Clearance Pricing &

Inventory Management for

Retail Chains
Stephen A. Smith
J. C. Penney Professor & Associate Director
The Retail Workbench
Santa Clara University
Dale D. Achabal, Ph.D.
L.J. Skaggs Professor & Director
Retail Management Institute
Santa Clara University

Retail Workbench Research & Education Center - Santa Clara University

The Retail Workbench
Founded at Santa Clara University in
1991
Mission: To improve decision making in
general merchandise retailing by applying
science to the art of retailing
Corporate Sponsors: Retail Department
and Specialty stores
Faculty in Marketing, Operations and MIS
from SCU and other universities
Retail Workbench Research & Education Center - Santa Clara University
Drivers of the Retail Industry
in the 21st Century

Consumers Demand for Greater

Choice
Better Information Systems
Detailed market info (POS + Web)
Desktop computing power

Retail Workbench Research & Education Center - Santa Clara University

Merchandise Trends in
Department and Specialty
Stores
More products in the assortment
More fashion merchandise
Shorter seasons
More private label merchandise

Retail Workbench Research & Education Center - Santa Clara University

Result: Clearance Markdowns(CMDs)
increase as % of Sales
33 %
Percentage of Dollar Sales

31 %
Markdowns as

26 %

21 %

16 %

11 %

6%

1970 1975 1980 1985 1990 1995 2000

Based upon Merchandising and Operating Results of Department and Specialty
Stores, National Retail Federation

Retail Workbench Research & Education Center - Santa Clara University

Retail Supply Chain Features

Long lead time & just 1 order

for fashion and private label
75% - 100% of merchandise sent
directly to stores for presentation
Inter-store transfers not economical

Retail Workbench Research & Education Center - Santa Clara University

Buyers Management of CMDs
Viewed as mistakes
Hope springs eternal
Seasonal demand evaporates
Must clear at any price
But selling half at 50% off >$
selling all at 80% off

Retail Workbench Research & Education Center - Santa Clara University

Additional Constraints
for CMDs
Clearance prices must be non-
increasing
Inventory must be revalued to each
new clearance price
(Weekly) Markdown budgets by
merchandise category
Same markdown at all stores (for
simplicity)
Retail Workbench Research & Education Center - Santa Clara University
Analytical Approach to
CMD Management
Sales Forecasting Model
Clearance Price Optimization at
Store and Item Level
Financial Performance
Measurement

Retail Workbench Research & Education Center - Santa Clara University

Sales Forecasting Factors
Seasonal variations
end of season drop
Holidays & Store Events
Percent Markdown
Advertising
Remaining On Hand Inventory
Store Presentation
Broken assortments

Retail Workbench Research & Education Center - Santa Clara University

Forecasting Model for
Weekly Item Sales
Baseline Seasonal Mechandising
Sales = x x
Sales Effect Effects

Based on Retail Workbench

empirical studies
Merchandising Effects tailored to
each retailer

Retail Workbench Research & Education Center - Santa Clara University

Example Merchandising Effects
Model

A I
M ( p, A, I , d ) = e p
A I e ( k ) d ( k ,t )
0 0 k

p = the current percent markdown

A = feature advertising space in percentage of a page
A0 = smallest ad size (typically a line list, which is 10% of a page)
I = current on hand inventory
I0 = base inventory level sometimes called fixture fill.
d(k,t) = 0,1 indicators for store events
, , , (k) = elasticities estimated by regression
Retail Workbench Research & Education Center - Santa Clara University
Forecasting Weekly Sales
Historical Data

New Sales Data

Stage 1
Initial Estimation of Stage 2
Model Coefficients
Weekly Forecasts &
Adjustment of
Certain Coefficients

Update Coefficients for:

