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Avoiding the Discount Trap

Apr 1, 2007

Many small retailers view markdowns as an almost inevitable conclusion at the end of a season, particularly if the sales expected in peak weeks don't materialize. However, for the most part, markdowns result from decisions made and actions taken much earlier, frequently before the season even starts. And they are not inevitable.

As a new season begins, small retailers need to plan sales conservatively and maintain lean inventories, to keep from slashing prices down the road. It is heavy inventories that lead to excessive markdowns and reduced margins.

This can become a vicious cycle, and sooner or later, retailers need to find a way out. Typically, a small retailer looks for opportunities to generate sales increases based on current trends and what happened, or didn't happen, the previous year. In general, such planning often adds up to a five to ten percent increase. When there's a planned increase, the biggest percentage increases usually are in the early months of the season, when sales are lightest.

This strategy is based on a certain logic. The dollar increase doesn't seem that big, and the later months seem more fully developed. But the most significant factor is the retailer's optimistic belief that this season's merchandise will be better, that the weather will break in the store's favor, and that goods will arrive on time this year.

Once the sales plans are set, inventory is bought, and it's usually brought in early in the season to set the store and support those early season increases. Yet these aggressive early sales plans frequently don't pan out, because they were so aggressive and were predicated on everything breaking just right.

Under this scenario, inventory begins to back up right away. The next round of deliveries come in, but the initial deliveries haven't sold through yet, and the retailer quickly becomes overstocked, making it more difficult to display merchandise properly and for customers to shop efficiently and effectively. This causes stagnation in the weekly sell through.

As the inventory backs up, frequent customers (the ones who represent the vital backbone of any successful small retailer) see the same merchandise assortments two, three, or even four visits in a row. This further depresses sales and sell through, while it also adds more back up to inventory. Yet ever optimistic, the retailer continues to believe that the business will build and everything will work out in the end.

Finally, about mid season, the retailer does discount merchandise in order to reduce inventories. But customers are smart. They sense that the store is overstocked, and that gives them the incentive to defer their purchases until levels get further reduced. They begin to realize that if they wait, they can probably buy what they want at an even lower price. This attitude feeds the cycle.

By the time the season is nearing its end, the retailer's optimism gives way to a fevered hope that the sales will come in and bring inventory levels back into line, before the clearance markdowns have to be taken. But the sales increases necessary to accomplish that goal aren't realistic. By then, the impact of those clearance discounts can be quite significant. The way to break this cycle is to plan sales conservatively and maintain lean inventories.

Following are ideas for how small retailers can significantly reduce their inventory levels, and their markdown exposure:

  • Plan the season flat. Unless you're in a strong growth phase and have been realizing sales increases of 10 percent or greater for the past four quarters, chances are your sales over the next six months will be within five percentage points of last year's sales. Going into the season, the prudent approach is to plan each category flat, as well as the season as a whole, unless there is a specific, compelling reason to plan an increase. By planning flat, you're less likely to commit to inventory that you may not be able to sell before your first markdown.
  • Plan the first couple of months flat. If you really believe a category is likely to run an increase, backload those increases into the later months of the season. As tempting as it might be to think there's opportunity in the early months of a season, the potential sales upside is more than offset by the markdown risk associated with the inventory brought in to support that planned increase.
  • Commit to lean inventories. Markdown risk is minimized when inventory is brought in as close to the anticipated time of sale as possible. Any inventory in excess of what is needed to support near term sales increases the risk of having to discount and sacrifice margin.
  • Maintain liquidity. Don't commit up front to the full sales plan. There's no way of knowing for sure before a season even begins how close sales are going to come in to plan, or what items or categories are going to break out and drive your business. Keep a portion of your sales plan in your back pocket, in the form of cash, as long as you can.
  • Avoid the last buy. Many retailers are tempted to make that last buy to capture that last sale. But inevitably, the last buy comes in right at the end of the season, and a significant portion is still on hand when markdowns are taken.

Information in this article was edited from a story on Inc.com.

Topic: Business Strategies

Related Articles: inventory 

Article ID: 112

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