Markdown Budgets for Retail Buyers: Help or Hindrance?

Production and Operations Management, 2017

Posted: 6 Jul 2017 Last revised: 1 Apr 2021

See all articles by Alper Şen

Alper Şen

Bilkent University

Masoud Talebian

University of Newcastle (Australia)

Date Written: July 4, 2017

Abstract

For many retailers, markdown decisions are taken by retail buyers whose compensation is based on sales revenue so their objective is to maximize it through the season. This implies that the buyers’ objectives are not perfectly aligned with the overall profitability the firm. Many retailers set markdown budgets prior to the season to control margin erosion and increase profitability. Markdown budget constrains the buyers on the amount of discounts that they can apply on a given inventory of merchandise and sets a limit on the dollar value of markdowns for the season. While markdown budgets may be useful in preventing excessive discounts, they can have a detrimental effect on the buyers’ ability to respond to poor market and remove distressed inventory. We investigate the effectiveness of this practice in aligning the incentives of buyers with that of the firm, and provide guidance on how these budgets should be established ahead of time. We consider a firm with a fixed inventory of a seasonable item, and a single chance to mark the price down. The retailer knows only the demand distribution at the beginning of the season, but the market information is revealed during the season to the buyer. We first characterize the buyer’s markdown policy and understand the circumstances under which this can be different from the retailer’s markdown policy. We use our model to determine the optimal markdown budget and quantify its effectiveness considering different factors such as the level of demand uncertainty, initial markup, and market’s responsiveness to markdowns.

Keywords: Clearance Sales, Pricing Policy, Incentive Alignment, Fashion Industry

Suggested Citation

Sen, Alper and Talebian, Masoud, Markdown Budgets for Retail Buyers: Help or Hindrance? (July 4, 2017). Production and Operations Management, 2017, Available at SSRN: https://ssrn.com/abstract=2997263

Alper Sen

Bilkent University ( email )

Department of Industrial Engineering
Faculty of Engineering
Bilkent, Ankara 06800
Turkey

Masoud Talebian (Contact Author)

University of Newcastle (Australia) ( email )

University Drive
Callaghan, NSW 2308
Australia

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