Discounts and Markdowns: Their Effect on Gross Profit

In retail, discounts and markdowns are a daily fact of life.   When we bought Widget A at a landed cost of $75.00, we planned to sell it at $125.00 to earn a gross profit of $50.00, yielding a gross margin of 40%. According to our business model, a 36% realized gross profit margin will cover all operating expenses and give us an acceptable net profit. The extra 4 points above our target gross of 36% gives us a cushion to cover the unforeseeable. What could be unforeseeable? In retail, a lot.

Widget A happens to be a seasonal product like a warm sweater. We planned delivery in September to catch the beginning of the fall/winter season and the ramp-up to Christmas shopping. November and December turned out to be the warmest on record, with not a hint of snow. There was a massive layoff at the plant that is the economic lifeblood of the town. To complicate matters, our buyer really liked this sweater, overestimated the number we would sell and bought in depth. By the end of October, we are seeing little or no movement in our pile of sweaters.

We keep a chart in the office like the one shown below. The chart helps us see the effect of discounts and mark downs on our gross profit picture.

Discounts and Markdowns and their Effect on Gross Profit:

Initial Selling Price

125.00

Cost Price

75.00

Planned Gross Profit

50.00

Initial Gross Profit %

40.0

Discount %

Sale Price

Realized Gross Profit

Realized Profit %

10

112.50

37.50

33.3

15

106.25

31.25

29.4

20

100.00

25.00

25.0

25

93.75

18.75

20.0

30

87.50

12.50

14.3

50

62.50

-12.50

-20.0

70

37.50

-37.50

-100.0

Usually a sale price will motivate the consumer, provided the item is something she really intended to buy. Anything less than 20% really won’t get her attention. At 20% off, you can see that our planned gross profit margin of $50.00 on this item is now $25.00 and our gross profit percentage has shrunk to 25%.

We manage to sell a few units at 20% off in November but, by the end of the first week in December, interest has slowed. We change the sale sign to 30% off and reconcile ourselves to living with a 14.3% margin. A week before Christmas, that pile of sweaters does not seem to have shrunk very much. Reasoning that the best time to move them out is when the store is full of Christmas shoppers, we slash the price by 50%. Finally, in the last few days, we see some movement at half price and when we close on Christmas Eve, there are 10 sweaters left. We’ll blow them out in our Boxing Day sale at 70% off.

The post-Christmas period was pretty quiet so we had an opportunity to do a post-mortem on the sweater fiasco. Here’s what we discovered:

Sales Analysis: Sweater - SKU No. 12345

Initial Selling Price

125.00

Cost Price

75.00

Planned Gross Profit

50.00

Initial Gross Profit %

40.0

Quantity Purchased

48

Units Sold

Selling Price

Sales

Unit Cost

Cost of Sales

Current Gross Profit

To Date Gross Profit

Gross Profit

% of Sales

Sales

Cost of Sales

Gross Profit

% of Sales

2

125.00

250.00

75

150.00

100.00

40.0

250.00

150.00

100.00

40.0

5

100.00

500.00

75

375.00

125.00

25.0

750.00

525.00

225.00

30.0

10

87.50

875.00

75

750.00

125.00

14.3

1,625.00

1,275.00

350.00

21.5

21

62.50

1,312.50

75

1,575.00

-262.50

-20.0

2,937.50

2,850.00

87.50

3.0

7

37.50

262.50

75

525.00

-262.50

-100.0

3,200.00

3,375.00

-175.00

-5.5

45

3,200.00

3,375.00

-175.00

As a result of our mark down strategy, we managed to sell 45 of the 48 units at an aggregate loss of $175.00. We invested $3,600. in inventory, managed a net return of minus 5.5% and we still have three units left. If anyone out there wants them, they’re available at a good price.

It’s ugly. Welcome to retail.

Dave Hands
Small Business Consulting
www.small-business-consulting.ca

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