As a retailer, what’s the first thing that comes to mind when you hear or see the word markdown?
Most retailers, treat “markdowns” like a dirty word (and last resort) when in reality, this shouldn’t be the case.
In fact, markdowns are an important part of a pricing continuum and can be used strategically to minimize inventories and maximize profits.
But how do you develop a pricing plan (including markdowns) for thousands of SKUs in your assortment?
We will look at five proven markdown strategies, why they sometimes fail, and how modern retail analytics lets you develop effective markdown plans that clear inventory while maximizing margins.
Before we get into that, let’s explore what a retail markdown strategy is.
What is a retail markdown strategy?
A retail markdown strategy is a plan that describes when and how certain products should go on markdown.
In order to be effective, retail markdown strategies must be part of that product’s overall product lifecycle strategy.
To ensure this is done accurately, retailers must have a holistic view and understanding of the factors affecting each individual SKU.
All too often, markdowns are a knee-jerk reaction to end-of-life inventories.
Due to this, most markdowns are not planned for in advance (or at least accounted for in the pre-season planning stages), and frequently drain profits considerably more than they have to.
Although, if done accurately, markdown strategies can greatly impact inventory management as well as profits.
What are markdowns in retail?
A markdown is a permanent price decrease for a product at the end of its lifecycle (or “seasonality”).
Markdowns are used to temporarily increase demand for low-demand products, ideally long enough to sell through all stock.
Markdowns are caused by excess inventory at the end of a selling season.
Further, markdowns are almost always inevitable. It’s nearly impossible to have the perfect amount of inventory to satisfy customer demand exactly.
Most retailers would rather have a little bit of extra inventory left over than not enough (which would signify that they lost sales). And cutting prices is the only way to clear this leftover inventory at the end of a season or of a product’s lifecycle.
Although markdowns can have a similar sales uplift to a promotion, the purpose and approach of these two pricing events are very different.
Promotional discounts are temporary and can have goals beyond sales uplifts, such as increased in-store traffic, or increased familiarity with new products.
Markdowns, however, have a single goal: get rid of end-of-life inventory by end-of-season, while maximizing gross margins.
Finding the Right Markdown Strategy for your Retail Business
Retailers need to consider many markdown strategies to find the one(s) that align with their products, their markets, and their overall business. It’s imperative that they understand not only the nuances of their retail business
Let’s take a look at five effective retail markdown strategies;
1. Develop clear KPIs and goals for your markdown strategy
Businesses measure things they care about.
And you know what they say — “what gets measured gets managed.”
Developing specific, measurable key performance indicators (KPIs) for your markdown pricing ensures your decisions align with company objectives.
You can use your KPI performance to inform future markdown plans as you start planning for the next product. The KPI could be something as simple as a target date for zero inventory. Or you could track the markdown’s impact on ROI.
The important thing is to monitor that KPI before, during, and after you set the markdown so you have time to react if necessary.
2. Adopt an agile/automated markdown pricing strategy
Online stores often adopt an agile pricing strategy that uses predetermined triggers to respond to changing inventory and market conditions. For example, they can keep their prices high when competitors are out of stock.
In more competitive markets, retailers can also use price matching to boost sales without cutting prices permanently.
Agile pricing can help you set pre-meditated markdown points (either by date, sales, or some other trigger) to ensure that you don’t wait too long for your markdowns and miss the chance for clearing your inventories with maximum margins.
Agile markdowns are not limited to online sales, retailers can adopt this strategy with their brick-and-mortar stores. In either case, retailers must have clear, data-driven criteria for what triggers the price actions.
3. Localize your markdown strategy by store attribute
Clustering stores by particular attributes lets you introduce markdowns selectively.
Store geography is one option to form localized store clusters that respond to weather-related sales cycles.
The summer selling season ends at different times in Maine and Arizona, so company-wide markdowns on cargo shorts are counter-productive.
Localized markdowns let you preserve profits in stores where products remain in high demand while accelerating sales in stores with fading demand.
And to use this retail markdown strategy to its maximum effectiveness, you can also localize markdowns based on other attributes like store formats, shared demographics, and other factors that impact demand (provided you have visibility into these criteria and a method to act on this data).
4. Plan your markdown timing in advance
In an effort to avoid last-minute drastic price cuts, retailers pre-plan markdown timing (and amounts) for products with specific lifecycles. In this way, retailers can leverage increased demand while maintaining higher margins.
New television SKUs maintain demand for up to twelve months while fast fashion SKUs need to disappear in sixty days. Knowing their assortment and the seasonality of their categories, retailers can plan a series of markdowns rather than waiting for end-of-life.
