Markdown Budgets for Retail Buyers: Help or Hindrance?
Production and Operations Management, 2017
Posted: 6 Jul 2017 Last revised: 1 Apr 2021
Date Written: July 4, 2017
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
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