Retail Markdowns 101 for Shop Owners

Sales, discounts, clearance, price reductions: these are all examples of retail markdowns. Shoppers love markdowns because they make them feel like they’re getting a good deal. Retailers benefit from markdowns because they help liquidate inventory. 

Shop owners, we’re giving you the full scoop on everything you need to know about how to successfully leverage markdowns while avoiding common pitfalls like predictability and damaging brand value and reputation.

What are markdowns in retail?

Retail markdowns are “reductions in selling price,” says Akshay R. Rao, General Mills Chair in Marketing at the University of Minnesota’s Carlson School of Management. Anything from coupons and discount codes that lower prices to seasonal clearances and store closing sales are considered markdowns.

These price reductions can be temporary or permanent, depending on a retailer’s strategy.

Markdowns vs. discounts

According to Rao, “a markdown is generally an unconditional reduction in price.” Think of a limited-time storewide 20%-off sale.

A discount, on the other hand, is conditional, like an employee discount, senior discount, or cash discount.

For all intents and purposes, both markdowns and discounts lead to reduced prices, so we’re using them interchangeably in this guide.

Types of markdowns

The three most common types of markdowns are temporary, competitive, and permanent.

Temporary retail markdowns

According to Kate Ashley, Associate Teaching Professor in the Supply Chain and Information Management Group at Northeastern University’s D’Amore-McKim School of Business,

“Some retailers offer temporary sales, for example, 30% off during a particular weekend, which creates a sense of urgency because prices go back up when a sale is over.”

Limited-time sales, buy-one-get-one (BOGO) promotions, and coupons are examples of temporary discounts.

Competitive markdowns

In order to stay competitive, some retailers offer markdowns through price matching. Customers must show that a competitor sells the same item for a lower price to access the discount.

Price matching is a strategy that allows firms to offer markdowns only to price-sensitive customers who take the time to research prices offered by competitors. The retailer is able to avoid advertising a marked-down price that might reduce customers’ perceptions of the good’s value.

Permanent retail markdowns

End-of-season clearances or discounts for damaged goods are examples of permanent markdowns.

[Some] retailers may wait longer to mark down items, but then offer steeper and steeper discounts as it gets later into the season. Here, the primary reason for customers to buy early is the risk that the item they want will be sold out by the time it’s offered at a deep discount.

Reasons for markdowns

The primary reasons businesses give discounts is to get rid of time-sensitive inventory, boost sales, and keep up with the competition.

Poor sales

When items don’t sell like retailers predicted they would, they have undesirable inventory that’s taking space away from products that could sell quickly. Marking prices down helps move inventory.

Most often, markdowns are monetary discounts to stimulate sales of slow-moving inventory that is most often targeted at price sensitive consumers who have been willing to wait for a price reduction, at the risk of the product being sold out.

Perishable inventory

Retailers in many industries face the problem of perishable inventory: goods lose value when they are held for too long.

Kate continues, “This can happen because of physical spoilage, in the case of fresh produce or other items with a limited shelf life; technological obsolescence, in industries such as consumer electronics; or items going out of style, for clothing or other fashion goods. Inventory is costly, and when a retailer has items on hand that are about to drop in value, markdowns are a way to drive demand and recover at least some portion of the investment in inventory.”

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Competition

If your competitor sells identical or similar items at lower prices than you, then you run the risk of losing customers to the competition. Sometimes, retailers offer discounts akin to their competitors to avoid losing business.

How to calculate markdown price

Knowing how much of a markdown you’re offering consumers can help you advertise these discounts and create buzz. The formula for a retail markdown is:

([Original Price – Sales Price] / Original Price) x 100 = Markdown %

So, if you’re selling a TV that was originally priced at $500 for $300, then your markdown percentage is:

([$500 – $300) / $500) x 100 = 40%

When setting discount prices, it’s important to consider your profit margin to ensure you’re not losing money. Even after a markdown, the sale price should be more than what you paid for it.

If a discounted item still isn’t selling, you could offer a bigger markdown. You may only break even in this case, but that’s better than losing the money you invested in the inventory by not making a sale.

Tips for implementing a markdown strategy

Follow these strategies to make markdowns work for your business.

Consider pricing psychology

Pricing isn’t just about profit margins, it’s also about perceived value and creating a sense of urgency. Leverage the psychology behind pricing before setting markdowns. 

