Few European consumer goods producers offer their retail customers incentives for adopting logistics practices that lower the cost of delivering products. Such incentives—which include performance-based trade allowances to reward retailers for placing efficient orders (say, for full pallets or truckloads of goods instead of partial ones)—represent a valuable opportunity for manufacturers to boost their margins and establish closer relationships with retailers. As retail consolidation¹ in Europe heightens the pressure on consumer goods companies, the importance of adopting performance-based logistics agreements will grow.

These are among the findings of research carried out by McKinsey in conjunction with the European Brands Association.² We collected data on the logistics terms negotiated by 12 global consumer packaged-goods manufacturers that in 2005 represented roughly 30 percent and 35 percent, respectively, of the sales of packaged foods and of home and personal-care products in Europe. The participants provided information on their relationships with retailers in five key countries: France, Germany, Italy, Spain, and the United Kingdom. We then used the data to determine the consistency of each manufacturer’s approach, both within and across countries, and the degree to which the terms associated with each transaction reflected the costs incurred to fulfill a retailer’s orders. A typical European consumer goods producer devotes 5 to 20 percent of its net sales to logistics allowances, rebates, store visits by sales representatives and merchandisers, and related back-office support. In many cases, overhauling the terms of such agreements with retailers would reduce these figures by one to three percentage points.

Yet only a third of the manufacturers surveyed employ performance-based logistics allowances, or “bracket” pricing,³ characterized by a standard approach to setting deal terms that reflect the cost of serving each customer (Exhibit 1). These companies typically enjoy logistics costs that are 10 to 20 percent below average because they weed out or modify the behavior of customers that order in small quantities, mix too many disparate SKUs, or submit orders by telephone or fax rather than online (through the Internet or electronic data interchange, for example).

Another third, “guided negotiators,” aspire to standardize logistics terms and orient them around performance but haven’t fully achieved either goal. In our experience, the inability of these manufacturers to negotiate performance-based discounts in a consistent way often reflects organizational issues: guidelines from headquarters fall by the wayside as companies try to implement them across operations in a number of countries, for instance, while salespeople without supply chain experience lack the necessary expertise to negotiate the most cost-efficient terms.

The remaining third of the companies are even further from a performance-based approach. “Net-net negotiators” make separate deals with each customer. Rather than varying terms according to the cost to fill an order, these companies negotiate to establish the prices charged to the retailer—typically a function of the relative market power of the players involved. “One-service providers” offer all customers a single level of service. This approach has the benefit of simplicity and may be necessary for a company such as Ferrero (a global confectionery producer), whose strategy revolves around high-touch customer service characterized, for example, by direct delivery to stores. However, since transport costs per pallet increase exponentially as order sizes fall (Exhibit 2), a uniform logistics allowance often depresses margins on small customers by at least two percentage points.

Manufacturers and retailers have hammered out the lion’s share of today’s logistics agreements during the past five years (Exhibit 3). Why have so few been based on performance? A perennial explanation is the fear that retailers will resist, but the potential for large shared cost savings of up to 2 percent of sales should alleviate any misgivings. A bigger problem is the disconnect we’ve observed between the sales and supply chain organizations of many consumer goods companies. Salespeople, whose compensation frequently depends on the revenues they generate, generally manage the relationships and negotiations with major retailers by emphasizing the completion of deals—even if the logistics component will erode margins. Members of the supply chain organization who could easily identify costly orders are rarely involved. These same dynamics were once widespread in the United States, but many companies there, facing intense margin pressures from “big-box” retailers, broke down organizational silos and gravitated toward bracket pricing.

It’s critical to promote early and open dialogue between retailers and consumer goods producers—a dialogue that focuses on the potential for joint gains. In our experience, an often-overlooked key to success is fine-tuning logistics terminology on a case-by-case basis to make it consistent with each retailer’s vocabulary. (For example, a retailer’s “advertising cost allowance” might represent the same type of expenditure as a supplier’s “promotional investment.”) As retailers and consumer goods producers begin a more fact-based dialogue, it often becomes clear that sales and purchasing agents lack the supply chain knowledge to assess the potential joint savings in a deal. When both companies bring their experts to the table, the odds of identifying and agreeing on how to share savings opportunities increase significantly.