customer P&L be structured?   [TOP]

• The order of traditional P&L expenses would be adjusted for an effective customer P&L. Trade expense is recognized after COGS. This fosters a clearer understanding of the impact of trade:

Gross Sales
- Terms
- COGS
MBT (Margin Before Trade)
- Trade
- Brokerage / Commissions
CM (Contribution Margin)

• For more sophisticated P&L's, other "costs to serve" can be included, such as…
  • Selling expense (salaries, benefits, facilities)
  • Freight & warehousing
  • Spoilage and damage
  • Information investments
  • Account specific marketing (when not included as trade expense)
  • Special services provided (in-store retail work, training, Point-of-purchase, category management)
  • Cost of special packaging, warehousing & shipping requirements
    
  • Excessive administrative costs (deduction management, inventory management)
  • Cost of capital (customer specific inventory, late payment)

What are some meaningful key ratios?   [TOP]

• Useful Key Ratios:
  • TS (Trade to sales) ratio = T / (Gross Sales - Terms - Trade)
  • CM margin % = CM / (Gross Sales - Terms - Trade)

Is all volume sold on a promotion incremental?   [TOP]

• No, promoted volume is sold to shoppers with some sort of in-store activity (Price discount, display, Ad).
• Incremental volume is the volume sold in excess of what would have sold without the in-store activity.
• The difference between Promoted Volume and Incremental Volume is subsidized shopper volume.
• Subsidized volume is volume sold on deal to shoppers that would have sold without deal.

Is all volume sold on deal to retailers promoted?   [TOP]

• No, volume sold on deal to a retailer may or may not be sold on promotion (promoted) to shoppers.
• Deal volume purchased by a retailer but not promoted to shoppers is called buyout volume, or subsidized customer volume.
• Buying-out volume, or forward buying, is a procurement strategy used by retailers and wholesalers to subsidize their margins. Buyout volume may be sold at full retail to shoppers or it may be diverted to other retailers at a price less than the inbound "divertee" could otherwise purchase the product.
• Bridging deals is a common practice among retailers/wholesalers. Deal bridging involves forward buying enough product on deal to eliminate the need to purchase "non deal" product until the next deal begins.
  

What about Every Day Low Price (EDLP) trade investment?   [TOP]

• Evaluating the effectiveness of an EDLP investment requires the same methodology as any other trade investment. The "incremental" volume is calculated in a slightly different manner.
• We will call incremental volume driven by EDLP Bump In Baseline (BIB). Bump In Baseline is the increase in baseline driven by the lower price:
  • BIB  =    Baseline volume with EDLP - Baseline volume without  EDLP
• Return on Trade can then be calculated:
  
  • ROTI = T / BIBm
• Breakeven can also be measured:
  
  • Bm + BIBm - T > Bm
    
  • BIBm - T > 0
    
  • BIBm > T

What if a promotion is run in addition to an EDLP program?    [TOP]

• This is called modified EDLP. First apply the EDLP evaluation. Next apply the standard profitability calculations.
  
• Treat "Bumped-Up" baseline as baseline for evaluation of modified EDLP.
  
• Include EDLP spending during the period and the additional event spending as trade investment.

How is slotting payback evaluated?   [TOP]

• Slotting is paid to get product into wholesalers' and retailers' distribution system and onto store shelve.
• Slotting requires a different calculation. Since slotting is generally a very significant expenditure, payback is evaluated on the length of time it takes to recoup a slotting investment.
• Calculate the CM Rate for the new SKU as follows:

   

Gross Sales (net of attrition*)
- Terms
- COGS
MBT (Margin Before Trade)
- Trade (excluding slotting)
- Brokerage / Commissions
CM (Contribution Margin)

CM ÷ Volume = CM Rate

* attrition is amount of existing product sales cannibalized  by new SKU

 

• To calculate the payback period:

1. Determine volume required for payback -
• Slotting Investment ÷ CM Rate  =  Volume Required for Payback
2. Then calculate the time required for payback -

• Volume Required ÷ Projected Weekly Volume = Number of Weeks to Payback

 

• In the past, manufacturers amortized slotting over several years. This is no longer
  an acceptable practice and is not in accordance with generally accepted accounting principles.  The decision to approve slotting is dependent on your business objectives & the amount of time in your financial year to generate contribution margin from the new SKU. 
• For most slotting decisions, manufacturers seek payback in the fiscal year the slotting is paid.  For some, where the goal may be more strategic and long-term, manufacturers may consider paying for distribution that does not payback in the same year.
  

Will fund allocation based on profitability cause fair & equitable issue with the trade?   [TOP]

• Not if administered correctly. All trade partners are not required to be treated identically. The keys are:
  • Treat competing trade partners fair and equitably, but not necessarily equally.
  • Do not put a retailer/wholesaler at a disadvantage to their competition.

What are the risks of applying ROTI to trade investment decisions?   [TOP]

• Erosion of brand equity when promotions are…
  
  • Too frequent
    
  • Or too deep
• Retribution from wholesalers and retailers for reducing their buy side margins
  
  • Distribution loss - especially fringe items
  • Higher retail prices (higher retailer margins)
    
  • Non preferred promotional execution (timing, quality of ads & displays)
    
  • Suboptimal shelving locations