Perceived value

There are many ways in which retailers can use psychology, but one key tactic is to employ the original reference price to convey the impression of a deal. This is why you see signage that employs [‘was x-dollars, is now y-dollars’] to convey to the consumer how much they are saving.

Ecommerce fashion brand Nasty Gal, for example, offers a perpetual 60% discount on products to boost perceived value while making the “discounted” prices seem like a great deal.

Charm pricing

Another tactic is to leverage so-called “charm pricing.” According to studies by University of Chicago and MIT, prices that end in a 9 (such as $59.99) have more demand than prices that end in other digits. 

Prices that end in a 0 are prestige prices, while prices that end in a 9 are value prices.

Experts recommend setting regular prices that end in even numbers and giving discounts that end in odd numbers.

Urgency

Some retailers offer temporary sales [to] create a sense of urgency because prices go back up when a sale is over.

Using language like “today only” or “limited time” pushes consumers to pull the trigger on a purchase they may otherwise wait for. Black Friday sales are a prime example of the success of urgency in markdowns.

Innumeracy

According to Rao’s research, shoppers tend to prefer discounts that aren’t associated with numbers, even when they’re equivalent in value to a numeric discount.

For example, consumers perceive a BOGO promotion as a better deal than saving 50% on two items. Rao’s research suggests that offering freebies is also an effective markdown strategy. 

Simple pricing

Restaurants often remove dollar signs and cent digits from prices on menus. Why? This strategy makes customers disassociate those numbers from money. Experiment with simplified pricing at your shop.

Localize your markdown strategy

If you have a brick-and-mortar presence and an ecommerce presence, or multiple shops and an ecommerce platform, no one says you have to offer the same prices at each point of sale. 

If pink pants sell well online but not in-store, then mark them down in-store, but not online. If pink pants sell well in your Montreal shop but not your Vancouver shop, then discount them in Vancouver but not in Montreal.

Optimize your markdown strategy to preserve profit margins.

Pay attention to competitors

How are competitors pricing similar products? Consider offering price matching so consumers shop with you instead of going to the competition. Doing so could help you gain a loyal customer, which is worth more overall than preserving a fraction of a profit margin on one item.

Leverage historical data

Use sales data to see how your discounts are contributing to revenue.

Understanding the customer is key to driving sales of discounted products: what motivates a shopper to buy might be very different across industries and companies.

Kate explains, “Using analytics to measure the customer response to different coupons and promotional strategies is a great way for retailers to fine-tune their markdown strategies and understand what types of discounts have the most favorable long-term revenue impact.”

Pitfalls of retail markdowns

When retailers offer markdowns, they run the risk of becoming predictable, damaging their brand reputation, and failing to consider product life cycles. Consider these pitfalls before changing your prices.

Becoming predictable

“The biggest challenge associated with retail markdowns is related to customer behavior,” Kate Ashley explains.

The frequency and size of markdowns can teach the consumer to anticipate when products will go on sale, buy in large quantities at the sale price, and wait for the next sale, thus harming retailer profitability because the product is never purchased at full price.

Stores like Target have become so predictable with their markdowns that bloggers publish the retailer’s markdown schedule online.

Avoid this hazard by varying how often you give markdowns and not telling employees about sales until they need to know about them.

Damaging brand reputation

Price isn’t just about profit margins, it’s also about perceived quality. Marking down prices, therefore, can make your brand seem cheaper, which is a big concern for luxury brands.

In fact, Louis Vuitton and Burberry burn their unsold products to avoid their products being sold cheaply and “preserve [their] reputation of exclusivity,” Vox reports. 

Once a retailer is known to offer significant markdowns, it can be hard to recover the customer’s perception of brand value that is needed to drive full-price sales.

Kate continues, “Advertising a marked-down price… might reduce customers’ perceptions of the good’s value. Some retailers may avoid markdowns altogether, or offer them very rarely, to avoid the pitfalls of reducing prices.”

Failing to consider product lifecycle

Sometimes retailers mark items down prematurely because they fail to consider a product’s lifecycle. High-consideration items, like cars or mattresses, may not sell as quickly as other products and may not need to be discounted.

Instead, they could benefit from a marketing boost to make them more desirable. Consider creating a demonstration of how the item is used, changing up how it’s displayed, or working with influencers to boost sales of slow-moving products.

Consider using markdowns at your store

When used strategically, retail markdowns can help you move inventory, build customer loyalty, and create buzz. If discounts are given without much thought, they can become predictable and damage your brand’s reputation. Carefully consider what, when, and how to offer retail markdowns for maximum results.

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