Retailers are tightening the screws at all levels when negotiating prices and trade terms. At a national level they are asking for more favourable trade terms from manufacturers along with more and more services - often without any additional counter-performance. At an international level, retailers are taking the opportunity to compare prices and trade terms across national borders in order to push prices to the lowest level possible.
Elsevier Food International, Vol. 6, Number 1, February 2003
Jens Abend, Udo Kopka and Konrad Gerszke

It is no wonder that frustration has been building among manufacturers both because of the growing power of retailers, and the lack of their own power, sometimes of their own making. The disproportionate power of the international retailers is based on their size, which resulted from mergers and international expansion. In addition, the retail industry is benefiting from today's greater transparency (due to more powerful IT systems), from a boost in investments in expertise, from the trend towards European products (e.g., multilingual packaging), and also from the introduction of the euro.
However, manufacturers' lack of power is often rooted in home-made problems. Above all, only a few companies have succeeded in establishing a strict and consistent system for negotiating trade terms. They often have separate systems for trade terms and product prices for individual retailers, as well as for the countries in which they are located. The reasons for this are differences in consumer prices and mostly uncoordinated national negotiations with the trade partners in the past.
The process becomes even more inconsistent when independent country organisations that handle their own negotiations also start offering different service packages. Furthermore, incompatible IT systems and a lack of transparency, for example, due to variations in bookkeeping rules make the necessary coordination exponentially more difficult. Moreover, many manufacturers do not know their customer profitability. Finally, in addition to the lack of suitable systems, most FMCG manufacturers lack suitable enterprise-wide processes and structures.

Systematic and pro-active
However, there are plenty of opportunities for consumer goods manufacturers to improve this situation. Therefore they should take a systematic approach to these issues and prepare for the two emerging challenges of the future:
Firstly, the balance of power between the players will have to be redefined as retailers energetically assert their demand for harmonisation of net-net prices and trade terms across countries, formats, and affiliated companies. There will remain only a few exceptions to reflect various customs/duties, taxes, transport, and service costs, and similar factors. This type of harmonisation poses a risk for manufacturers that generally amounts to two to five per cent of net sales.
Secondly, further takeovers and mergers as well as the formation of buying groups will give retailers even more opportunities to compare trade terms. Manufacturers should prepare for this eventuality by analysing the scenarios for possible mergers of customers in the retail sector.
At first glance, both of these challenges pose a considerable profit risk for manufacturers and therefore also substantial earnings potential for retailers. However, the way in which these profits and losses will be divided up in the end depends on who acts first. Manufacturers in particular must become more pro-active instead of just reacting to the steps taken by retailers. By making selective adjustments early on, manufacturers could systematically minimise their profit risk associated with individual retailers by about two-thirds.
This goal can be achieved using three complementary measures (see Figure 1). These measures are prepared by taking a systematic
Selectively inventory of prices, trade terms and conditions to create transparency and by setting reference prices for each product beforehand.

Selectively adjust net-net prices
In cases where prices in individual countries significantly differ from the reference or target price, manufacturers should selectively adjust the net-net prices they have calculated. Net-net prices take into account deduction of all special trade terms and, if necessary, other costs such as customs/duties, taxes, and logistics expenses (Figures 2 and 3). It makes sense to adjust these prices in three steps.
First, manufacturers should deal with prices that significantly exceed the reference price. This lowers the risk only minimally in the quantitative sense but the effect in qualitative trade terms is often substantially greater. In one specific case, all extreme deviations from the reference price were adjusted by reducing the prices of only 35 of 1,000 products. Twenty-four of these prices exceeded reference prices by over 100 per cent. Sales only fell by 0.03 per cent. If in turn the retailer had confronted the manufacturer with this price overrun at their annual negotiations, the consequences would have been far more serious. The retailer could have extrapolated this sample of 35 across the board and demanded the difference to be paid retroactively.
The second step should involve selectively raising product prices in countries where prices fall below the minimum reference price and, therefore, also outside of the price corridor.
This could drastically reduce the risk of retailers demanding that net-net prices for these products (in this case 43 products) should be reduced to the level of the least expensive country (representing about one-third of the entire harmonisation risk). The price increase resulted in an increase in sales of one per cent, also a small amount.
After these deviations from reference price are corrected, the last step comprises prioritising products according to their risk potential. In this concrete case, ten per cent of the products were responsible for two-thirds of the overall profit risk. The risk was decreased by a further third when the company adjusted the prices of only eleven additional products selectively and step-by-step (e.g., during a relaunch).

