In the financial battle between retailers and manufacturers, who's
got the power? PRADEEP CHINTAGUNTA, Robert Law Professor of Marketing, explores this industry tug-of-war.
EVERYONE BUYS GROCERIES–AND LOTS OF THEM. In the United States,
consumers spent more than $346 billion on groceries in the past
year. These profits are primarily split between manufacturers
and retailers, and the power dynamic between the two is constantly
changing.
Pradeep Chintagunta, Robert Law Professor of Marketing, approached
the study of the retailer-manufacturer relationship as a natural
extension of his research on competitive interactions among manufacturers.
“Most of this research tries to look at data from a specific industry,
and a specific group of firms, and then tries to understand it,”
said Chintagunta.
“In general, this falls under the category of new industrial organization
research, where instead of looking across many different industries
to come up with general conclusions, we look at a specific industry
and draw conclusions from it.”
Often the analysis of competitive interactions among manufacturers
is performed with retail data, which raises some potential problems.
“The argument is that you can say a lot about manufacturer interactions
with retail data, but in fact it’s the retailer setting the retail
prices, so it’s hard to infer interactions among manufacturers
with just retail data,” he said. The only way to separate out
retailer and manufacturer interactions is with access to the prices
that manufacturers are charging retailers.
“The problem with a lot of this kind of research is that we don’t
have access to that information. Fortunately, we had data from
a project at Chicago, the Dominick’s project, which we tapped
into,” he said.
In the Dominick’s project, the grocery chain and several brand
manufacturers cooperated with the GSB’s marketing group in various
research projects, yielding significant data that included retail
prices and margins. From this, manufacturer prices could be inferred.
“These data, while not perfect, still give us useful information
about what price manufacturers are charging retailers,” Chintagunta
said.
With this information, Chintagunta and his colleagues Vrinda Kadiyali
of Cornell University and Naufel Vilcassim of the University of
Southern California began working to understand interactions between
manufacturers and retailers.
The conventional wisdom is that retailers now have greater power
than manufacturers. Widespread and intensified competition among
manufacturers has driven down their prices. In addition, retailers
can access consumer data to determine which brands are successful
(or not) and use this information to pressure manufacturers to
cut them a better deal. Another factor is the introduction of
private labels by retailers–like Jewel brand at Jewel food stores–that
provide a budget-priced competitor to national brands. Proponents
of retail power cite practices such as slotting fees–the practice
of retailers charging manufacturers a fee for shelf space–and
increased trade promotions as evidence that retailers have more
power.
To see if conventional wisdom was on track, Chintagunta turned
to the data. A comparative study of profitability in the grocery
business tracked over twenty years found that the overall profitability
has not changed significantly. “If overall profitability hasn’t
changed, what’s all this talk about the shift from manufacturer
to retailer?” Chintagunta asked. “If there has indeed been a shift,
then the retailer should be showing higher profits than before.”
And if retailers aren’t making more money, who’s got the power?
In the manufacturer-retailer channel, or the line of distribution
between the manufacturer and the consumer, relative power of the
manufacturer and the retailer can be measured as the percentage
of channel profits accruing to each group.
To determine who is winning this tug-of-war, Chintagunta and his
colleagues used a model from the economics literature to study
the interactions among several manufacturers and a retailer.
Considering the entire channel, they looked at the big picture,
or the size of total channel profits, and the split, or who is
getting what piece of the pie. Taking four product categories–refrigerated
juice, analgesics, toilet tissue, and paper towels–the researchers
estimated manufacturer costs. To determine the total channel profits,
they subtracted the manufacturer’s cost from the retail price.
Since the retailer’s margins are available from the data, one
can determine the share of the pie accruing to the manufacturer
and the retailer.
The problem when trying to compute total channel profits, according
to Chintagunta, is that it’s almost impossible to ascertain the
manufacturer’s cost. “In many cases manufacturers themselves can’t
tell you their costs. The accounting department will give you
one measure of the cost; for tax purposes, there is usually a
different measure of the cost; and the operations people probably
use yet a different measure,” he said.
“We decided to estimate costs rather than depend on data from
manufacturers. If there’s one innovation in the methodology, it’s
that we looked at the prices that the manufacturer charges the
retailer, and the prices the retailer charges the consumer, and
from there we figured the costs that manufacturers incurred to
make and sell the product.” To do this, Chintagunta used data
on retail sales and manufacturer and retailer prices to create
a model assuming that manufacturers and retailers maximize profits.
“This also gave us insights into interactions among channel members
and provided lessons for manufacturers and retailers,” he said.
But first, to answer the original question, who’s got the power?
Though retailer profits haven’t increased–a somewhat puzzling
scenario at first–Chintagunta quickly learned that retailers are
getting “a larger piece of a shrinking pie” as price-sensitive
consumers demand lower and lower prices. Retailers in fact do
wield the greater power, at least for the time being.
Lessons for manufacturers
Perhaps as important as the answer to the original research question
of power were Chintagunta’s insights for manufacturers and retailers.
If consumer price sensitivity is the manufacturer’s enemy, he
said, then building brand loyalty is a way to overcome downward
pressure on retail price. In a price category like paper towels,
for example, it seems reasonable to think that all products are
similar and that there is little opportunity for brand loyalty.
But Procter & Gamble has built loyalty by offering additional
value to the customer with its ‘rinse and reuse’ Bounty and a
‘select a size’ product that perforates a standard sheet so a
customer can use the towels in half-sheet increments. The bottom
line is that if manufacturers can cultivate a loyal core, they
might be able to retake their market, or at the least, retain
their margins.
Lessons for retailers
What does the future hold for retailers? With the consolidation
in retailing–Chicago grocers Jewel and Dominick’s are now owned
by national chains, for example–and the consolidation in the manufacturing
sector, it’s possible that maintaining the status quo is the most
retailers can hope for.
Another threat to retailers comes from online grocery services,
which–if successful–could shift power back to manufacturers or
to online retailers. But of the online grocers, Chintagunta said,
only Peapod has been even moderately successful. Many offer only
dry and canned goods in a field where consumers want a one-stop
shop. And the key to success in online commerce, particularly
in the case of groceries, is trust. Consumers need to believe
that they will receive exactly what they ordered, in good condition,
exactly when they need it. Earning customer trust is no small
task.
One way for retailers to keep the power and fight online grocers
is to offer their own online shopping services. Retailers could
capitalize on their respected name and loyal customer base to
attract online customers with established trust in the store.
Armed with this information on the roles of loyalty and price,
Chintagunta said, retailers and manufacturers can make smarter
decisions as they attempt to increase their profits–and power.–M.M.B.