Markdowns are price reductions applied on the original price of the product, in order to accelerate its sale velocity and generate cash.
Markdown (%) = (Original Price – Sale Price) ÷ Original Price x 100
Markdowns are expressed as a percentage of original price and are calculated by deducting the sale (reduced) price from the original price and then dividing the result by the original price and multiplying by 100 to get the percentage
Read Also: Retail Math 101
Discount Formula Example
Let’s say that an item normally sells for 70$ (original price) and will now be marked down and sold at 55$
Discount (%) = (Original Price – Sale Price) ÷ Original Price x 100
Discount (%) = (70 – 55 ) ÷ 70 x 100 = 15 ÷ 70 x 100 = 21.4%
So this item will be sold at 21.4% discount or is marked down by 21.4%
Use our online discount calculator
Retailers know from the time they plan their buying that they are going to sell part of the inventory at full price initially and then start subjecting it to different levels of markdowns until it is cleared.
So when they plan their Open to Buy, they factor these markdowns into the process to accurately calculate the required purchasing budget.
For example when you buy 100,000$ worth of inventory, you can plan to sell 25% of it at full price (i.e at the intake margin).
Then after few weeks on the floor, you will start applying the first markdown to it, say 25% off. This markdown will clear another 30% of the inventory.
After another few weeks, you will apply the second markdown, a deeper discount, to it; say 50% off, and this clears another 30% of the inventory.
At the very end you will then apply a final clearance markdown of 75% off and clear the remaining 15% of it; or even 13% and the rest is then written off as obsolete stock.
This process is called planned markdowns.
Planned markdowns are set during the retail budgeting process in advance, before the year starts. At this stage, a marketing or events calendar is prepared with all the planned markdown events dates and the sales budget is adjusted based on that.
This is a very important planning step, because sales and margins get affected by markdowns, and so the final profitability of the business.
That’s why it is a best practice to create a plan and stick to that plan throughout the year.. unless there is a need for a different strategy.
Which takes us to the next point..
Retail Markdown Strategy
Markdowns are a very powerful weapon and tool for any retailer to use as part of their strategy . They are used to influence the demand on the products, and drive sales and cash flow.
A retailer should have a markdown strategy in place that includes both, planned markdowns and unplanned markdowns for when they are needed. This markdown strategy should be linked to his pricing strategy as we will explain here.
You might say ” But why wouldn’t the retailer buy exactly the amount of inventory that he/she can sell at full price, so they don’t need to give discount?“
In fact, this would be an ideal scenario, but in real life it doesn’t happen.
The retailer can never be sure how much exactly he will sell during the season and what sizes will sell in what quantities. He can only make a best guess, based on last year’s data and his forecasting.
In order to be on the safe side and have enough inventory to meet higher demand and not miss on sales opportunities or run out of popular sizes early, retailers typically keep enough forward stock cover at all time.
This is simply excess stock that serves as a safety net, so stores don’t risk being empty if demand exceeded what they planned for or any delay in shipments happened for any logistical reasons.
And here is when markdowns come into play.
Based on the actual performance of sales during the season, retailers then start using markdowns to drive demand and clear stocks, so they can stay on the targeted forward cover all the time.
For example, if the forward cover is 4 months, but sales have not performed as budgeted and now the cover is 6 months, the retailer will then use the next markdown event (say, Mid Season Sale) and apply deeper discount or include more SKUs in the markdown, to clear this extra stock and get back to 4 months cover.
If sales went better than budgeted, well, that’s why we had the forward cover and now we didn’t miss on the sales opportunities that came our way.
Besides the planned markdowns that are accounted for in the sales budget, sometimes retailers will need to action markdowns that have not been planned, as part of their inventory management process.
As we mentioned, markdowns are a powerful tool, and this tool should be brought forward when it is desperately needed.
If sales are not happening, inventory levels will start to rise and cash flow will start to dry up. In this case, retailers will start applying different markdown events or promotions to help clear this inventory and bring in more cash.
We say, desperately needed, because we should warn here that if markdowns start to get used without real need for them, they will start to lose their efficiency and this could have very serious long-term consequences.
Markdowns & Pricing
Because markdowns are inevitable as we have shown here, a retailer should factor them into his pricing process from the start.
This way, the end of year profitability will be in line with the budgeted profit margins, because the planned markdowns have been taken into consideration.
Markdown Strategy By Category
We also recommend setting different markdown strategies for different categories, because your product categories are not the same and will not perform the same. Not everything will have to go on 50% discount and not everything will even need to be cleared at the end of the season.
Some products, such as NOOS (Never out of stock) products, will actually rarely go on discount.
This should also be taken into consideration while pricing these products initially, so that their price remains competitive and at the same time deliver the targeted margins.
Learn about the pricing process in details in our Pricing Blueprint (premium)
Read More On:
- Retail Pricing
- Inventory Management 101
- Gross Margin Types
- Inventory Turnover
- Setting Intake Margins Right
Retailer & Founder of Retail Dogma, Inc.
Rasha has 14 years of retail & ecommerce experience. She has started an ecommerce business in 2008, and later worked at H&M, Bath & Body Works, Victoria’s Secret and Landmark Group. She’s lived in 4 different countries, speaks 3 different languages and holds a BSc in Pharmaceutical Sciences and an MBA in Strategic Management & Marketing.