How to Get a Leg Up on Markdowns
It's one of the great nail-biter decisions of retailing: just when to hit the markdown panic button. Discount chain ShopKo Stores Inc. got nervous this spring, as shopper after shopper shunned its stretchy nylon track pants. They had a comfortable elastic waist. They had bright, contrasting stripes down the sides. But they simply weren't budging at their original price of $16.99. ShopKo didn't want to resort to its strategy of years past: whittle the price a bit here and there, then chop it methodically once a month -- to $9.99, then $7.99, then $3.99. Instead, it took only two measured swipes, marking them down to $10.79 on average in early May, then to $9.75 a month later. And it held firm there. With the new pricing plan, ShopKo sold out the last 12,500 pairs during the three-month clearance period, for a gross profit margin of 31% -- nearly double its forecast.
Airplane Seats and Bikinis
It wasn't a random decision. ShopKo is one of a handful of retailers, including J.C. Penney Co., L.L. Bean Inc., Liz Claiborne Inc. and Gymboree Corp., trying to perfect the science of the markdown. They have been experimenting with sophisticated new software programs to test principles similar to "yield management," which airlines mastered years ago to eke out the maximum profit from every seat. Like a seat on a particular flight, an item such as a bikini is in demand for a limited time; as the end of the season approaches, its value to customers plummets. A big challenge: trying to outfox customers who have been more willing to wait and wait for a bargain. Using number-crunching consultants, armed with mathematical models pioneered by think-tank researchers and astrophysicists, the stores analyze historical sales data to pinpoint just how long to hold out before they need to cut a price -- and by just how much. Their progress marks a new step in a growing trend toward highly flexible prices -for everything from mortgages to eBay merchandise. Instead of taking a one-pricefits-all approach, buyers and sellers are increasingly meeting in customized marketplaces transformed by technology. With exploding competition from discounters and specialty stores, markdowns are soaring, making them a decisive issue in retailing. Marked-down goods, which accounted for just 8% of department-store sales three decades ago, have climbed to around 20%, according to the National Retail Federation. Retailers hate markdowns. Discount an item too late, and stores are stuck with truckloads of inventory. Too early, and they lose profits as people snap up items thrown on the bargain table prematurely.
Retailing Wild Card
"You can intelligently and consistently predict a lot of other components of your business," says Steve Raish, chief information officer of J.C. Penney. But "markdowns -- in particular seasonal markdowns -- are one of the least predictable elements." The technology, still fairly new and untested, requires detailed and accurate sales data to work well. And even if the new software programs can help crack the markdown riddle, they can't solve other problems, such as poorly chosen
merchandise or a weak economy. "This is not the savior to the profitability of the company. This is just one more tool in the tool chest," says William Podany, president and chief executive of ShopKo. As discounters improved their apparel selections over the years, department stores have found themselves constantly staging sales to stay competitive. Much of the attention on markdowns in recent years has been regulatory, as state attorneys general charged numerous retailers with deceiving consumers by raising prices and then offering a discount off the inflated price. In some cases, investigators couldn't find any evidence that the goods had ever been sold at the so-called "original" price. ShopKo, a chain of 141 stores that likens itself to Target Corp.'s discount stores, began hunting for a technical edge early last year. As part of its effort to get a handle on the business, it turned to Spotlight Solutions Inc., a start-up that is one of the leaders in the markdown-software field. Spotlight's software uses mathematical models created by researchers such as Dr. Dale Achabal, a bespectacled professor who acts as an adviser to the company and sits on its board. In the early 1990s, retailers complained that they were overwhelmed by all the sales results bar-code technology was vacuuming up, Dr. Achabal says. "They had more data, but they didn't have better information to make decisions," he says. So he and others began working on computer programs that would make sense of this mass of data. In 1993, Target installed an early system based on his research.
'Seasonal Demand Curve'
Behind the surprising gains: pricing analysis similar to that developed by the airlines, which can calculate with great precision just how many seats to hold open at premium fares for last-minute passengers and how many to sell ahead of time at lower prices. By analyzing several years' worth of sales data from similar items, Spotlight's retail software estimates a "seasonal demand curve" for each new product. Sometimes resembling a jagged peak, other times a smooth wave, the curve predicts how many units would sell each week at various prices. For merchandise with short-term appeal -- the bikini, for example -- sales typically climb for several weeks, spike, then trail down until the "outdate," or the date a retailer wants to sell out of the item. The software also uses sales history to predict how sensitive customer demand will be to price changes, what economists call "price elasticity." To create its new markdown program, ShopKo fed three years' worth of sales data from each store into Spotlight's computers, which suggested markdown prices based on how quickly the product category was expected to sell in each of the company's six store groups. The system uses the data to calibrate a system of mathem atical models that incorporate such factors as price elasticity and the number of weeks until the outdate. It then solves equations to determine the most profitable price cuts for each product. Software, however, can't predict unexpected events such as a major snowstorm or a surprise sale at a rival store. So it "learns" during the season, according to the developers of the programs, adjusting recommendations weekly based on new sales data.
"There will always be things you don't expect," says Scott Friend, president and chief executive of ProfitLogic, a competitor of Spotlight that draws heavily from the talent pool at Harvard University and the Massachusetts Institute of Technology. But because the software systems start with more precise forecasts and adjust their recommendations to early sales results, he adds, "on average, we are a lot more accurate" than past practices. Before Spotlight, ShopKo was drowning in sales data. To determine which items were stagnating on shelves, store buyers had to sift through stacks of weekly reports with overall sales of each product. The reports also listed inventory levels and how many weeks remained until the outdate. With thousands of different products selling in more than 100 stores, overwhelmed buyers had to plan most markdowns before each season began. They revised their plans twice a month, marking down an item at the same time across all stores. That chain-wide approach, common to many retailers, often sacrifices goods that could have sold at full price in some stores, and ends up leaving too much merchandise unsold in others. Another common practice is to chip away at price tags, with lots of small discounts. Dr. Achabal's research concluded that a combination of two markdowns will never be as profitable as a single markdown. Arriving early enough to tempt customers, the first markdown gives the greatest boost to profits, and extra price cuts simply add profit-eroding labor costs. Before recruiting Spotlight, ShopKo had tried shifting its markdown dates. At one point, it carried some leftover merchandise into the next year, a practice it has abandoned. For the most stubborn clearance merchandise, it even offered an extra 25% off. "That created a lot of traffic, but it was terribly hurtful to our gross margin performance," says Mr. Podany, the ShopKo chief executive. Within a few weeks of starting to review forecasts in the pilot project in October, employees saw surprising recommendations. In its high-volume "superstores," for example, the average first markdown suggested by the program was 25.7%. In the lowest-volume stores, it was 46.3% -- nearly twice as much. Says Paul Burrows, ShopKo's chief information officer, "We never would have been able to tackle that manually."
Cutting Labor Costs
Smarter markdowns also saved labor costs. ShopKo has calculated that it costs 18 cents to change the price on a single garment tag, and 24 cents to revise a shelf label. Whenever it lowers prices, clerks scurry through the stores in the early morning, wielding "price guns" that spit out brightly colored stickers with a new price. Before using the software, ShopKo frequently marked down products three or four times. Now, it often does it only once or twice. Mr. Podany is waiting for a full year of data to pass final judgment on the new method. But the retailer is moving ahead with plans to use it throughout its stores by this fall, and it even hopes to eventually create a separate markdown schedule for every location.