Avoiding Heavy Retail Markdowns
Small retailers need to plan sales conservatively and maintain lean inventories to keep from slashing prices down the road.
Published by Inc.com
It's January, the holidays are over, and for many small retailers the clearance season is in full swing. As some owners look around their stores they may be pleased that inventory levels seem to be in line and they're not having to clear out a significant percentage of their buy at heavily marked down prices. For other small retailers, however, those inventories look heavy. For too many, heavy inventories -- leading to excessive markdowns and reduced margins -- are a chronic problem.
There's not much that a small retailer can do about inventory levels at this point beside take their medicine and move on to the next season. Yet this can become a vicious cycle and eventually owners need to find a way out. But how?
Many think that markdowns are something that happens at the end of a season, when sales anticipated in those final peak weeks don't materialize. But the truth is that, more often than not, markdowns result from decisions made and actions taken much earlier, frequently before the season even starts.
Here's what typically happens. A small retailer looks for opportunities to generate sales increases based on current trends and what happened, or didn't happen, the previous year. When the plans are rolled up, they frequently add up to a five or ten percent increase. And when there's a planned increase, the biggest percentage increases usually are in the early months of the season, when sales are lightest. There's a certain logic behind this: The dollar increase doesn't seem that big, and the later months seem more fully developed. But the most significant factor is a merchant's optimism that this season's merchandise will be better, the weather will break just right, the goods will arrive on time this year.
Once the sales plans are set, inventory is bought, and it's usually brought in early in the season to set the store and support those early season increases. Yet these aggressive early sales plans frequently don't pan out, because they were so aggressive and were predicated on everything breaking just right. The inventory begins to back up right away. The next round of deliveries come in, but the initial deliveries haven't sold through yet, and the retailer quickly becomes overstocked, making it more difficult both to display merchandise and for customers to shop. Weekly sell-thru percentages stagnate.
As the inventory backs up, frequent customers -- the backbone of any successful small retailer -- see the same assortments two, three, four visits in a row, further depressing sales and sell-through's, and further backing up inventory. Still, the merchant usually believes that the business will come, and everything will work out in the end.
Once mid-season markdowns are taken in an effort to bring inventory back in line, customers become incentivized to defer their purchases until levels get further reduced. Customers are smart; they can sense when a small retailer is overstocked. They understand that if they wait they can probably buy it even cheaper. This customer reticence feeds the cycle even further.
By the time the end of the season arrives, a merchant's optimism has given way to a fevered hope that the sales will come in and bring inventory levels back into line before the clearance markdowns have to be taken. But the sales increases necessary to accomplish that feat simply aren't realistic. And when those clearance markdowns are taken, the impact is pretty significant.
I call this impingement, where early inventories impinge of the sales of later inventories, leading to inflated inventories and excessive markdowns. And the way to break this cycle of impingement is to plan sales conservatively and maintain lean inventories.
Here are a few ideas for how small retailers can significantly reduce their inventory levels, and thus their markdown exposure, at the end of the season:
- Plan the season flat. Unless you're in a strong growth phase, and have been realizing sales increases of 10 percent or greater for the last four quarters, chances are your sales over the next six months will be within five percentage points of last year's sales. Going into the season, the prudent approach is to plan each category flat, as well as the season as a whole, unless there is a specific, compelling reason to plan an increase. By planning flat, you're less likely to commit to inventory that you may not be able to sell before your first markdown.
- Plan the first couple of the months flat. If you really believe a category is likely to run an increase, backload those increases into the later months of the season. As tempting as it might be to think there's opportunity in the early months of a season, the potential sales upside is more than offset by the markdown risk associated with the inventory brought in to support that planned increase.
- Commit to lean inventories. Markdown risk is minimized when inventory is brought in as close to the anticipated time of sale as possible. Any inventory in excess of what is needed to support near-term sales increases the markdown risk.
- Maintain liquidity. Don't commit up front to the full sales plans. There's no way of knowing for sure before a season even begins how close sales are going to come in to plan, or what items or categories are going to break out and drive your business. Keep a portion of your sales plan in your back pocket, in the form of cash, as long as you can.
- Avoid the last buy. Many retailers are tempted to make that last buy to capture that last sale. But inevitably, the last buy comes in right at the end of the season, and a significant portion is still on hand when markdowns are taken. The last buy is almost always unprofitable. Avoid the last buy, and drive your sell-through percentages at the end of the season to minimize markdowns.
Nothing melts margins and profitability faster than excessive markdowns. And the key to keeping markdowns in line is to plan conservatively and maintain lean inventories throughout the season. Avoid impingement, drive your sell-through, maintain fresh assortments, and you'll see a real difference on the bottom line.