Markdown-onomics

The cold, hard truth about why the post-Christmas sales started before Christmas this year—and why stores don’t expect anyone to pay full price for anything anymore.

By Maureen Tkacik

Less than a month ago, Saks Fifth Avenue broke the unbreakable rule of retailing: It started its post-Christmas sale before Christmas. Just like that, on December 21, Saks management examined all that they had sold, and all that they still hadn’t, and, with the help of powerful software, made the snap decision to roll back prices an additional 40 percent, with Christmas a whole three shopping days away.

This was, to the retail business, somewhat akin to the domestic wiretap scandal: shocking, outrageous, desperate, an unnerving sign of troubled times; yet, on the other hand, it was kind of a yawner, prompting the question, hasn’t this been going on for years now?

Already, every retailer and his spinoff chain seem to give everyone and his uncle “friends and family” discounts; already, there are a million ways to shave an additional 10 percent off already-reduced prices. Even things that don’t appear to be marked down sometimes actually are, as I learned on a post-Christmas trip to the Roosevelt Field Mall: A pair of rhinestone-studded jeans marked $120 at Abercrombie & Fitch rang up as $39.90.

But it was the Nordstrom sales rack that began to bring me closer to the dark heart of why nearly everything seems to be on sale, nearly all the time. There, on a hanger, was a camisole, covered in leopard spots. Leopard print, I realized, is always on sale. Over in shoes, leopard-print clogs and zebra-print mules were both marked down 65 percent; in the handbag department at Bloomingdale’s, zebra-print Coach bags were 30 percent off; even at Club Libby Lu, a store targeting 5-year-olds, purple and pink leopard pajamas were 50 percent off. Year after year, in store after store, animal prints hit the sales racks first and often stay there till the clearance sales. At Saks, a pair of gauzy lilac leopard wrap dresses had been marked down three times, from $475 to $284.90 to $189.90 to $113.40, a price that was, so my friend claimed, “Cavalli-esque.” But how is this good business? How is anyone making any money?

Increasingly, that question is of secondary concern. The leopard-print shopper, retailers have decided, is more important than any of the individual items she buys. Because though the average leopard-print shopper is exceedingly price-sensitive—she’ll never pay retail—she plays an important role in the shopping economy. She can be counted on to come out every year on December 26, and probably the 28th and 29th, to sort through the clearance rack—all those glittery cropped sweaters and shearling boots that help every store beat last year’s numbers. And, more important, like the system itself, she is not entirely rational.

“You know what I’ve gotten so into that Dawn got me started on?” says one such woman, a fortysomething Leopard Lady in her chosen habitat, wearing a puffy black vest and faded jeans tucked into knee-high wedge-heeled boots. Instinctively she shuffles through the animal-print aisle, piling her gold-flecked left arm with stuff. “Those collapsible hangers they sell on HSN, I tell ya; before, my closets were so full I couldn’t go shopping,” she continues, referencing, for the uninitiated, the Home Shopping Network.

“Now, I’m like, I can shop again!”

And that is the point: This shopper can be counted on to buy stuff few others will. Leopard skin is just the bait.

There was an era in which a red 30 percent off sign meant something simple: The supply of a given item surpassed demand at the full price, and the equilibrium needed to be corrected. Maybe the floor needed to be cleared to make room for new shipments, or maybe a blizzard had kept folks away for too many critical shopping days. Either way, a retailer’s mistake had become a consumer’s lucky break. The more desperate the retailer, the bigger the opportunity. Because in the days before computers—and markdown-optimization software—retailers didn’t always know what exactly they had on hand, or what precisely wasn’t selling. So when stuff needed to go, out came the red tags.

Then there was another type of sale: the sale meant to stimulate sales, in which a store advertises a certain segment of goods at a deep enough discount to lure more shoppers through the doors. This type of sale is usually planned, and it is the reason Wal-Mart discounts Barbies and DVD players below wholesale prices during the holidays and why all the big bookstore chains mark down the New York Times’ best-seller list by 30 percent, even though you’d think these high-demand books would be able to command full price.

Interestingly, the sale to stimulate sales was pioneered with largely philanthropic intentions. In 1877, department-store baron John Wanamaker realized the textile mills and factories from which he bought much of his merchandise were out of commission in December, making for a meager Christmas for many working-class families. At the same time, he knew he would have to cut back on his own employees’ hours after the holiday season. So he placed a huge order of bed linens for delivery in January and agreed to advertise them for sale at cost in something called a “white sale” in 1878. This kept people employed and gave shoppers a theretofore-missing reason to buy stuff in January. It performed so well that an annual tradition was born.

