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Customer Focused Retail Strategy

Understanding customer decision making to inform markdown management

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In a competitive sales environment retailers need to set markdown strategies based on a clear understanding of how customers form their buying decisions. Retailers informed by an awareness of how customers behave in relation to the size and timing of item markdowns can greatly increase their sales performance.

Research from Nikolay Osadchiy, assistant professor of information systems and operations management at Goizueta Business School, highlights how the decision to purchase an item at regular price or wait for a possible markdown involves a multi-step mental process and that this process is predictable.

According to Osadchiy and co-authors Manel Baucells (University of Virginia) and Anton Ovchinnikov (Queen’s University), consumers weigh factors such as the value of the item, the delay in getting the item, the likelihood of being able to purchase the item, and the magnitude of the price discount.

Everyone likes a bargain and this is reflected in the fact that, according to these researchers, nearly 1/3 of unit sales and 1/5 of dollar sales are generated at markdowns, with markdown revenues translating into major profit increases. So the importance of markdown management to modern retailers is clearly critical.

The problem is the proliferation of markdowns – with ‘sales’ now seemingly an all year round phenomenon – has led to ‘strategic waiting’; where every time a consumer enters the store he or she mentally ‘solves’ a wait-or-buy problem – should they buy the item now or wait for a possible markdown. Being aware of the behavioural regularities surrounding this decision, and incorporating them into markdown management offers substantial revenue opportunity for retailers.

The researchers core idea is that the wait-or-buy decision reflects a multi-dimensional trade-off between the delay in getting an item, the likelihood of getting it, and the magnitude of the price discount. Multiple studies in the decision analysis, psychology and behavioural economics, showed that all these trade-offs are prone to behavioural regularities by which decision makers deviate from the discounted expected utility model (i.e. the utility (desirability) of future consumption, as perceived at the present time as opposed to consumption now).

Bearing in mind our natural preference for ‘sooner rather than later’ gratification, the researchers present evidence that people view these trade-offs in a non-linear and interdependent way. For instance, individuals’ sensitivity to risk of not obtaining an item depends on the time delay and the magnitude of the discount, or sensitivity to time delay depends on the price discount and risk. They capture this interdependecy through the notion of ‘psychological distance’ i.e. “buy now for sure” (zero distance) and “perhaps buy later” (both time and risk distance).

In conclusion the researchers say that they “Solve the consumer’s wait-or-buy problem and embed it into the firm’s markdown optimization problem. We calibrate the model parameters using experimental data, validate it out-of-sample, and show that accounting for the behavioural anomalies results in substantially larger markdowns that the current literature suggests and leads to noticeable revenue gains.”

Listen to Nikolay Osadchiy discussing consumer purchasing habits on the Dana Barrett Show HERE

READ THE RESEARCH PAPER: Behavioral Anomalies in Consumer Wait-or-Buy Decisions and Their Implications for Markdown Management, Manel Baucells, Nikolay Osadchiy, and Anton Ovchinnikov, 2016.

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