When consumer goods manufacturers set out to improve their efficiency, they usually start with marketing and production. Trade spending—the payments they make to retailers in hopes of encouraging promotion—is almost always overlooked. Yet for improving the profitability of a consumer goods manufacturer, this is among the most important levers, up there with pricing, media spending, production costs, and distribution. Indeed, McKinsey has found that proper management of trade spending can increase a company’s return on sales by two percentage points.

In consumer goods, "trade spending" means all of a manufacturer’s cash payments to grocery retailers beyond "terms and conditions," such as bonuses, discounts, and advertising allowances. One example of trade spending is the central-warehouse discount; another is the second-placement fee. In all, these payments account for up to 30 percent of the costs of a typical consumer goods manufacturer (Exhibit 1).

Such is the power of retailers that an absolute reduction in trade spending is hardly realistic. Competition for limited shelf space is intensifying, particularly in center-city grocery outlets with 600 to 800 square meters of selling space. More intense pressure from private labels is also weakening the position of manufacturers. In addition, more and more of them are...