How to Determine Markdowns in Retail

Manage Your Merchandise by Using Markdowns the Right Way

Pile of tags that say "sale price" representing markdowns

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An eye for fashion is important, but it's not going to ensure your business is a success. Retail owners must understand how to buy and sell their merchandise to make a steady profit. They must be able to manage their inventory by determining how much merchandise to purchase, how to price the merchandise, and when to mark down the merchandise to encourage sales and move it out of the store.

What Is a Markdown?

A markdown is a reduction of the original price of goods to increase sales. Compared to a sale or promotional event, a markdown essentially is when you change the list price to a lowered price permanently. For example, you decide to sell your tennis racket, which is listed at $300, for $250, therefore taking a $50 markdown. However, you bought the racket a few years ago for $150, so your initial markup (IMU) is $150 double the cost. This is referred to as keystone pricing. Upon the sale of your racket, you will not receive a 50 percent gross margin. The new markdown price will yield a 40 percent margin.

Retail Buying and Markdowns

Retail buying is less about fashion and more about math. It is essentially about determining how to sell merchandise before you pay for it. If you do not understand the math and that you will have to mark down a percent of the items that you purchased, you will lose money.

We tend to fall in love with our buying decisions, sometimes to the detriment of our store. Markdowns are inevitable. But markdowns done right can be healthy; they keep a store fresh and inviting. Many retail store owners believe their items will sell for the original price "if they just give it a little more time." Customers vote early on your merchandise, so it's a smart strategy to mark down items sooner rather than later. 

Timing Markdowns

Use a calendar to plan the timing of your markdowns. They should occur after the items have been in the store for a certain period of time. For example, some stores automatically mark down an item after 60 days, especially if it is not a regular, replaceable item. Then, the next markdown may occur at 90 days, with the final markdown planned at 120 days. This process can pressure an owner to use an open-to-buy system that will keep inventory current and salable.

Managing Inventory

As a general rule, use the following "Rule of One-Thirds" model to determine how much inventory to buy. For example, if you buy 10 radios, you will sell one-third at full price, one-third at a 25 percent discount, and one-third at a 60 percent discount. Doing the math, you may be inclined to buy 7 radios instead of the initial 10. In other words, the more backstock you have of an item, the more likely it is to be marked down at some point. 

Another item to consider when analyzing your markdowns is inventory turnover. There is a direct correlation between inventory turnover and markdowns. A high turnover usually means fewer markdowns, while a lower inventory turnover usually means higher or more markdowns. 

Dating Purchases

Use dating on your purchases from vendors to help your cash flow and offset the timing of markdowns. Dating is when the vendor gives you extra time to pay for merchandise after it is delivered. For example, most invoices are due within 15-30 days after the merchandise is shipped; however, if the vendor gives you more time to pay, you may actually be able to sell it before payment is due.