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The Markdown Blues, Revisited


Thoughts on what smaller retailers can learn from watching their larger competitors wrestle in the mud.

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It's been a while since I've read anything quite like this. Part food fight, part mud wrestling, part theatre of the absurd.

A recent New York Times article ("First the Markdown, Then the Showdown" by Tracie Rozhon, February 25, 2005) recounted the tong war currently taking place between the major department store chains and their vendors. It seems they're fighting over markdowns. 

"For holiday shoppers, there were bargains galore. By Thanksgiving weekend, Saks Fifth Avenue was offering 40 percent off; Macy's was selling furs for "40 and 50 percent off - plus an extra 15 percent." Now the stores and the clothing makers are arguing about who is going to pay for the profits lost because of all those markdowns."

"Merchants say they have no choice but to mark merchandise down because of the weak demand. Suppliers say the stores panicked, marking down items too soon. They claim the merchants should have stuck to the sales plan, which was hammered out between the merchants and suppliers before the stores even saw the designs."
For years, markdown money has been a part of the relationship between large retailers and their vendors. As originally conceived, markdown money compensated retailers when a specific style or grouping from a vendor turned out to be an unexpectedly weak seller. The retailer and the vendor shared the expense of liquidating the inventory.

But as time has gone along, things have changed. Retailers aren't just asking for markdown help on troubled merchandise now, they're asking for markdown help on everything. Markdown money has now become a revenue stream.

"Now, the merchants are demanding the difference between what they thought they would make as profit on clothes and what they received in the end, according to financial officers at several companies."

"In the annual ritual of price-slashing, analysts, bankers and clothing manufacturers agree: the fighting is a lot more intense this year."
In the retail trade, it's called "partnering with your vendors". The vendors might instead call it a good old-fashioned shakedown. Whatever you call it, however, there are some important things that smaller retailers can learn from all this pushing and shoving:

Vendor Management, Risk and Leverage
In any supply chain, in the short term inventory risk will pool with the weakest link in the chain. In this instance, the weaker link is the vendors, as large retailers have gone through one round of merger and consolidation after another over the last decade and a half. Large retailers have the market leverage to force the financial risk of carrying inventory onto their vendors. Once they reached Thanksgiving, the retailers had no incentive to hold the line on markdowns because they knew they could force their vendors to pick up the tab.

Conversely, twenty years ago when the retail industry was far more fragmented, vendors had the leverage to insist that retailers assume the financial risk of their purchases. If a retailer bought it, and it didn't sell, the retailer took the markdown hit.

Many smaller retailers may feel like the large retailers did back then. They feel like they need their vendors more than their vendors need them. But most smaller retailers have more leverage than they might think, if they manage their vendor base skillfully.

You can only be important to so many vendors, and you must be important to the vendors that you do choose to do business with. The volume you do with your vendors is almost surely more important to them than you think it is. Where else could they go to replace your business? Who else will represent their full line, and test all their new items? Who else do they have an open, honest and forthcoming relationship with like you? Who else do they have the confidence will be around for the long term because you've got your i's dotted and t's crossed?

Understanding leverage in your vendor relationships is not so much about taking advantage as much as it's about building solid business relationships to work together to serve the customers needs.. And while in the short term risk will pool with the weakest link, in the long term it is not in any vendors interest to put their customer's sales and margins under stress.

Merchandise Management, Buried Costs and the Customer
Underlying this battle over markdown money is one inescapable conclusion: when Thanksgiving rolled around, the retailers had too much merchandise. Without any markdown risk of their own, the retailers had no reason to prudently manage their inventory. Buy a big number, sell what you can before Thanksgiving at your planned margins, and after Thanksgiving slash away as deeply as you need to sell it all through.

Their vendors went along, as they always do, because of the size of the purchase orders. For a long time, the vendors understood how to play this game; they simply built the markdown money into their prices upfront, wink-wink, and everybody was happy. Except the retailers treat markdown money just like revenue, they expect to run increases every year.

Contrast this to a recent quote from a Wal-Mart spokesman. "We expect our suppliers to drive the costs out of the supply chain. It's good for us and good for them." (New York Times, "Don't Blame Wal-Mart" by Robert Reich, February 28, 2005)

Excess inventory is excess inventory. It doesn't matter whether the cost of marking it down later has been buried in the purchase price. All that does is inflate the retail price, shrink the gross margin, or both. And the carrying cost of retail inventory, which includes costs of storage, financing, insurance, handling, shrink, damage and obsolescence, is typically 2% to 2 1/2% a month.

To be truly successful, smaller retailers must carefully plan their sales and inventories, communicate those plans to their vendor, not over-commit to too much inventory at any one time, and constantly update their plans as business develops. Like Wal-Mart, they must continually challenge their merchandise management practices to eliminate unnecessary costs and protect margins.

After reading Ms. Rozhon's article, it's no wonder that so many large retailers have struggled for so long. There doesn't seem to be a whole lot of focus on the customer.

"Experts say calculations over markdown money are one reason customers are complaining that all the clothes in department stores look alike - both manufacturers and retailers are increasingly playing it safe, avoiding "way out" fashion and chance-taking." Smaller retailers can learn from this, just as they can learn from the successes of companies like Wal-Mart, and so many others; you must offer your customers quality products, compelling value and outstanding customer service each and every day, no matter what your niche. And if you do, you can thrive against any competition.


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