HoukTPM

April 6, 2008

Irrational behavior

One of the cornerstones of economic thinking in recent decades has been that consumers, companies, and markets are driven by rationality. Each player acts in its own interests, and the result is to the overall benefit of all. And it mostly works.

There are those, however, who point out that not all behavior is rational. Or that behavior that is rational in one role might be irrational when a player shifts roles. This mostly comes from a school of thought called behavioral economics and popularized in the book, Freakonomics.

We can see this happening in our business in, for example, channel-stuffing. We all know that channel-stuffing makes no sense. What value is there in selling 100,000 units to a major customer who doesn't need them? Certainly you make your numbers for this quarter, but at great cost (customers aren't going to take units they don't need unless you cut them a great deal), and you've just put yourself in a really big hole for the next quarter.

Totally irrational, right? Yes, to the supplier. But not necessarily to the employee who made the deal. His or her interests may be very different - e.g., quarterly bonuses. And the longer-term negatives might be of less interest to someone who may move along to another position or another company (with a record of meeting tough objectives).

Corporate policies in trade promotion are also sometimes not entirely rational, either. As long ago as the early nineties, I recall advising clients and readers that rather than slanting their trade promo programs entirely toward their biggest customers, they should consider taking steps to try to ensure the survival of smaller customers. A sharply diminished customer base, after all, would be likely to result in lower prices.

Totally rational: Fewer customers means increased bargaining power for those customers means lower prices. I'm not claiming to be a genius for seeing this - it was apparent to anyone watching the scene unfold. Which means that everybody did what I was suggesting, right?

Er ... no. Actually, they did the exact opposite, because it was in their short-term interests to build sales the quickest, easiest way - through bigger customers.

None of which is to say that analyzing markets and making plans based on assumptions of rationality is necessarily wrong, simply that we must remember that companies are made up of people, and that people are sometimes irrational.

A trade promo tactic I don't recommend

Anytime I've worked on helping a client set up their trade promotion management system, one of the first questions is, "What are the promotion types you will need to track?" The answer is usually a fairly predictable list: Ad (sometimes broken down by media type), Display, TPR, maybe Signage, sometimes Slotting, and so on.

Occasionally, there's a surprise, but to date I've never come across "Bribes" as one of the spending categories. I hope I never will, but it looks like a possibility.

According to this article, Home Depot has recently fired a few buyers who were living quite nicely on the largesse of some of their suppliers - home theaters, cars, ..

In case it sounds tempting (might be cheaper than slotting), it appears that the suppliers have been bounced or are being reviewed. It wouldn't surprise me if the DoJ decided to join the review.

A follow-up to "Could it happen here?"

I should have mentioned in my last article, on the likelihood of stronger enforcement of laws regulating trade promotion in the US, that what clearly can happen is private lawsuits by aggrieved parties. We've seen a number of such private actions in recent years, some of them resulting in significant penalties (e.g., LePages/3M, Conwood/US Tobacco).

Now a new suit has been filed by a Kia dealer, alleging that his supplier has been offering larger advertising allowances to other Kia deales in his market. Shocking!

According to the lawsuit, dealership vice president Jim Barnett discovered the advertising program in December 2006 when he "inadvertently" opened a Federal Express envelope that had been misdirected to his dealership.

Inside were letters addressed to some of Barnett's competitors, showing that Kia Motors had been providing them with advertising incentives of $10,000 to $35,000 a month in a "Regional Marketing Fund program."
Just a reminder: If you're sending out a notice about a special program, make sure you don't mail it to customers who are excluded from the program.

More seriously, even though the article states flatly (and truthfully) in regard to Robinson-Patman that "the government no longer enforces the law," the possibility of suits by customers or competitors is still very real, and potentially (ask US Tobacco, who got hit for $1 billion) very expensive.

Meanwhile, back at the blog ...

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