The Markdown Mirage: Why Discounts Don’t Always Add Up

With Black Friday and Christmas looming large on the retail calendar, many retailers are gearing up for what is for many, both an opportunity and a challenge. Consumer sentiment about the economy, and shopper spending confidence have been inching up over the past few months, yet despite the recent interest rate cuts in both the UK & US, consumer worries about high interest rates continues to curb spending.

As we move into these critical months where consumer expenditure peaks, it is vital that brands are equipped to face the competition for customer attention. Retailers will need to manage the promotional pressures, being able to clear through stock at pace whilst crucially protecting their margins – a not insignificant challenge! Pricing & deals will be key, with customers who feel they are getting good deals treating themselves to little luxuries.

To win, vendors will need a comprehensive markdown pricing & optimization strategy to help drive sales while preserving profitability.

But what exactly is markdown optimization? How does it fit into a retailer’s broader pricing strategy? And is it the silver bullet it’s made up to be?

What is Markdown Optimization?

Markdown optimization is the calculated reduction of product prices to sell stock faster, while attempting to minimize the impact on profit margins. This isn’t a matter of randomly slashing prices across the board, but rather an intentional, data-driven approach that factors in the optimal timing and depth of discounts for specific products. The goal is to strike a balance between clearing inventory and maximizing financial returns.

As retailers approach key sale periods, markdowns become a strategic necessity rather than a last resort. During the intense promotional periods of Black Friday and Christmas, inventory clearance must be done with precision to avoid waste, but without harming profitability. The role of markdown optimization is to ensure that the right products are discounted at the right time, for the right customers.

Why is Markdown Optimization Necessary?

Markdown optimization becomes especially crucial during the high-stakes months leading into the holiday season for several reasons:

1. Clearing Overstocks

Retailers typically overstock in anticipation of heightened demand during these peak periods. However, when that demand doesn’t materialize for certain products, markdowns help ensure that inventory is not left sitting in warehouses post-holiday season, tying up valuable working capital.

2. Maximizing Sales Velocity

The retail market moves fast during the Black Friday-to-Christmas period. If retailers are too slow to react with markdowns, they may lose out to more aggressive competitors. Conversely, reducing prices too early or too steeply can erode margins unnecessarily.

3. Matching Consumer Expectations

During these peak sale events, shoppers expect discounts. With the advent of online price comparison tools, consumers are savvier than ever, waiting for deals and comparing markdowns before making purchases. Customers will typically visit 3 different websites before a purchase with almost 60% citing price as their first criteria affecting their buying decision.?Markdown optimization helps meet these expectations in a way that is both strategic and profitable.

4. Boosting Profitability Post-Season

Properly optimized markdowns help retailers end the season with minimal leftover stock, allowing them to move into the new year in a healthier inventory position. This also helps make space for new products and reduces the need for drastic clearance sales, which tend to be margin killers.

Key Capabilities for Effective Markdown Optimization

Markdown optimization isn’t simply about deciding when to cut prices—it’s about having the right capabilities in place to make informed, data-driven decisions. To do this, retailers need some key capabilities as enablers:

1. Data Analytics

Sophisticated data analytics are the backbone of effective markdown optimization. Retailers need to have clear insights into sales trends, consumer behavior, and inventory levels. By utilizing AI based tools to analyze historical data alongside current demand signals, they can identify which products are underperforming and where markdowns should be applied and to what depth.

2. Demand Forecasting

In a fast-moving retail environment, knowing what products are likely to fly off the shelves and which ones will require a price reduction is critical. Advanced demand forecasting models, powered by AI or machine learning, can help retailers anticipate consumer demand and apply discounts with precision.

3. Inventory Visibility

Knowing how much stock is available and how quickly it’s moving is vital to successful markdown strategies. Real-time inventory management systems can help identify which products need a markdown, allowing retailers to target discounts efficiently and avoid unnecessary price cuts on popular items.

4. Competitor Benchmarking

Understanding the broader market context is essential. Monitoring competitors’ pricing strategies and keeping track of their discounting behaviors allows retailers to remain competitive without undercutting themselves. This ensures that markdowns align with market conditions rather than being a reactionary move that risks excessive margin loss.

