Retail Owners: Explain to me the Microeconomics of The Clearance Sale

retail markup is closer to 60-70%

I presume you are asking about clothing retailers given your reference to TJMaxx etc. In the clothing world, retail prices are usually complete BS. So, the big sales still have plenty of profit baked into the price. The clearance racks that are 70%+ off are a very small portion of inventory and do not lose much money. The real fight in retail is market share. You will lose more profits to your competitors by having customers skip your store than you will having customers buy clothes at sale prices with smaller profit margins. That is why retailers like Sears and Kmart are dying. People skip them over for online retailers and for other big boxes like Target. That means that Sears has to close stores and sell less stuff. That is the retail killer.

You're always trying to get as much as you can for your product. No one is going to be able to predict demand perfectly, so there will always be slow movers that didn't end up getting the price point you want. In order to be able to clear room for newer items that will sell at a higher margin, you'll want to get these slow moving products off your shelf. Further, you can't just sit on it because you'll have to write it off as a product reserve, at which point even selling it at less than cost is going to help the financials.

Part of the thinking is that if the company doesn't get the inventory off the shelves (at any price) and thus off books by the end of the tax year (Jan 31 for a lot of retailers), then you lose the tax deduction for the inventory purchase for that year. It can really jack the income tax up, even though the company spent the cash on the inventory. This is a big part of the purpose of the "after-Christmas sale" and the "white sale".

Old EA guy wrote:

Part of the thinking is that if the company doesn't get the inventory off the shelves (at any price) and thus off books by the end of the tax year (Jan 31 for a lot of retailers), then you lose the tax deduction for the inventory purchase for that year. It can really jack the income tax up, even though the company spent the cash on the inventory. This is a big part of the purpose of the "after-Christmas sale" and the "white sale".

Ehhhh....not really. The revenue (taxable income) isn't recognized until the sale, either.

Yes, really. Google it. Retail accounting 101. It's a big tax issue with retailers. Think about it --if you're really break-even on income and expenses, but you can't deduct all the cost of goods sold, all of a sudden you have a taxable profit and owe tax. If you sell the item, you have income and an offsetting expense, and potentially break even, meaning no tax.

Retailers want slow sellers off the shelf for opportunity cost not tax write offs.

A slow seller is taking the place of a better selling item - older product sell slower and slower.

Also markup and margin depend on the product footwear and apparel are typically 50% at a retailer. But remember a branded store or outlet - dosen't need to make money selling wholesale. So at a branded store lets say a brooks store receives a 100$ shoe at $25 while Joe's Running Shop buys the shoe from brooks for $50 and sells it for $100.

However even if a store buys a product for $50and sells it for $100 - they must pay all their expenses with that $50. So even a 30% off may be cutting into what they need for rent payroll marketing events repairs etc. But they need to move the product out to bring in better new product that will sell at whole retail price.

Electronics and Hardgoods have much slimmer margins. Food is all over the place with single ingredient pantry items having low margins and processed snack foods having high margins.

They can test the inventory for impairment. If it’s worth less than what they paid for it, they write it down to accurately report the value of the assets the company owns.

I used to work for a jewelry company.

All gold items were marked up 7x.

All diamond products were marked up 6x.

They would run sales where 'all gold chains 50% off'.

A $150.00 wholesale chain, retails for 1050.00, but is on sale for $525.00.

Old EA guy wrote:

Yes, really. Google it. Retail accounting 101. It's a big tax issue with retailers. Think about it --if you're really break-even on income and expenses, but you can't deduct all the cost of goods sold, all of a sudden you have a taxable profit and owe tax. If you sell the item, you have income and an offsetting expense, and potentially break even, meaning no tax.

Dude, I don't have to google it - I'm a CPA.

"Think about it --if you're really break-even on income and expenses, but you can't deduct all the cost of goods sold, all of a sudden you have a taxable profit and owe tax"

If you can't "deduct all the cost of goods sold" it's because you didn't sell that item, meaning you don't have taxable profit on that item. I can go more in detail with examples/math, but I think you can get there without the need.

Sounds like you're calling revenue and taxable income the same? Or being terse maybe.

He's talking about selling at a discount, remember? Lower profit-- it might only be recovering cost.

I'm quite aware the income and expense come in the same year. You've missed my point. If you can sell the item before the end of the tax year, you have a timing match between cash expense and COGS deductibility in the same year. If you can't sell the product before year end, then you have no deduction and a timing mis-match that can easily create taxable income where there was no net cash flow. This causes problems.

People new to retail inventory discover this painful truth routinely. Maybe you can do an NOL carryback the next year to fix it - but probably not if you're usually profitable.

I've done returns for a lot of retailers who look at this way. Maybe they weren't typical. They would rather sell at a discount to get rid of the tax.

In some states you have to pay property tax on items you have on hand on Dec 31. This is a big reason car sales are so common right after Christmas.

When I managed a running shop (we sold other stuff as well), the MSRP was 100%. So if the shoe cost us $50, MSRP was $100. We discounted 20% so we sold it for $80. We would often do our clearance racks at $5 over our cost and clearance was only if the item just had not sold or if the maker had stopped making it or an "odd" size like 11.5 (for some reason that was a size that did not sell for us--weird how I still remember that).

Essentially you have to factor in that you will not sell everything.

So getting rid of stuff first cut our loss and kept us from having to pay taxes on the merchandise.

It also cleared shelf and display space for newer items.

Since people decided to talk accounting, I’ll address the real question; which was economics.

There’s different types of goods, consumers, and firms. Your undergrad Econ courses teach you representative firm models where we assume all firms and agents are homogenous (the same) to keep the math easy and solvable with paper.

In reality this isn’t true. Some firms make more profits by selling quantity. So they sell discount products. Likewise there’s a consumer’s who prefer discount products. In other words some consumers who can afford a 150k car buy a 15k Honda. And just remember not all goods can be sold at deep discounts.

Yes, I realize that you can lower your tax expense by being less profitable, such as by selling a bunch of items at a big enough discount to be a loss (less than cost) at the end of the year. That would be a cash flow management strategy, and a pretty poor one at that because the lost cash flow from the steep discount would outweigh the future cash flow benefit when you pay taxes. I am glad to know there are retailers out there unwise enough to do this because it gives a competitive advantage to those of us who know what we are doing.

Jorvack and Countant get it.

This guy gets it. The above rationale for clearance sales (not just post-Christmas) is spot on. If the product can’t be moved quickly or returned to the vendor, it needs to be moved off the racks at a steeply reduced rate to make room for higher margin options.

Also, the longer that product stays on the shelves, the less shoppable your store becomes. Good luck selling premium apparel products in a store that has a bunch of XXL shirts in SP’ 17 colors on the racks.

Something that may not have been pointed out, is that the word "Clearance" gets people in the door. And even if there's no profit in the clearance items, chances are the buyers will also buy other stuff not on sale.

Wrong average mark up for footwear is 45% apparel is 50%. After factoring all expenses a $100.00 shoe sale nets ~ $5.00 profit.