Retail Markdowns

Guest Post: Our long time friend and associate, Linda Carter, with The Retail Management Advisors recently published this wonderful explanation of markdowns. She was gracious enough to allow us to re-post her article. This is a great summary and I highly recommend signing up for her newsletters.

A simple definition of markdowns is the difference between the original retail price and the actual selling price. Markdown dollars are calculated by subtracting the Actual Selling Price from the Original Selling Price. Markdown percent is Markdown dollars divided by Sales.

The National Retail Merchants Association adds a bit more to the definition. They define a markdown as “a reduction in the originally marked retail price of merchandise, primarily taken for clearance of poor selections, broken assortments, prior stock, for special sales events, and to meet competition.” Markdowns may be permanent or temporary. Generally, a temporary markdown is called a Point of Sale markdown and handled at the point of sale. It is only taken when there is a sale. These would include 4th of July or Back to School “sales”. If, however, the retailer made a mistake and bought too large of an assortment of umbrellas and raingear and the area suffered a drought, these items might receive a permanent markdown as the value is reduced permanently that season and the goal is to turn the merchandise into cash and get it out of the store as quickly as possible. If the permanent markdown is removed or cancelled at some later date, the retail price reverts to original selling price, the resulting amount is called a markdown cancellation, not a markup.

In the retail world, markdowns may not be liked but they cannot be avoided. They are a fact of doing business. Colors or styles unpopular with your customers will only move with significant markdowns. Of course, any time you take a “deal” and purchase three year’s inventory of socks you are taking a huge chance. What if a new fiber is introduced or a new color or design becomes all the rage and all of your sock budget is tied up in what was bought last year. If you really want to know if you have made a poor buying choice, study your markdown racks.

Over-buying is the #1 cause of excessive markdowns. Stores don’t go out of business due to high markdowns. They go out of business because they can’t move the merchandise quickly enough to bring in the required cash to meet their obligations. Stores suffering from cash flow problems may have difficulty paying their vendors on time. And how many employees will work without receiving their paycheck in a timely manner?

Also, keep in mind, the price paid for an item has nothing to do with the markdown price. Customers do not care how much the buyer paid for the merchandise. When it comes to sales and merchandise choices, a professional buyer’s only concern should be how quickly the inventory will convert to cash. Sometimes mistakes are made and those “really cute hats” that the buyers knew would sell like hot cakes just don’t. Sometimes, the only person who just loves those hats is the buyer and vendor who sold them . . . especially the vendor who knows they will not have to take them back.

From time to time, stores are reluctant to take large markdowns, and in some cases even refuse, to mark anything down below cost. The idea is that money may be lost when in reality much more is at stake by not getting cash out of slow selling stock and replacing it with new product. The only thing worse is storing merchandise year after year just to bring items out next season. Your regular customers know when you bring out the same merchandise over and over.

Generally, those markdowns relating to the customer-education factor (or just over-buying . . . again) will be permanent markdowns. These markdowns may be referred to as “backroom” markdowns, “bulk” markdowns or “permanent” markdowns. These markdowns serve to devalue the inventory for reporting purposes decreasing both insurance and taxes (if applicable). Remember, the markdown can be reversed if the circumstances change.

On the other hand, markdowns intended to stimulate sales throughout the store are usually called temporary markdowns or point of sales markdowns. These are taken when the item sells and do not devalue all inventory in that class.

Check the example below. After month 3 (see the red notation), the retailer using the retail inventory method decided the purses were not moving as expected and decided to take a permanent markdown of 25%. The inventory amount (cost and retail) decreased although no sales were recorded.

	Retail Inventory Method for Markdowns					Cost Inventory Method for Markdowns
	Cost		Retail			Cost		Retail
	Qty	$	Qty	$		Qty	$	Qty	$
Beginning Inventory	–	–	–	–		–	–	–	–
Purchased 100 purses at $40 each	100	4,000	100	10,000		100	4,000	100	10,000
Sales MO 1 (5 units)	-5	-200	-5	-500		-5	-200	-5	-500
Sales MO 2 (12 Units)	-12	-480	-12	-1200		-12	-480	-12	-1200
Sales MO 3 (13 units)	-13	-520	-13	-1300		-13	-520	-13	-1300
Balance after 3rd mo of season	70	2,800	70	7,000		70	2,800	70	7,000
Permanent MD 25%		-700		-1750
Balance after 3rd MO of season	70	2100	70	5250		70	2800	70	7000

 

Now, consider how many classifications in a store may be in this same situation. When this situation is multiplied over several classifications, the difference can be major. Who wouldn’t enjoy paying less for insurance and property taxes? This will have the most impact at the end of the year when reporting inventory values for property tax valuation. You may say the end result is virtually the same, but consider 3 months of savings in investor cost. The true savings comes in early recognition of the error and taking that permanent markdown as soon as the mistake is discovered.

In closing, the following is a list of potential reasons for markdowns from Retail Merchandise Management by John Wingate, Elmer Schaller and Leonard Miller.

Markdowns from Overbuying
– Failing to plan sales by class
– Failing to buy in small experimental quantities prior to placing large orders
– Buying more goods than needed in view of stock on hand and planned sales
– Buying the wrong styles, colors, fabrics or sizes
– Poor scheduling of deliveries
– Overdependence on a few “pet” resources
– Failure to examine incoming merchandise for quality control

Markdowns from Poor Pricing
– Setting initial mark-up too high
– Setting initial markup too low so customers are suspicious of the value
– Failure to check competitors prices for same or similar merchandise
– Deferring price reductions too long
– Making first markdown too small-a 10% or 15% markdown does not mean much today

Selling Errors leading to Markdowns
– Poor display of merchandise on the sales floor
– Failure to educate sales staff about merchandise
– Careless handling of merchandise
– High pressure selling leading to high returns

Sales policies Leading to Markdowns
– Meeting price competition
– Having special sales of regular stock
– Using special sales of promotional merchandise leading to promotional remainders
– Maintaining complete assortment through most of the season
– Having large markups coupled with large markdowns to exploit the comparative price appeal
– Taking premature markdowns
– Policy of carry-over
– Giving away free samples to customers

The Retail Management Advisors provide an affordable Open-To-Buy service to independent retailers as well as general management consulting to retail store management. For Open-To-Buy we help you set up and monitor the Open-To-Buy included in your software package or provide and process a monthly OTB for you. Other areas of focus include: budgeting, cash flow projections, incentive compensation plans, store policy manuals, procedure manuals, shrinkage control, merchandise performance review, as well as many other issues that occur in a retail environment. A new service added this year are SWAP (Share With A Peer) groups for retailers.