Describe the impact of trade promotions on cycle inventory

Question

What will be an ideal response?

Answer 1

Answer: Manufacturers use trade promotions to offer a discounted price and a time period over which the discount is effective. The goal of trade promotions is to influence retailers to act in a way that helps the manufacturer achieve its objectives. A few of the key goals (from the manufacturer's perspective) of a trade promotion are as follows:
1. Induce retailers to use price discounts, displays, or advertising to spur sales.
2. Shift inventory from the manufacturer to the retailer and the customer.
3. Defend a brand against competition.

In response to a trade promotion, the retailer has the following options:
1. Pass through some or all of the promotion to customers to spur sales.
2. Pass through very little of the promotion to customers but purchase in greater quantity during the promotion period to exploit the temporary reduction in price.
The first action lowers the price of the product for the end customer, leading to increased purchases and thus increased sales for the entire supply chain. The second action does not increase purchases by the customer but increases the amount of inventory held at the retailer. As a result, the cycle inventory and flow time within the supply chain increase.
Trade promotions lead to a significant increase in lot size and cycle inventory because of forward buying by the retailer. This generally results in reduced supply chain profits unless the trade promotion reduces demand fluctuations.

The retailer can justify the forward buying because it decreases his total cost. In contrast, the manufacturer can justify this action only if they have either inadvertently built up a lot of excess inventory or the forward buy allows the manufacturer to smooth demand by shifting it from peak to low-demand periods. In practice, manufacturers often build up inventory in anticipation of planned promotions. During the trade promotion, this inventory shifts to the retailer, primarily as a forward buy. If the forward buy during trade promotions is a significant fraction of total sales, manufacturers end up reducing the revenues they earn from sales because most of the product is sold at a discount. The increase in inventory and the decrease in revenues often leads to a reduction in manufacturer profits as a result of trade promotions. Total supply chain profits also decrease because of an increase in inventory.