How Retailers Became Ad Platforms

A rapidly growing number of major retailers are today creating and operating their own advertising platforms — a phenomenon widely referred to as retail media. Nobody has had more success in the space than Amazon, which in 2023 earned $46.9 billion from advertising, comprised primarily of sponsored ads on its site. This figure exceeds the annual global revenue of Coca-Cola and makes Amazon the third-largest advertising platform in the United States, behind only Google and Facebook.

Few retailers anticipated 10 years ago that advertising would become a huge growth driver for them, but Amazon’s success has goaded them into action. Retailers as varied as Dick’s Sporting Goods, Home Depot, Instacart, Lowe’s, Macy’s, Ulta, and Walmart now all own and operate retail media platforms. In 2023, Walmart earned $3.4 billion from retail advertising, and Target and Instacart both earned more than $1 billion.

Why are so many retailers doubling down on retail media? Because they’re recognizing that it’s a growth opportunity not to be missed. McKinsey estimates that by 2026, retail media will add $1.3 trillion to enterprise values in the U.S. alone, with $820 billion of that amount extracted by retailers. McKinsey also predicts that by 2026 profit margins for retail-media platforms will be between 50% and 70%. The Boston Consulting Group is even more sanguine, estimating profit margins of between 70% and 90% by 2026. This is a high-growth, high-margin advertising business, one that contrasts favorably with retailers’ low-growth, low-margin core businesses, and as a result, many forward-looking retailers have decided that the time to launch a retail media platform is now.

In our work as scholars and corporate advisers, we have helped many retailers and manufacturers navigate this new environment successfully. In this article, we’ll review the main different kinds of retail media, discuss three strategic challenges that they present, and provide guidance for effectively managing those challenges.

What is Retail Media?

Retail media is a broad term that refers to three different kinds of programs.

At “high-low pricing” retailers, such as CVS and Tesco, which operate physical stores and offer frequent promotions, retail-media programs focus on delivering digital coupons through loyalty and rewards programs. Because the coupons are accurately targeted and arrive when customers are about to make purchases, these coupons can be astoundingly profitable. In a recent study, we discovered that the in-store coupons issued by a large German supermarket chain generate large sales lifts for essentially every brand. The effectiveness of coupons has recently prompted many retailers that historically lacked loyalty programs, such as Publix and Lowe’s, to introduce them.

By contrast, at retailers that offer fewer price promotions, such as Walmart and Amazon, retail-media platforms typically focus on sponsored search and advertising on their e-commerce sites and other digital channels. At these retailers, the focus of retail media shifts from helping customers find discounts, to helping customers find products.

A third type of retail media is operated by retailers that want to extend their reach beyond their own e-commerce sites. In a remarkable innovation, some retailers now sell advertising on Facebook, YouTube, TikTok, and other third-party advertising platforms. This allows them to also help manufacturers build their brands earlier in the purchasing funnel (when customers are identifying brands and forming preferences), as opposed to other types of retail media that focus on what happens later in the funnel (when customers are choosing which products to buy). By observing customer responses in their own first-party transaction data, retailers are often better placed to target this advertising than the third-party advertising platforms themselves. Amazon Advertising, Kroger’s 84.51o, Target’s Roundel, and UB Beauty are all investing heavily in this capability.

Three New Challenges

Despite their differences, all three of these types of retail media introduce similar strategic challenges for manufacturers and retailers.

Organizational Tensions

In the past, manufacturers and retailers negotiated funding in annual sales meetings between the brand’s sales team and the retailer’s merchants. Now that retailers play a prominent role in building brands, the scope of the retailer-manufacturer relationship is more complicated.

On the retailer side, merchants are still involved, but so are the retailer’s media team, together with the department that owns the loyalty program. At one of the largest global grocery retailers, the newly founded retail media department faced significant internal resistance when it proposed growing retail-media revenue. Seventy-five percent of the campaigns requested by brands in the first year of operations were blocked by merchants, who feared that increasing couponing budgets would reduce the retailer’s bargaining power in their annual trade negotiations with the brands.

