Markdowns or No markdowns for Luxury Retailers?

Luxury retailers in the west offer markdowns to push sales, banking on the Sales effect. However, while determining whether to offer markdowns, they need to consider that customers’ desire for exclusivity (Snob effect) and forward-looking customers’ willingness to wait for marked-down prices (Strategic effect) might affect sales adversely. To get the maximum benefit, luxury retailers need to balance the impacts of these effects by offering some items on markdown, especially in the second selling period.

While multi-brand luxury retail is still in its infancy in India, stores like Saks Fifth Avenue, Neiman Marcus, and Nordstrom in the US often offer markdowns (heavy discounts) on their

seasonal products (e.g., Winter Collection garments) to drive sales. By offering markdowns, luxury retailers can increase sales (known as Sales effect), but it can also cause a lack of exclusivity and reduce consumers’ willingness to buy (known as Snob effect) since luxury customers pay for uniqueness. At the same time, foresighted customers might wait for deep discounts to buy (known as Strategic effect). Because of the interaction between these various effects, the real impact of markdowns on sales and profits of luxury retailers is hard to determine. A study uses a game-theoretic approach to to answer the question: Should luxury retailers offer markdowns on seasonal products?

The study estimates that even though it is counter-intuitive, customers’ exclusivity-seeking

behaviour is the reason luxury retailers opt for markdowns. They ration the products and sell less than the demand (also known as inducing a buying frenzy) to increase buyers’ willingness to pay a higher price for exclusivity during the initial selling period. The desire to be part of a small group of consumers convinces buyers to pay a high price. Then, in the next selling period, the retailer offers a marked-down price and a larger number of pieces for sale.

Interestingly, this behaviour of retailers is more pronounced when the proportion of high-value customers is neither too high nor too low. These high-value customers, who are exclusivity-seeking, are willing to pay full price and buy during the first selling period despite knowing about markdowns in the second period. So, in the second period, the retailer can target low-value customers by reducing the product’s exclusivity and offering a larger volume for sale at a lower price, which increases overall sales and profits despite a lower margin.

For example, a retailer might sell a Diwali-themed leather handbag for ₹ 12,000 at first and

offer only a dozen pieces for sale. High-value customers would be willing to pay that price to be among the very few owners of the bag. Then, in the next selling period, the retailer might mark the price down to ₹ 8000 and offer 50 pieces for sale to low-value customers who are not so particular about the exclusivity of the handbag.

The study also estimates that the impact of strategic thinking by buyers affects profit less as the number of exclusivity-seeking customers increases. However, this does not mean that the retailer can ignore the strategic effect of forward-looking buyers. Ignoring it can be costly and can lead to a fall in profits by up to 45%.

The study has relevant insights for luxury retailers looking to increase sales. As a rule of

thumb, they can use markdowns in the second period of selling, especially for “masstige” brands (brands considered prestigious but less rare and more affordable, e.g., Calvin Klein). Globally, over half of luxury shoppers buy a luxury good only when it is marked down. So, it makes sense to use markdowns on certain products to drive sales.

However, luxury retailers also need to consider the number of customers looking for

exclusivity. If there are too many high-value customers who want high exclusivity for a certain product (e.g., fur coat), then they can avoid markdowns and sell only at full price. For such products, they can implement rationing to induce a buying frenzy. They can create waiting lists or introduce limited edition products to this effect. Balancing customers’ need for exclusivity and their willingness to buy more during markdowns will allow luxury retailers to make maximum gains.

The study, while promising significant insights for luxury retailers, looks at only the short-term

impact of markdowns. It does not consider the long-run impact of markdowns on consumer valuations of the brand. Given the importance of brand value for luxury goods, it is important not to extrapolate the estimates of this study to the long term to avoid risk of brand value erosion.