Nearly 130 years later, we are still holding white sales in January, which brings us to the final reason a store’s management these days will hold a sale: because they did it last year. A successful sale one year forces a store manager to “anniversary” those numbers the next year and every year for eternity, because the one number retail managers care about more than any other is the “comparable store sales” increase or “comp,” the monthly percentage with a plus or minus sign in front of it that compares the selling season this year with the same one last year. Investors consider the comp to be the most reliable measure of a store’s financial health.

So white sales are now semi-annual, and back-to-school sales start in July, and on the most closely watched shopping day, the “Black” Friday after Thanksgiving, doors now open at 5 a.m. (Another way of pumping numbers: Increase store hours.) Most of these sales settle into a sort of yearly rhythm called a markdown schedule, which often begins with a 20 percent or 30 percent price cut on select seasonal goods two or three weeks into the thirteen-week selling season, followed by a series of as many as five price cuts over the next six weeks. But in recent years, stores, dogged by procrastinators who wait around until the stores have administered their deepest discounts, have begun to deviate from once-sacred schedules and traditions. Holiday markdowns, which used to begin on Black Friday, are now moving toward early November at some stores. The chief executive of a mid-size housewares chain told me he makes the decision whether to take more markdowns every Monday morning.

On a certain level, constant sales make sense. Customers have varying levels of price sensitivity—your average mother is more price-sensitive than your average woman, and your average woman is more price-sensitive than your average man, which is why items purchased by moms—sweaters, kid’s clothes, cereal—tend to have larger bands of price “elasticity,” meaning the demand for them changes much more when the price changes. So they get steeper markdowns than items purchased by single men, like suits, Bose speakers, and Nike Air Force Ones. The same customer also exhibits varying levels of price sensitivity about different things. For the housewares chain, for instance, there are three tiers of merchandise: the top tier, standbys like Lodge cookware that stay in stock and very rarely go on sale; the middle tier of trendier gizmos like fondue makers; and the lowest tier of seasonal items like mulling spices, which are the first to get marked down.

But a few irrational factors are at work as well. First: fear. The fear of “comping down”—selling less stuff than last year—not only drives a lot of selling decisions, but it drives a lot of buying decisions. That’s why, at department stores especially, so much of the merchandise looks like it’s from last year; deviating too much from the predictable formula delivers unpredictable results. It’s also probably why a buyer in the Saks organization decided, around this time last year, to order a large shipment of Teri Jon silk blazers for the fall 2005 season in a very 2004 shade of emerald green, because both blazers and emerald green had done so well in 2004. The shipment, of about twenty blazers, arrived at the Fifth Avenue store in late August, with price tags reading $410.

Retail managers have traditionally been awarded holiday bonuses on the basis of comps, and in the days when they were empowered to make decisions, they liked to mark down items early and often. Will Speed, an industry veteran and amateur retail historian, recalls receiving a shipment of hideous yellow sweaters as a district manager at the Merry-Go-Round chain, the mall’s premier purveyor of Guess jeans in the eighties. “God, I hope the buyer was fired for that sweater,” he says, rolling his eyes. As soon as Speed laid eyes on the sweaters, he pulled out the markdown paperwork. “I got permission,” Speed remembers with a lusty grin and a hint of his native Carolina lilt, “to drop the price to one dollar.”

There is a certain rush, an undeniable high, to executing a markdown like that. Customers react; they are flabbergasted, thrilled. If they take you up on the offer of the $1 sweater—or maybe the leopard-print mules—chances are almost nil that they will leave with that alone. Suddenly those Z. Cavariccis, at $90 a pair, seem more like Levi’s; the little Guess dress more like a Rampage. They storm the doors. They wait in line. They inspire other shoppers to come inside. The first white sales were like that; Black Friday sales are a form of this, writ large. Big markdowns can cause ripples of excitement throughout a store.

But when Saks discounted the emerald-green blazers from $410 to $245.90, there were no ripples.

At that stage it wasn’t too worrisome. So many discounts are priced into the cost of goods these days that it is possible to mark an item down severely and still make money. When items need to be marked down—and sometimes when they don’t—buyers simply return to their vendors, whoever sold them the ugly sweaters or the emerald blazers, and demand kickbacks, known in the business as “markdown money.” Markdown money has been around in some form since the middle of the century, but by the eighties, it had become systematized; only a few big brands—Polo and Nike, for instance—have the power to resist ponying up. But for the most part, these days, vendors factor markdown money into their own margins, by skimping on a button or two here, some extra stitching there, applying the pressure to their own factories. Clothes got chintzier. Eventually, 30 percent discounts, tacked on coats and holiday dresses by mid-October, stopped seeming like discounts at all. Even at Neiman Marcus, lauded for its “disciplined” approach to discounting, regular clients know they can usually convince a clerk to hold desired purchases for them until the first wave of markdowns.

