The Science Behind Markdowns: Understanding the Economics of Clearance Sales

How can huge discounts designed to move out inventory end up being profitable? Let's dive into the science behind clearance sales in retail.

The Science Behind Markdowns: Understanding the Economics of Clearance Sales

You walk past a store with big signs touting 50%, 70%, even 90% off. Surely this retail brand is going out of business, right? Yet another casualty of Millennials or Gen Z or whichever demographic we’re pinning the blame on these days, yes? Not so fast. They could just be leveraging a strategic retail tool in order to improve their business: the clearance sale.

Clearance sales are a unique aspect of retail, distinct from regular sales. While regular sales are often planned to be tied to seasonal changes, holidays, or marketing strategies, clearance sales have a different purpose. They're specifically aimed at liquidating inventory that's no longer desirable or needed in the store. This could be due to a variety of reasons like seasonal changes, overstock, or products not resonating with customers as expected.

Unlike regular sales, which might offer modest discounts to boost sales volume, clearance sales typically feature significantly steeper discounts. The primary goal here is to move merchandise as quickly as possible, making room for new, more relevant stock. But that doesn’t mean that clearance sales can’t be profitable.

In fact, there have been whole academic papers written about the theory and economics of clearance sales, modeling pricing for maximum profitability. Let’s take a look at how your brand can use data & analytics to get the most out of your EVERYTHING MUST GO extravaganzas.

The Economics of Profitability in Clearance Sales

So how can huge discounts designed to move out inventory end up being profitable? First, consider that clearance sales help in recovering some portion of the cost of the inventory, which is better than a complete loss if the items go unsold. This recovery of cost, albeit lower than the original price, contributes to the overall financial health of the business. And typically, clearance items are subject to “no returns, no refunds” clauses making the margins even better by avoiding the secretly expensive returns problem in retail.

Clearance Sales and Inventory Management

Next, a key aspect of why clearance sales are beneficial is the way they aid in inventory management. Holding onto old inventory is costly for retailers—not just in terms of space, but also in the capital tied up in unsold goods. By clearing out aged inventory, stores can free up valuable shelf space and reduce storage costs.

Additionally, it helps in maintaining a fresh and relevant product lineup. Fashion trends change rapidly, and what was in vogue a season ago might be passé now. Clearance sales are an effective tool to remove such out-of-trend items. They also address products with low sell-through rates (an important retail KPI you should be tracking), ensuring that only the most desirable items occupy your valuable retail space.

Loss Leading and Foot Traffic

It’s also no surprise that some clearance sales operate on a loss-leading strategy. This means that the items are sold at a price lower than their cost, with the aim of attracting foot traffic generated by the allure of steep discounts. This can lead to additional sales of regularly priced merchandise that savvy retailers will place strategically next to similar clearance items.

In fact, diving into your retail data will reveal the products that correlate with high average order values – meaning, the products that are frequently purchased in high value bundles – which can be the perfect “impulse buy” items to prominently display near clearance items. Customers drawn in by the big deals will also often end up browsing and purchasing these regular-priced goods, well compensating for the loss incurred on the clearance items.

Targeting Deal-Seeking Demographics

Clearance sales are particularly effective in reaching specific demographics, especially those who are price-sensitive and deal-oriented. These consumers are often on the lookout for discounts and are more likely to visit a store if they know a clearance sale is on. This is a unique way retailers can tap into this wary demographic, expanding their customer base.

In fact, the academic paper referenced at the start of this blog post delved into the right amount of discounting that retailers should do in order to entice those budget-conscious shoppers who have been waiting on the sidelines, while also catering to the average clientele of the brand. This is where your historical sales & pricing data trends can come in handy, showing you the sweet spots where the right amount of discounting correlates to the highest amount of sales volume. (check out a quick version of understanding “price discrimination” in this Berkeley article)

Additionally, such sales can build goodwill among these customers, who might feel they are getting a bargain, thus enhancing customer loyalty and potentially leading to future full-priced purchases.

Running a Successful Clearance Sale

To run a successful clearance sale, strategic planning is crucial. A few tips to keep in mind:

Timing & Predictability: It’s awful to throw a party that no one comes to. Be sure to time your clearance to when your customers are available. Aligning clearance sales with the end of a season or a holiday period can increase their effectiveness, and can train your audience to expect clearance sales at predictable intervals throughout the year.

Item Selection: Using your retail analytics to know which low sell-through, aged/outdated, and overstocked products to mark for clearance is key. Always have the data to back up the steep discounts your store is offering.

Marketing & Displaying: Retailers should clearly mark down items and segregate them from regular inventory to avoid confusion. Effective marketing is also key—promoting the sale through various channels like email, social media, and in-store signage can maximize its reach.

In conclusion, clearance sales, while different from regular sales, play a crucial role in the retail economy. They not only help in managing inventory and recovering costs but also attract a broader range of customers, ultimately contributing to a store's profitability and market presence. With strategic planning and execution driven by the right retail data, clearance sales can be a powerful tool in your arsenal.

Is your retail analytics telling you the right products to move to clearance? We can help. Schedule a free demo with our expert retail data technicians today.