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Retailers perfect science of markdowns

Software dictates when, what, how much to slash

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It's one of the great nail-biter decisions of retailing: just when to hit the markdown panic button.

Discount chain ShopKo Stores Inc. got nervous this spring, as shopper after shopper shunned its stretchy nylon track pants. They had a comfortable elastic waist. They had bright, contrasting stripes down the sides. But they simply weren't budging at their original price of $16.99.

ShopKo didn't want to resort to its strategy of years past: whittle the price a bit here and there, then chop it methodically once a month — to $9.99, then $7.99, then $3.99. Instead, it took only two measured swipes, marking them down to $10.79 on average in early May, then to $9.75 a month later. And it held firm there. With the new pricing plan, ShopKo sold out the last 12,500 pairs during the three-month clearance period, for a gross profit margin of 31 percent — nearly double its forecast.

It wasn't a random decision. ShopKo is one of a handful of retailers, including J.C. Penney Co., L.L. Bean Inc., Liz Claiborne Inc. and Gymboree Corp., trying to perfect the science of the markdown. They have been experimenting with sophisticated new software programs to test principles similar to "yield management," which airlines mastered years ago to eke out the maximum profit from every seat. Like a seat on a particular flight, an item such as a bikini is in demand for a limited time; as the end of the season approaches, its value to customers plummets. A big challenge: trying to outfox customers who have been more willing to wait and wait for a bargain.

Using number-crunching consultants, armed with mathematical models pioneered by think-tank researchers and astrophysicists, the stores analyze historical sales data to pinpoint just how long to hold out before they need to cut a price — and by just how much.

Their progress marks a new step in a growing trend toward highly flexible prices — for everything from mortgages to eBay merchandise. Instead of taking a one-price-fits-all approach, buyers and sellers are increasingly meeting in customized marketplaces transformed by technology.

With exploding competition from discounters and specialty stores, markdowns are soaring, making them a decisive issue in retailing. Marked-down goods, which accounted for just 8 percent of department-store sales three decades ago, have climbed to around 20 percent, according to the National Retail Federation.

Retailers hate markdowns. Discount an item too late, and stores are stuck with truckloads of inventory. Too early, and they lose profits as people snap up items thrown on the bargain table prematurely. Gap Inc. said its profit margins on June sales fell well below its internal forecast after it was forced to take deeper-than-expected markdowns on a mountain of merchandise, from Gap T-shirts to Old Navy shorts. And Neiman Marcus Group Inc. has cited steeper-than-planned markdowns for the second time in as many months in estimating a loss for its fiscal fourth quarter, ended July 28.

"You can intelligently and consistently predict a lot of other components of your business," says Steve Raish, chief information officer of J.C. Penney. But "markdowns — in particular seasonal markdowns — are one of the least predictable elements."

The technology, still fairly new and untested, requires detailed and accurate sales data to work well. And even if the new software programs can help crack the markdown riddle, they can't solve other problems, such as poorly chosen merchandise or a weak economy. "This is not the savior to the profitability of the company. This is just one more tool in the tool chest," says William Podany, the 55-year-old president and chief executive of ShopKo, based in Green Bay, Wis.

End-of-season sales — held two or three times a year — first came into vogue in the 1950s, as an easy way to clear inventory and free up cash. In the 1960s, department stores began adding back-to-school sales to draw in customers as the summer tailed off.

But as discounters improved their apparel selections over the years, department stores have found themselves constantly staging sales to stay competitive. "They don't even name sales anymore, because it would have to be called the 'June 13 sale,' followed by the 'June 14 sale,' " says Erik Gordon, a marketing professor at the University of Florida's Warrington College of Business.

Much of the attention on markdowns in recent years has been regulatory, as state attorneys general charged numerous retailers with deceiving consumers by raising prices and then offering a discount off the inflated price. In some cases, investigators could not find any evidence that the goods had ever been sold at the so-called "original" price. Kmart Corp. recently responded to a complaint from the Jewelry Advertising Review Program, a coalition of local Better Business Bureaus, which contended that Kmart was claiming to sell its jewelry at discounts from "original prices" that were not frequently offered. Without admitting wrongdoing, Kmart said it had changed its jewelry pricing to sell its jewelry at regular prices for at least 183 days each year.

ShopKo, a chain of 141 stores that likens itself to Target Corp.'s discount stores, began hunting for a technical edge early last year. The 39-year-old retailer, which also operates Pamida, a 229-store chain of small mostly rural discount stores, was facing a difficult year in 2000, which ultimately ended with disappointing sales of $3.5 billion and a $15.8 million loss. It subsequently had to cut jobs, close some stores and put remodeling and expansion plans on hold.

As part of its effort to get a handle on the business, it turned to Spotlight Solutions Inc., a Mason, Ohio, start-up that is one of the leaders in the markdown-software field. Spotlight's software uses mathematical models created by researchers such as Dale Achabal, a bespectacled professor who acts as an adviser to the company and sits on its board.

Trained in marketing and regional economics, Achabal in 1980 co-founded the Retail Management Institute at Santa Clara University, a private Jesuit school in California. He currently directs the institute, which includes the Retail Workbench, a corporate-sponsored think tank.

"There will always be things you don't expect," says Scott Friend, president and chief executive of ProfitLogic of Cambridge, Mass., a competitor of Spotlight that draws heavily from the talent pool at Harvard University and the Massachusetts Institute of Technology. But because the software systems start with more precise forecasts and adjust their recommendations to early sales results, he adds, "on average, we are a lot more accurate" than past practices.