Eliminate specific trade terms
The second measure manufacturers should take to reduce their profit risk is to eliminate specific trade terms and conditions that are only offered to a single retailer in just a few countries. This does not minimise the calculated risk because the net-net prices are being harrnonised. However, it prevents the retailer to request expansion of these trade terms to other countries. Therefore, this measure substantially lowers the potential risk. In the example mentioned above, the FMCG manufacturer had to review nine types of trade terms and conditions of a single retailer because these trade terms were offered in no more than two of seven different countries.
The focus here should be on eliminating non-performance-related trade terms, such as basic fixed bonus, merger bonus, or central group bonus. In return, manufacturers could offer to expand performance-related trade terms, such as bonus for sales growth, order size bonus, and merchandising bonus (Figure 4). If the retailer had been the first creating the necessary transparency, the retailer would certainly have come to the manufacturer with a request to extend the favourable original trade terms to other countries as well.

Develop a harmonised price and trade term system
Theoretically, the development of a harmonised and performance-based trade terms system (of course with no negative effect on profits) is the most effective of the three measures. However, experience has shown that retailers are hardly willing to accept such harmonisation straight away.
Harmonising retail and wholesale prices is not attractive per se to either retailers or manufacturers because of conflicting interests. Retailers would like to see the most favourable prices and trade terms extended to all countries and formats - preferably with a guarantee that no country formate would be offered less favourable conditions. Manufacturers want to defend their overall customer profitability so that each reduction in net-net prices is compensated for by an increase elsewhere. In view of their conflicting objectives, a possible compromise would be for retailers to accept actual cost differences between countries (due to customs/duty, taxes, etc.) as a price factor and for manufacturers to simply benefit from the higher overall margins in countries with a higher retail price level.
Because of these expected difficulties, manufacturers should indeed develop a harmonised and performance-based trade terms system, but initially use it only as an internal guideline to which they acclimate individual retailers step-by-step as described in the first two measures. Manufacturers should only attempt broad, short-term harmonisation if they possess considerable market strength (for example. based on extremely strong brand-name products) and/or can assume that retailers will be more accepting of these measures. Generally speaking, consumer goods manufacturers can, however also achieve their goal of risk minimisation without this third measure.

Transparent and consistent
All three of the measures described are only effective if the prerequisites are right in place. That is why companies have to start this initiative by taking a careful inventory and creating transparency. A prerequisite for active reduction of profit risk is achieving the necessary transparency concerning actual prices and trade terms. The objective should be to base the argumentation in negotiations with retailers on a foundation of facts. To this end, FMCG manufacturers should systematically collect their internal information on prices trade terms and services offered to each individual retailer and evaluate these using a uniform system for all countries and customers. Manufacturers should also calculate actual and comparable net-net prices. Experience has shown that the key lies in the detail in this case. Precisely assessing all services and trade terms (including those that may be hidden in the logistics or marketing budget) and allocating them to each retailer and each product group frequently uncovers a substantial discrepancy with regard to the already existing net-net price calculation. In other words, it often turns out that these "old" prices are not really net-net.
The success of these measures is not only ensured with thorough preparation but also with systematic follow-up. After manufacturers have implemented these measures, they must consolidate the results and prevent local digressions from the planned target system. To this end, manufacturers should establish and standardise individual processes: for instance, institutionalising a process to calculate net-net prices and risk, enforcing the obligation to seek permission to deviate from the reference price corridor, and ensuring the use of a blacklist of trade terms that should not be agreed with customers. In addition to these pragmatic solutions, the company should also aim to achieve medium-term improvements such as harmonising internal accounting, preferably to account for sales and costs by customer while calculating and allocating all services and trade terms using a uniform system. Moreover, pricing and negotiation processes should be better coordinated. And last but not least, manufacturers should consider partial centralisation of local decision-making structures particularly with regard to prices and trade terms for regional or international customers.