5. Flexible Dynamic Pricing

The ability to respond quickly to changes in demand or competitive activity is vital, especially in the lead-up to big sales events like Black Friday and Christmas. Retailers need to be flexible in how they adjust prices—whether that means temporary discounts, flash sales, or even scaling back markdowns when products begin selling faster than anticipated.

The Problem with 'Traditional' Markdown Optimization

Despite its critical role in the retail playbook, markdown optimization has significant limitations. One of it's key issues is that it focuses narrowly on product margin - in other words, what’s the minimal reduction in product price required to drive enough sales uplift to hit a target stock clearance?

This approach prioritizes hitting a specific sell-through at the expense of a more holistic understanding of profitability. Here’s why this is a sub-optimal approach:

1. It Ignores the Operational Costs of Markdowns

Markdown optimization on product margins fails to account for the cost of running the markdown itself. The discounting of products comes with its own set of hidden cost; updating price tags, managing promotional campaigns, moving stock to appropriate sale locations, processing higher sales volumes and returns – these can all add up. These operational costs are often not factored in the traditional approach to markdown optimization.

2. It Draws Focus Away from Alternative Stock Exit Strategies

Traditional markdown optimization fails to consider alternative inventory exit routes. Instead of defaulting to a price cut, retailers should explore how a markdown compares with other methods of clearing stock to determine which is most profitable. It may be operationally cheaper for excess inventory to be bundled with other products as part of a value deal, sold to discount outlets, or even reallocated to secondary markets. These alternatives are often overlooked with retailers focusing too heavily on markdowns as their go-to strategy for clearing stock.

3. It Misses Opportunities for Profitability

Markdown optimization, with its product-centric approach, can lead to missed opportunities for more creative pricing strategies. Retailers might be so focused on hitting their stock reduction targets that they miss opportunities to protect margin or even upsell complementary products. Focusing solely on markdowns can blind retailers to these more nuanced, often higher-value strategies.

4. It Overlooks Factors such as Goodwill and Sustainability

Finally, markdown optimization fails to account for intangible factors like goodwill or sustainability. When markdowns are based solely on product margin, the long-term brand impact of discounting, such as eroding customer perceptions of value, or the sustainability implications of liquidating stock, are overlooked. If these factors can be quantified and integrated into an operational margin, retailers could more holistically evaluate markdown decisions, incorporating not just immediate profitability, but also long-term brand health and environmental goals.

The Bottom Line

Markdown optimization remains a necessary tool, especially as we head into high-pressure sales periods like Black Friday and Christmas. However, it should be treated as one piece of the broader pricing puzzle. By understanding its limitations - especially its narrow focus on margin uplift - retailers can broaden their strategic approach to include alternative stock management solutions, which can ultimately yield better results.

As retailers gear up for the holiday season, now is the time to fine-tune markdown strategies, but also to think beyond them. Exploring a combination of markdowns and alternative stock exit strategies can position businesses for both higher profitability and healthier stock positions heading into the new year.

?

Capgemini Invent has a comprehensive Pricing & Promotions proposition that covers markdown optimization amongst many other pricing strategies. To find out more about how your business can adopt these pricing models or upgrade your pricing capabilities please reach out for a conversation.

References: ?

1.?GfK (2024).?Insights, Data Science, Analysis Blog & Business Intelligence. [online] GfK. Available at: https://www.gfk.com/insights?countries=Global. [Accessed: 18 October 2024].

2. Race, M. & Islam, F. (2024).?Bank of England holds UK interest rates at 5%. [online] BBC News. Available at: https://www.bbc.co.uk/news/articles/cgq8ydy8e79o. [Accessed: 18 October 2024].

3. Sherman, N. (2024).?US goes big with first interest rate cut in four years. [online] BBC News. Available at: https://www.bbc.co.uk/news/articles/cz04md0zdrno. [Accessed: 18 October 2024].

4. Sillitoe, B. (2024).?The Christmas Forecast 2024. [online] Retail Week. Available at: https://www.retail-week.com/christmas-forecast-2024. [Accessed: 18 October. 2024].

5. KPMG (2017).?The Truth about Online Consumers: 2017 Global Online Consumer Report. [online] KMPG. Available at: https://assets.kpmg.com/content/dam/kpmg/xx/pdf/2017/01/the-truth-about-online-consumers.pdf. [Accessed: 18 October 2024].