Base Sales
Price sensitivity

Retail Workbench Research & Education Center - Santa Clara University

Forecasting Model Hierarchy
Parameter Type

Department or Class Seasonal Variations

Items or SubClass Merchandising Effects,

Base Sales

Store or Forecast Allocation

Metro Area

Sizes & Forecast Allocation

Colors

Retail Workbench Research & Education Center - Santa Clara University

Clearance Price Optimization:
Inputs
Forecasted Sales for remainder of
the season
On Hand Inventory at each store
Out-Date (End of Season)
Unit Salvage Value of Unsold
Merchandise

Retail Workbench Research & Education Center - Santa Clara University

Decision Variables

p(t) = markdown price in week t

I0 = initial inventory level
(may be fixed)
I(t) = remaining inventory in week t
s(t) = s(p(t),y(I(t)),t) = sales in week t
where y(I(t)) = inventory effect on
sales

Retail Workbench Research & Education Center - Santa Clara University

Optimal Control Problem:
Maximize Gross Margin
te
max p (t ) s (t )dt + ce ( I 0 se ) c( I 0 )
t0
subject to I ' (t ) = s (t )
te
I 0 s (t )dt = se
t0
where c( I 0 ) = a piecewise linear cost
and ce = unit salvage value.

Retail Workbench Research & Education Center - Santa Clara University

Solution Properties
Optimal weekly sales trajectory is
proportional to seasonal effects.
Optimal price trajectory depends on I(t).
1 y ( I (t )
P( I (t )) = pe + ln , where
ye
pe , ye at time te come from boundary conditions.
pe 1 / = c' ( I 0 ) determines I 0 .

Step function approximation works well

for optimal price trajectory.
Retail Workbench Research & Education Center - Santa Clara University
Financial Performance Measures
Revenue Capture Rate =
Revenue Obtained during CMD Cycle
Units at CMD Start Original Retail Price

Inventory Sell Through =

average % of inventory sold each week
frees floor space for newer merchandise

Retail Workbench Research & Education Center - Santa Clara University

Case Study
Mid-Size Retailer with over 300 stores:
Increased Profitability
Capture rate increased by 10-15%
> $15 Million per year revenue increase
Faster Inventory Conversion = Fresh Assortment
Inventory sell through increased by 15 - 20 %
Shortened Markdown Cycle by 20%
Significant Labor Savings on re-pricing
Better Markdown Dollar Forecasting
- Forecast Error percent cut in half at chain level

Retail Workbench Research & Education Center - Santa Clara University

Spotlight Solutions Results

See www.SpotlightSolutions.com for more information.

Retail Workbench Research & Education Center - Santa Clara University

Recent Pilot Results

Control
Group Spotlight
Stores Stores
$GM / $Revenue 44% 48%
% of Inventory Sold 62% 71%
Length of Season 13 wks 11 wks

Retail Workbench Research & Education Center - Santa Clara University

 Optimal Markdowns are
Targeted by Item and Location
100
90
80
Higher sell-through and more
70
gross margin can be achieved by
60 matching supply with demand
50 and setting prices optimally.
40
30
20
10
0
None 25% Off 33% Off 40% Off 50% Off 60% Off

Typical 1st Markdown Decision Optimal Markdown

Retail Workbench Research & Education Center - Santa Clara University

Additional Benefits of Optimal
Markdown Strategy
Floor Space Increases for New, Higher Mark Up Goods

Higher Sell-Through at 1st Price Reduction

Lower Avg. Inventory Positions
Reduced Inventory Carrying Costs
Higher Turns
Opportunity to Increase Sales Floor Space Utilization with New,
Full-Price Merchandise Earlier
Increased Customer Satisfaction with a Less-Cluttered Sales
Floor
Retail Workbench Research & Education Center - Santa Clara University
Profitability Impacts

For a retailer with 33% of revenue

from CMDs, typical $GM increase
has been 4% of revenue.

If yearly revenue = $1 Billion,

this equals $40 Million per year!

Retail Workbench Research & Education Center - Santa Clara University

 Learning Faster Than
The Competition is The
Only
Way to Gain a
Sustainable
Competitive Advantage

Retail Workbench Research & Education Center - Santa Clara University