Price Adjustment Techniques

What you’ll learn to do: Examine common price adjustment techniques

Most know of the phrase “never pay retail” but may not understand the mechanics behind how retail prices change over time. A price adjustment is any change to the original price of a product in inventory by a retailer. There are three primary forms of price adjustment: promotion, price protection and markdown. We will explore all three of these price adjustments in this section.

Learning Outcomes

  • Understand the three types of price adjustments used by retailers
  • Explain how retailers can reduce the amount of product that ends up in markdowns
  • Summarize the options for liquidating markdown merchandise

Markdown Optimization Software

A price adjustment is any change to the original price of a product in a retailer’s inventory. There are three primary forms of price adjustment: promotion, price protection and markdown. One caveat: different retailers use different terminology and even accounting methods in this area. We will discuss retail price adjustments in their most commonly-used context.

several signs that read 50%A promotion is a temporary form of price adjustment. This is when a product is “on sale” for a designated time period and will return back to its original or “regular” price after the promotion ends. Retailers like to be able to show a value in the sale, so a comparison between the regular price and the promotional price is thought to stimulate more unit sales. There are regulations, usually enacted by state, as to how a “regular” price is established- usually it is based on how long a product has been in inventory at a certain price. The retailer must be cognizant of this when planning promotions and must limit the amount of time the product is “on sale” or else the promotional price will become the new “regular price.”

Price protection is a common form of price adjustment and the one that probably comes to mind first for the consumer. What happens when a shopper purchases a product on Sunday only to see it advertised at a lower price on Monday? Most retailers offer “price protection” for a time period before and after a product has been reduced in price by a promotion. Most retailers will offer to refund the difference in price for 10- 30 days after purchase.

Another form of price protection is “price matching”.  This is closely related to the concept of competition-oriented pricing discussed earlier in this module. Price matching is the price adjustment made by a retailer when the same product purchased is advertised or available in the competition for a lower price. Retailers will usually refund the price difference, although in fiercely competitive situations, they have been known to offer 5% or 10% additionally on top of the difference in price.

Finally, a markdown is a permanent form of price adjustment used by the retailer to “liquidate” the inventory of a product or category of product. There are many different approaches to how retailers manage this form of price adjustment. Some retailers have an internal policy that establishes how much the first markdown must be. Depending on the retailer or the product category, first markdowns can range from 20% off to 50% or even 60% off the original price.

Also, retailers may have a set schedule of when subsequent markdowns are taken to ensure that the inventory will be eliminated by a target date. For example, an item marked down to 40% off could then see an additional price adjustment in four weeks, with an additional 30% off being applied to its price. Two weeks later a retailer could slash further and take another 20% off that price. The markdown process can be manually managed (monitor sales based on the latest price adjustment and calculate weeks of supply) or automated using a variety of software applications available to retailers.

Practice Questions

Reducing Product Markdowns

Every retail buyer or store owner wants to reduce markdowns. The old-school adages that address this issue is “buy the right stuff” or “buy less and sell more.”

Markdowns should not be regarded as necessarily a bad thing—they are a constant factor in retailing and a cost of doing business. Therefore, markdowns should be part of the retailers seasonal and annual plan and factored in to financial performance expectations. Is there such thing as selling out of each and every product in a retailer’s inventory? Actually there is, but not at the original price—markdowns is the method by which retailers do sell out.

But to answer the question, there are several ways retailers can manage to reduce their markdowns.

First, we have to remember that the planning and purchasing of retail assortments is both an art and a science. Products that are considered seasonal or fashionable are the most volatile and difficult to predict. Inclement weather in a market can destroy sales of summer goods while an instant change in fashion tastes can derail a once-established trend. Retail buyers typically must make buying selections 6 to 12 months in advance in many cases.

So the first way a retailer can reduce markdowns is to have a strong supply chain. A strong supply chain can help reduce the lead time in the procurement process. For a volatile fashion category, some retailers have established supply chains that allow them to order 10 weeks in advance instead of 6 months. In seasonal categories, a sound supply chain can provide some flexibility to the later replenishment orders to help retailers compensate for slower sales.

A second method to reduce markdowns is timely receipts of product. If a retailer has purchased a quantity of goods based on planning a selling period of 18 weeks, and the vendor is two weeks late on delivering those goods, there will technically be a two-week surplus of supply for the retailer to deal with. Usually, the retailer will negotiate some sort of compensation for this type of issue, but on-time deliveries are a must to keep markdowns within planned guidelines.

A third method of reducing markdowns for multi-store or multi-channel retailers is the distribution of goods. Most larger retailers have specialists responsible for distributing incoming product to ensure the right quantities are routed to the right locations- either the right stores or regional warehouses for direct shipment to online buyers. This can be almost as tricky as the initial procurement function. There is nothing worse for a buyer than to sell out of product in one market while taking big markdowns in another due to poor distribution decisions.

Finally, the last method we will discuss to reduce markdowns is quick reaction by merchants to slow sellers. If an item is underperforming its forecasted rate of sale, it will only accumulate in quantity and tie up inventory dollars until it is liquidated- usually resulting in a big markdown at season-end.  Recognizing slow sellers and taking immediate action will serve to give the item more time to sell at a price that may be more attractive to shoppers. Good retailers will not wait and hope that sales will magically increase but instead take a healthy initial markdown right away. The old retail adage “the first markdown is the best” can actually reduce markdown dollars overall and free up dollars to purchase better-performing items.

In reviewing all of the methods we have discussed for retailers to reduce markdowns, we find a common denominator: execution. Implementing a strong supply chain, pushing for timely receipts from your vendors, ensuring accurate distribution of product through your sales channels and being quick to react to underperforming items all involve the discipline of good execution of a plan.

Practice Questions

Liquidating Markdown Merchandise

Once retailers decide to markdown a product or product category, it remains in inventory until sold out. How do retailers handle the process from initial markdown to final liquidation?

The first method we discussed in an earlier section. Most retailers will have a set process, including markdown percent thresholds, that will be used to sell through markdown merchandise. For example, the first markdown could be set at 40% off original price for a period of four weeks. Then the products could be reduced further by another 25%-33% for a set period of, let’s say, another four weeks. After that, it may be time for “last call” where the product is reduced an additional 50% off.

Larger retailers will use set company promotions as the target dates to take the series of price reductions. For instance, a product may be marked down at first and featured in an Easter Sale. Then, the next markdown may be taken to coincide with the Mother’s Day sale (for the sake of this example we will assume that this is a product that appeals to women). Then, a Summer Sale could be a good time to take the final price hit and liquidate the remaining inventory.

Another method used by retailers (and wholesalers) is to sell markdown goods in “lots” (large chunks of merchandise) to third-party liquidation companies. These are usually companies who only deal in surplus, off-price goods and they in turn re-sell those products to secondary and tertiary markets. In many cases these third-party companies have international outlets by which to liquidate the markdown goods.

Finally, some retailers have designated channels within their company to dispose of markdown products. Outlet stores began in this way. These so-called clearance outlets started by “inheriting” the markdown products of high-end retailers who did not want to have clearance product on their sales floor. We have all seen the popularity of outlets evolve into entire malls of such stores. So much product can be sold at outlet stores that they could not rely on markdown leftovers alone. Retailers now have full-time buying and distribution staff responsible for keeping the outlet version of their brand well-stocked with original product.

Practice Questions