From myth to math: Harnessing the halo effect of promotions

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At any given time, up to one third of a retailer’s assortment is on promotion. Most of these promotions are meant to turn a stand-alone profit. Retailers set them up in such a way that the expected uplift in volume and the subsidies suppliers provide (“vendor funds”) will offset the negative margin impact of the discount. Other promotions are set up as loss leaders. In these cases, the discounts are so high that the promotion doesn’t turn a profit just from the sales of the promoted item, not even after the supplier’s contribution.

Typically, loss leaders are featured on the front page of a circular or in online ads. Retailers run loss-leading promotions to trigger incremental trips to the store, either by attracting new shoppers or by causing existing shoppers to increase the frequency of their visits. Retailers hope that these shoppers don’t just come to buy the deeply discounted product itself (“cherry-picking”) but that they buy a basket of goods that creates profitable revenue growth.

So much for the theory. In reality, many promotions don’t turn a profit at all, or at least they don’t add nearly as much profitable revenue as retailers expect. To manage promotions according to their real ROI, retailers would have to be able to quantify the sales of non-promoted items caused by a promotion, the so-called halo effect. But so far, there has been no reliable method to quantify the halo effect of promotions.

Even more sophisticated approaches to measure the impact of promotions have usually been limited to the items on promotion. At best, leading practitioners have tried to quantify indirect losses caused by the substitution effect1, i.e., the percentage of shoppers buying an item on promotion instead of their first (full-price) choice. More than a decade ago, pioneers tried to quantify the halo effect of promotions with in-store surveys, but the results were so imprecise that category managers have been skeptical about any such efforts ever since. And even in today’s data-rich environment, many retailers still follow yesterday’s rules of thumb. Examples from grocery include:

  • Putting canned soft drinks on promotion may attract many cherry-pickers, but retailers feel they have no choice because all their competitors are doing it.
  • Thanks to the high volume uplift potential and subsidies paid by suppliers, national A-brands are considered to be well-suited for promotions.
  • Among perishable products, milk is a classic choice for promotions because it is an important value item (“KVI”) and can build traffic.