Known and unknown markdowns: challenges for brands | Sidely

Known and unknown shrinkage: challenges for brands

Margot Bonhomme
February 09, 2024 - 5 min reading

Inventory management is a fundamental aspect of mass retailing, as sales volumes dictate. However, inventories frequently reveal significant deviations from theoretical volumes. While losses can have an impact on all players in the distribution chain, it is common practice to address this issue only from the retailer's point of view.

And yet, as a brand whose products are distributed in supermarkets, you are also affected by this phenomenon.

That's why Sidely is offering you the opportunity to familiarize yourself with markdowns and their various components. We'll review the various actions you can take on your own - and in collaboration with your distributors - to reduce both known and unknown markdowns.

Definitions of known and unknown markdowns

During the physical inventory, which takes place at least once a year, a discrepancy between actual and theoretical stock levels is frequently noted.

Markdowns are the result of a negative difference between booked (actual) stock and theoretical stock. 

But let's start by defining these two concepts:

  • Actual stock = stock in store + stock in reserve ;
  • Theoretical stock = initial stock + quantity purchased - quantity sold.

The formula below evaluates markdowns in terms of quantity.

Total markdown = actual stock - theoretical stock.

[We'll illustrate the formulas with concrete examples a little further down the article]. 

💡 Markdown is always less than 0. In the event of a positive result, we speak of excess markdown, i.e. actual stock higher than theoretical stock. Very rare, this excess is generally the result of labeling errors. For example, a product on promotion which displays the initial price and not the reduced price. Free goods / products offered by suppliers can also generate overstocking.

We can then determine the loss of earnings in terms of value, and evaluate it as a percentage of sales. This is the markdown rate: 

Markdown rate = loss of sales due to markdowns / Sales x 100.

What is known markdown?

Known markdown measures the number or value of unsold products which are no longer in actual stock due to events identified and recorded in the markdown book.

The markdown book is a document in which products unfit for sale are reported.

Known markdowns have many causes: 

  • Breaking ;
  • Damage to products during transport;
  • Shelf life ;
  • Products on display ;
  • Products used for tasting ;
  • Sales ;
  • Promotions.

Price reductions are part of the markdown known when considering losses in value (sales). In this case, markdowns are not a problem, since it is generally strategic to sell off products at the end of a series, or with a short use-by date. However, manufacturers and distributors can try to optimize inventories to avoid having to lower selling prices.

Supermarket operators generally use the expression "breakage rate", as "damaged" products often make up a considerable proportion of known markdowns.

What is shrinkage?

Markdown corresponds to products that have not been sold and no longer appear in stock for unidentified reasons. It is therefore the loss of merchandise whose origin has not been identified.

A phenomenon that is far from anecdotal, since the global barometer of theft in commerce and distribution indicated in 2017 that shrinkage was worth 5.3 billion euros in France!

It is calculated as follows

Unknown markdown = total markdown - known markdown.

The most common causes of shrinkage are :

  • Flights ;
  • On-site product consumption ;
  • Labelling errors ;
  • Logistical problems.

Example of known and unknown markdown calculation for a product line

Superstore markdowns: disparities by industry

Before asking us how your brand can take action on product losses linked to logistics, storage or shelving, it's worth recalling an important concept: the rate of markdowns and the nature and origin of inventory discrepancies are not the same depending on the products you offer for sale.

Electronics and jewelry are particularly vulnerable to theft, due to their generally high prices. 

Fashion and clothing are also subject to this type of markdown, which also includes returns.

Another example is health products, whose size tends to "facilitate" shoplifting. 

It's worth noting that the inflation seen in virtually all sectors in recent years has been accompanied by an increase in supermarket theft.

In the food sector, markdowns are generally linked to the expiry of products, whether fresh or not. The rate of breakage is higher in fresh departments than in other departments. Perishable foods have a high rate of breakage due to expiry dates, hence the increased frequency of promotions. The EGalim 3 law excludes fruit and vegetables from the resale-at-loss threshold, which is set at 10% of the actual purchase price. 

In other sectors, breakage accounts for the lion's share of markdowns. For example, appliances often include fragile technological components, increasing the risk of damage during transport. What's more, it's common to put products on display for demonstration, and these are often offered for sale at a preferential rate, as they have already been unpacked, touched etc.

Finally, it should be remembered that some industries are subject to markdown cycles, as in the case of the toy department. During the Christmas season, theft and breakage are more widespread than during the rest of the year.

Combating known and unknown markdowns

If your distributors (both retail chains and points of sale) have more or less effective processes and habits for managing and reducing both known and unknown markdowns, you have every right to look into the matter. After all, it's your products that disappear, and your distribution contract may in some cases require you to assume or contribute financially to the loss of earnings!

However, if your sector managers are trained in best practices for reducing product losses, they can pass on these best practices to their department managers and other store teams, and work to improve the systems in place (or not) for this purpose.

If in-store markdowns can't be completely avoided, they can always be reduced. As well as protecting you from possible economic losses, you'll also be showing your business partners that you're proactive in improving distribution processes and increasing profitability.

As a general rule, it's important for your brand to anticipate markdowns. Although most loss-generating incidents or commercial events take place at the retailer's premises, you need to act on three levels: 

  1. Anticipation and negotiation : markdowns are an integral part of the distribution contract, and some chains may ask you to contribute. Be vigilant and make sure you know the ins and outs; 
  2. Day-to-day operations : define efficient processes and train teams;
  3. Check that processes are being followed, report and analyze results.

Known markdowns: causes and solutions

Problems encountered Solutions
Breaking Design robust packaging. Monitor breakage rates, in collaboration with the distributor. Identify products most susceptible to breakage, and adapt handling and shelving procedures.
Product damage during transport Train delivery personnel to handle packages and products. Design robust packaging.
Product demonstrations and tastings Set up regular inventories to determine the loss of earnings following the introduction of demonstrations or tastings.
Product shelf life Set up discount programs on products close to their expiration date to recover part of the price. Fruit, vegetables and dairy products can be processed in the catering department at the point of sale to keep costs down. Coordinate with sales outlets to optimize inventory management. Advise your distributor on how to use products that are nearing their sell-by date.
Sales and promotions Monitor margins. Limit unjustified price cuts. Analyze previous years' operations before launching new programs, but also work on current trends to avoid launching operations based on old contexts.

Shrink: causes and solutions

Problems encountered Solutions
Theft (or consumption in the aisle without purchase) Encourage your distributors to implement deterrent methods: anti-theft devices, electronic tags, remote surveillance. Educate staff on the subject, and on how to identify the signs of shoplifting. Although these imperatives seem to be the responsibility of the retailer or outlet, the experience and common sense of your sector managers can make all the difference: if they notice any shortcomings or areas for improvement, they must act! You can also supply products already fitted with secure packaging.
Return of goods Systematic verification of merchandise with proof of purchase.
Labelling errors. Ex: difference between the price displayed on the shelf and the price at the checkout. Ensure that logistics processes and technologies are mastered throughout the supply and distribution chain.
Logistics problem Set up more regular inventories to pinpoint the area(s) (delivery, storage, department) affected by markdowns. Where losses are difficult to identify precisely, intermediate counting systems can be set up to identify the critical phase. For your part, make sure you systematically check the order on dispatch from your factory and on arrival at your distributor.

By now, you're familiar with every aspect of retail markdowns, both known and unknown. While it's true that stores are still on the front line when it comes to these issues, you can take action to limit losses for your brand and establish a win-win collaboration with your distributors. This will help combat shrink and demonstrate your commitment to a common goal: sales performance in supermarkets. To achieve this, your ability to work proactively with the distributor will play an essential role.

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