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Performance Pays
By Nancy Moffitt
Wharton Marketing Professor David Bell has seen his research take shape as practice—and strengthen the retail industry.
David Bell was nervous. He'd been asked to give
a talk at a retailing conference in San Francisco
and, to his surprise, found upon arrival that
he'd been scheduled as the keynote speaker.
Before him was a room of 75 or so of the nation's
leading retailers and manufacturers, two
groups known for decades of bitter conflict, with the retailers camped
stiffly on one side of the room, the manufacturers on the other.
The speech he'd prepared was a somewhat abstract mathematical/economic analysis of trade promotions – deals manufacturers
and retailers had traditionally used as weapons in a zero-sum
game. Manufacturers had long been tied to an "off invoice" system
that gave retailers periodic discounts during a promotion period—discounts
that, in theory, retailers were supposed to pass on to
consumers. But retailers had abused these promotions, often "forward-
buying," the practice of purchasing more than they could sell
during the official promotion period and/or diverting the product
to other retailers who were not privy to the trade deal, thereby
pocketing the savings themselves. Not surprisingly, manufacturers
despised the system, and even retailers claimed to be frustrated by
funds wasted on administrative and inventory costs.
Bell, an associate professor of marketing, was about to propose
an overhaul of the dysfunctional arrangement—a way to seek peace,
and profits. But in a room with many more manufacturers than retailers
facing him, he wondered how what he was about to propose
would go over. "I was quite worried about how my talk was going
to be received," said Bell. "But there I was, so I just forged ahead
with it."
The upshot: Bell told the group that retailers are not inherently
"evil"—they were simply responding to the incentives on the table.
A solution could be found, Bell said, in a variation of what was then
a new but unpopular type of trade promotion known as pay-for-performance—rewarding retailers based on what they sell rather
than offering up-front discounts. If manufacturers were willing
to sweeten their pay-for-performance deals enough, the counter-intuitive result was that they could offer a better deal to retailers,
yet make themselves, and ultimately consumers, better off in the
process. Give away more money to get more money, Bell told the
manufacturers, wondering what the reaction would be among the
embattled, cost-conscious crowd.
"But they were surprisingly candid—as were the retailers," he
said. "Both agreed that the system was problematic, but I think that
after our discussion the manufacturers were less enamored with the
view that retailers were underhanded and that all the retailers were
doing was responding to an incentive system fueled in part by the
manufacturers themselves."
"If you give a retailer an incentive that's based on what she's going
to buy, then she's going to try to optimize the buying function,"
Bell said. "So you have to turn the incentive around and say, 'Ok,
instead of giving you a dollar for everything you are buying from
me—a discount—I'll give you a dollar discount for every case of
product that you sell, that you scan through your system.'"
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