At independent boutiques, the markdown process tends to be more straightforward. “At the end of the season, I just walk around the floor and do it,” says Steven Alan, whose eponymous stores sell basic men’s and women’s casual clothing from a few small vendors, including his own line. Small, unproven lines sell to him on consignment, which minimizes some of his inventory risk; but unlike big department stores, he can’t demand markdown money—and doesn’t want to. “A lot of people don’t realize that we sell stuff at a loss, but I’d much rather sell something at a loss and get rid of it.” Alan usually slashes prices only once, by between 30 percent and 50 percent, at the very end of a season (his post-holiday sale began January 11), and generally marks down everything but his own Steven Alan line, for which the demand is steady enough that he doesn’t have to. If stuff is left over after that, he adds it to his sample sales. Alan hedges his own risks by representing small designers with bigger retailers and selling his line online, but says “it can be a really tough business, especially in New York.”

Once they go down the markdown road, retailers have a hard time turning back. They can’t risk losing sales to competitors, or alienating their shoppers, or pissing off the newspaper-ad salesmen whose industry they subsidize with their glossy weekly circulars, or—most important—missing the comps that decide their bonuses. “If business was good, we marked down because we could afford to do it,” says Speed. “And if business was bad, it was because we were trading margin for volume in hopes of making our numbers.” In other words, if X, then Y; if not X, then Y. Markdowns became like liquor, consumed equally in times of grief and celebration. But for the green blazers, nothing was working. By December, Saks had reduced them again, from $245.90 to $163.90.

Addiction to sales started with department stores. But no sooner had specialty stores like the Gap and Ann Taylor swooped in to steal market share than they were getting hooked themselves. Because they sourced all their own merchandise—instead of buying from an array of fashion houses, like department stores do—their margins are higher, which gives them greater latitude on markdowns. A friend of mine who monitors sales and promotions counted twenty separate sales, from a summer-passport promotion to a friends-and-family sale, during 2004 at Gap alone; last year had so many she stopped counting in June.

As it happens, that friend is named . . . well, we’ll call her the Mall Maven. She is a small cog in the big wheel that keeps retailers putting things on sale. Maven is a former retailer and mother of two grown children who has fashioned a second career for herself essentially going to the mall, every mall, from sparkling Neiman-anchored emporiums in Dallas to the loneliest, saddest collection of dying shops on the South Side of Chicago. Today, we are wandering around a small women’s-apparel chain at the Westchester, a ritzy mall just outside Scarsdale.

“See this number?” she says to me loudly, fingering the price tag on a crocheted shrug. “‘Four-five-oh-five. That means it arrived somewhere, either here or the warehouse, in the 45th week . . . ” She closes her eyes. “November.”

“That stuff actually just came in,” the shopgirl pipes in.

“Then it must mean the warehouse,” Maven says, pleased, arriving at the point: “So how did you guys do this month?” Maven smiles knowingly, empathetically. Forgivingly.

“Uh, not as well as last year.”

“Was it really bad?”

“Nooooo.” The girl pauses. “Not double digits.” The comp is down, but only in the single digits. Maven presses on.

“Just this store, or the whole district?”

The shopgirl hesitates. “I have it all written down somewhere. I really don’t know.”

Maven smiles. She never comes on too strong the first time; one store’s data is useless on its own anyway. She will visit at least ten stores in this chain over the next month, and, being the type of mom who can instantly tell a son’s “friend” from a “friend with benefits,” she will assess the direction of the chain’s comps in part using a composite sketch of the reaction she gets when she asks, “How’s business?”

There are hundreds of researchers like Maven exploring malls across the country at any given hour, because retail has become an obsession of hedge funds. They love retailers, particularly smaller specialty retailers like Abercrombie & Fitch and Chico’s, for the very thing that bedevils them: comps. Retail is the only industry that regularly releases financial figures once a month (in the case of Wal-Mart, once a week). This quirk renders retail stocks some of the most volatile stocks around. If Maven sees a bad month unfolding at Urban Outfitters, or an extraordinarily good month at Bebe, the investors she works for can make a nice profit shorting Urban or buying call options on Ann Taylor. All this stock-market interest over the years has not only escalated retailers’ obsession with their comps, and subsequent reliance on sales and markdowns, it has infected small retailers that might otherwise roll with the punches. One retail CEO, whose comps came in positive but below expectations, was fired by his board. “Do they think I’m incompetent? No. But they will tell me, and it’s true, that all anyone else cares about is comps.”