In the case of TVs, the retailer may markdown prices in month six, again in month nine, and make the steepest cut in month twelve — just as the new model is around the corner. However, the retailer may adjust the timing and size of the markdowns based on holidays and major sporting events.
Markdown timing is not a precise strategy and will vary by product, by market, and even by store.
Markdown Timing Schedule Example;
A common markdown timing schedule may look like this: 60 days – 30% |
5. Use alternative pricing strategies in your markdowns
A straight price cut may not be the best way to mark down end-of-life products.
Retailers have many other pricing strategies to choose from.
Buy-One-Get-One bundle pricing has the financial impact of a 50% price cut, but it doubles the number of units customers buy. Similarly, you can use optional pricing to pair an end-of-life accessory with a related product at full price.
It should go without saying that this doesn’t work across the board in every situation. Pairing a winter jacket with a TV purchase may not work particularly well. But pairing an end-of-life Blu-ray movie with a TV makes a lot of sense.
Each type of markdown works best with certain products in certain situations. The key is to know whether these options are better than a simple price drop.
Why do markdown strategies fail?
Used properly, these retail markdown strategies can work wonders for your margins.
But when they fail, it is often because retailers did not fully consider these common issues:
Markdowns are product-specific
Manually planning markdowns for every SKU in an assortment is impossible (without specialized markdown software) for all but the smallest retailers. Everyone else must focus resources on high-impact products.
For the vast majority of SKUs, general markdown policies within each product category will apply.
At best, this leaves money on the table. But when things go wrong, the costs quickly mount.
Markdowns are context-sensitive
Markdowns look straightforward on paper, but the in-store reality is always different.
The response to a markdown will vary due to timing, seasonality, markdown type, price elasticity of demand, and many other variables. When retailers do not account for these variables fully, their markdown strategies fall apart.
Markdowns don’t exist in a vacuum
Determining a retail markdown strategy without considering a product’s entire price strategy throughout its life cycle will be ineffective.
An optimal markdown strategy should be a part of a larger pricing strategy which begins with initial pricing and accounts for all promotional events.
Furthermore, your pricing strategies should work in tandem with your assortment strategies, because if you don’t consider other products in your categories and families when setting pricing, you may run into issues of product cannibalization.
Why are retail markdown strategies important?
The need for markdowns does not appear out of thin air. It must be considered at the top of the product lifecycle.
Retailers may execute the product introduction perfectly and get solid results from their promotional plans only to see the product’s profit margins erased by end-of-life markdowns.
Consider a retailer that sells a $10 hat for $40 with a healthy 75% margin. At the end of the season, the retailer marks down the price by 50% to clear inventory quickly. This strategy has worked for the past few years. Selling off the hats with a 60% margin. But is this the optimal strategy? Could the hats sell just as quickly with a 30% discount? Could the retailer be saving more on their ROI without impacting demand? |
Markdown strategies also impact other products.
In this example, offering a hat-and-gloves bundle may boost demand enough to clear inventory without the steep markdown. But this cannot happen unless the retailer planned to have enough gloves in stock.
Without early planning, a retailer’s markdown options will be severely constrained.
The only way to gain actionable insights into markdown pricing is by digging deep into a retailer’s data while considering a number of other relevant factors. Basing a pricing strategy on previous years’ sales data alone causes baked-in steep markdowns and miscalculations.
How to choose the right retail markdown strategy
Retailers with large assortments struggle with markdown strategies because their spreadsheet processes are not considering these three realities of markdowns:
- Markdowns must be part of a holistic pricing strategy for each product across its life cycle.
- Markdown pricing must clear out end-of-life inventory while maximizing gross margins.
- Knowing how, or even whether, markdown prices will work requires a nuanced understanding of the factors that impact product demand.
Leading multi-channel retailers know that dealing with this complexity across multi-thousand SKU assortments manually is a time-consuming process that leads to inconsistency and inaccuracy.
By leveraging AI technology they automate and optimize markdowns and overall pricing strategy across every product’s lifecycle.
An effective markdown optimization solution accounts for the entire business. It uses a highly accurate demand forecast and AI to proactively recommend intelligent markdown strategies based on all relevant factors discussed above.
This means that an advanced solution can recommend strategies that are optimized to get rid of the dead products by end-of-season while maximizing gross margin. And isn’t that the goal?
Want to see our markdown optimization solution in action?
Book a free demo today or contact our team if you have any questions.
