Markdown – What is a markdown?

In finance, a markdown is a reduction in the price and value of an asset.

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Markdowns are designed to increase sales, so they usually occur when a business can’t sell a
product at its current price.
By reducing the price, a markdown makes a product or service more desirable for customers.
After a markdown, each unit has a lower profit margin, but overall sales revenues are higher
because more units are sold.

Markdowns and pricing

When setting a price for a particular good or service, it’s important to value the product
accurately.

According to the theory of supply and demand, if the price of a commodity is too high, fewer
units will sell. As such, if a business overestimates the market value of a product, it will struggle
to make sales. On the other hand, if the price of the product is too low, it could become
unprofitable.
Markups and markdowns are used when businesses under or overvalue a product. A markdown
adjusts the price of a product to reflect the price consumers are actually willing to pay – it’s
therefore the devaluation of a product.
If sales don’t increase after the first markdown, it might be necessary to continue marking down
the price of a product until it sells at a profitable rate. There should be enough time between
markdowns to sufficiently test the impact of the new price.

Types of markdown
As well as misvaluing a product, there are a few reasons why a company might use a markdown.

Clearance markdowns

If a retailer doesn’t plan on restocking an item, it could be more cost-efficient to sell the product
at a reduced price than to pay for storage. By reducing the value of a product, clearance
markdowns speed up sales and therefore get rid of excess inventory.
Damaged goods markdowns

If a unit of a product is damaged, it’s unlikely to sell for the same price as a non-damaged unit.
It’s therefore common to reduce the price of any spoiled or defective goods.

Competitive markdowns

Also known as price-matching, competitive markdowns occur when a business reduces the price
of a product to match its competitors’ prices. If two companies sell the same product at different
prices, the company with the higher price is likely to sell less.

Example of a markdown
Markdowns are common in many industries and are frequently used in retail. For example, a
clothes retailer produces a new line of jeans, which are sold for £50. After three months of poor
sales, only 20 pairs of jeans have been sold for a total of £1,000.

The retailer reduces the price by 20% to £40. Three months later, 50 pairs of jeans have sold for
a total of £2,000.

Although the clothes retailer makes less profit per pair of jeans, overall profits increase because
more units are sold as a result of the more attractive price.

Markdown vs. discount

Markdowns and sales discounts are similar concepts, but there’s one important difference: a
markdown is a reflection of value whereas a sales discount is not.
Both markdowns and sales discounts involve the reduction of price – but for different reasons. A
markdown is an adjustment of price to reflect a lower market value, whereas a sales discount
doesn’t change the valuation of a good or service.

Instead, discounts are reduced rates offered for specific reasons – such as seasonality, customer
loyalty or demographics (such as discounts for students or pensioners).

Both markdowns and discounts can be temporary or permanent. If a product sells much better
than expected after a markdown, the price might be adjusted again. This could be because the
markdown was too much, or because of external factors such as an improving economy or a
change in market trends.

Markdowns for brokers and investors

Although the term ‘markdown’ is usually used to refer to a reduction in price, it might also be
used when talking about investment and brokerage. In this context, the markdown is the
difference between the price the broker or investor pays for an asset and the price they sell it on
for. This type of markdown might be considered commission.