On the brand side, the sales team is now joined by a team responsible for the brand’s media strategy, with oversight by brand marketing and brand finance. The challenges introduced by the increased number of stakeholders are perhaps best illustrated by what happens when a pilot campaign is profitable. In that case, the brand media team and retailer ad team both typically express a desire to grow spending quickly. However, they face resistance from the brand’s sales and finance teams, which both view any increase in trade spending as a shift in margin to the retailer. Brand finance also requires that any incremental spending be reallocated from other media budgets. The challenge is that incremental brand spending is fundamental to the success of retail-media platforms. Without it, there is no way for retailers to satisfy their financial goals.

Transparency

In retail media platforms, retailers both execute the advertising and report on its performance. This breaches a fundamental principle of accountability: separating execution from measurement. There are many opportunities for obfuscation. Brands cannot see which impressions they are buying, the margins the retailer is earning, or the attribution algorithm that is used to measure performance.

Brands are aware of this issue. At a leading German discount retailer, large brands refused participation unless common ad-fraud detection software was integrated into the platform. These solutions provide advertisers with an independent assessment of ad events, such as views and clicks, contributing to transparency and accountability.

At least some of the reporting gaps in retail media are attributable to technology challenges. Other gaps can be attributed to data challenges, such as unobserved purchases at other retailers or identity fragmentation. As retailers extend their media focus beyond their own sites and higher up the purchasing funnel, it becomes increasingly difficult to identify which marketing actions caused a customer to buy.

Bargaining Power

In the short term, retailers need appealing content from major brands to gain traction for their media platforms. However, once a platform reaches scale, bargaining power tends to shift in favor of the retailer. If retail media makes customers more loyal, retailers will no longer depend upon brands to attract customers.

Retail media may also increase competition by lowering entry costs. There are reportedly more than 20,000 skincare brands sold at Amazon, and each of these brands competes for customers’ attention. Retail media can help overcome this obstacle. By asking brands to help grow their media platforms, retailers are essentially asking incumbents to lower the entry barriers that protect them.

Recommendations for Retailers

In the coming retail-media age, retailers will need to create new touchpoints with manufacturers. These touchpoints should extend from traditional trade negotiations to advertising and media relationships, where retailers are no longer buyers but sellers. Advertising has larger profit margins than core retailing, which both enriches and amplifies the importance of annual purchasing negotiations. Merchants and retail media teams must coordinate to align on the goal of extracting value from retail media.

Developing transparent reporting systems must also be a priority. Retailers need to be able to credibly measure the return on ad spending. This will require building experimentation capabilities into retail-media platforms. Retailers need to be careful not to make the same mistake that large technology companies made in the past when obfuscating ad performance data.

Retailers will also need to adjust their focus over time. Initially, collaborating with manufacturers will be critical. In the long run, the focus will shift from collaboration to bargaining over the value that is created.

Recommendations for Manufacturers

Sales, media, finance, and marketing teams are all involved in the new relationship with retailers. At manufacturers with large brand portfolios, such as P&G or SC Johnson, each brand will now have multiple touchpoints with the retailer. This will require a major redesign of internal processes and incentive structures.

The lack of transparency and threat to accountability will force manufacturers to develop alternative reporting systems to evaluate the return on ad spending independently. Right now, retailers and brands are evaluating different reporting solutions, and none are yet mature. This provides an opportunity for brands to play an important role in establishing measurement standards that reveal what they are buying, how much they are paying, and which customers are responding.

Manufacturers must also wake up to the bargaining power threat they will face once retailers’ media platforms are mature. If retail-media platforms lower entry barriers, manufacturers will need to create new sources of differentiation. They can learn from how P&G responded when private labels also disrupted retailer-manufacturer relationships: by doubling down on innovation, which led to a decade of profitable growth.

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The retailer-manufacturer relationship is undergoing significant disruption, creating new sources of growth but also new challenges. Retailers and manufacturers that want to tap into this growth will have to rethink not only how they collaborate with each other but also how they organize and collaborate internally. This is expected to result in profound changes in the retail sector and provide growth and profit opportunities for firms that prepare their business now for the retail-media disruption. With retailers now building brands, the retailer-manufacturer relationship is fundamentally changing. To win in this new world, both sides will need to adjust their strategies quickly.

Copyright 2024 Harvard Business School Publishing Corporation. Distributed by The New York Times Syndicate.

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