So how do retailers stay in business with so much pressure to do what they did last year? These days, they’re largely leaving the decisions to software programs of the sort developed by the airlines and Wal-Mart to determine optimal prices. For each SKU (stock-keeping unit) in stock, the software plugs in data from the merchandise type and class, the rate it is selling at the current price, the warehouse supply of the unit, the trends last year in terms of how similar merchandise sold, the level of sensitivity to weather patterns experienced in the past by similar merchandise, and the relationship of an increase in sales of that type of merchandise to the sales in other divisions.

“The easiest way to put it is, what do a jar of salsa and a little black holiday dress have in common?” explains Rick Chavie, a vice-president at the software company SAP, which makes markdown-optimization software. I am stumped.

“Well, they’re both something you use only once, they’re both evidence of great taste, and they’re both very simple, but the details can be very important.”

Perhaps you thought a little black dress was a classic; something you could wear again and again. Not so, according to Chavie. “No one wants them after the holiday season.” And that’s where the details, and the risks, play in: If the dress is just to die for, it might fly off the shelves at the rack rate. But if it’s just okay, with some semi-weird stitching, it will need a swift, deep markdown because the season is short and so many other stores sell the same type of thing. And at that point, Chavie explains, “it’s all about how can I get the most in my market basket.” Maybe, he explains, “you bundle salsa verde with salsa roja. Or discount the dress and place it next to a pair of shoes, some dangly earrings, some tights. Mark down the salsa if you buy it with a bag of tortilla chips.”

Chavie’s software can plot the relationship between the price-elasticity curves of all these things in relation to one another. There is usually either some sort of cannibalization effect (discounting the little black dress spells doom for the little red dresses) or an affinity effect (discounting the little black dress boosts the black-fishnets business). If a company can keep proper track of the margins they make on all its units, it can afford to lose money on one thing (remember the leopard print) if it knows it will inspire purchases of a more profitable item (black leggings). “The idea is to sell the entire look,” explains Mark Silverstein, co-author of Trading Up, a book about the luxury boom. “If you can do that, it is profitable.”

Software programs like Chavie’s are loaded onto company intranets, where they give retail executives markdown suggestions on a daily basis. And lording over those programs are two numbers, the desired minimum gross margin and the ever-important desired comp. During the year, when sales aren’t as closely tracked and executives can use excuses like hurricanes and the timing of spring break to explain away lackluster comps, retailers might worry about their margins. But in December, comp is all anyone cares about.

Which is how the post-Christmas sale leapfrogged in front of Christmas.

In 2003, Saks Inc., the owner of Saks Fifth Avenue and assorted mid-range department stores in the South and Midwest, invested in a state-of-the-art markdown-optimization-software package. Humans and computers tend to mark down goods differently: The humans take multiple terraced markdowns, and the computers like to make a single swift, dramatic cut and hold steady for longer.

Around December 21, a computer at Saks Fifth Avenue apparently determined that a swift, dramatic cut was in order. “It was a last-minute decision, but it worked,” says an employee. “It got attention.”

The price of the emerald-green blazers fell below $100, a price at which one was picked up, along with two other 40 percent–off blazers and a full-price black dress, by one Pamela Wallin, Canadian consul general to New York. Twelve remained on the sale rack, the contents of which, a saleswoman told me, would be shipped out the following week—most likely to a distribution center for the company’s Off Fifth outlet stores. The rack already had that forlorn, outlet-store look. Wallin riffled through it with speed and mastery. When she lived in Canada, Wallin hosted the country’s version of Who Wants to Be a Millionaire.

But in New York, Trading Up co-author Silverstein says, even millionaires can be extremely price-sensitive people, because the environment is such a “tempest” of hyperconsumptive behavior. In a new book about bargain hunters, Silverstein profiles a waiter who goes on systematic end-of-season shopping sprees at Diesel and Armani, stocking up on Rubbermaid containers to store it all. A friend of mine in Williamsburg even invested in the collapsible hangers, and on a recent Saks visit, I found myself handing over the old AmEx to buy one dirt-cheap “Cavalli-esque” dress. There’s a bit of the Leopard Lady in all of us.