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Markdown-onomics

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“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.”


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