News from The Globe and Mail


Tuesday, March 25, 2003

If you can draw a crowd of New York conventioneers at 8 o'clock on a Sunday morning, you're handing out hangover remedy or courtside seats for the Knicks, right?

Not necessarily.

If it's a conference of retailers and you've found a new way to squeeze more out of profit margins, then it's standing room only whatever the hour.

At least that's what Michael Stanek, CFO of Toronto-based Northern Group Retail Ltd. found when he showed up to anchor a daybreak seminar at the National Retail Federation conference in New York this past January.

Mr. Stanek tends to attract an audience these days because he represents a rare breed of retailer.

He is one of only a handful with first-hand experience of a concept known as markdown optimization. It's an e-business application that is becoming a hot button in retail circles.

Northern Group -- the only retailer in Canada to use the technology -- runs a version called Pricing4Profit from ProfitLogic, a Cambridge, Mass.-based developer. Northern Group is using Pricing4Profit to estimate and make recommendations on markdowns for products sold in its 280 stores under the Northern Reflections, Northern Getaway and Northern Traditions banners.

Markdown optimization is part of a brand new category of applications called merchandising optimization tools. These software applications link point-of-sale and head-office merchandising systems to extract data that can be used to support the decision-making process.

Systems can be built in-house or run on a subscription basis through an application service provider, with authorized users accessing the data from their desktops simply by using a Web browser.

The category includes pricing, replenishment, assortment, allocation and promotional optimization tools -- many of which are just emerging. "The jury is still out on some of these applications," says Hung LeHong, research director for GartnerG2 in Toronto. "Some have only been available in the past few weeks."

But markdown optimization is generating interest because it has actually been up and running for more than a year, is relatively quick to implement and according to retail analysts, can deliver the quickest "hit" in terms of return on investment. Big guns such as J.C. Penney Co. Inc., Home Depot Inc. and the Old Navy division of Gap Inc. have already added it to their arsenal.

So what's this application do to make it so desirable? In simple terms it's predictive modelling software that takes store data and compares it with historical sales data to forecast when, where and what size of markdowns should be taken. As Mr. Stanek puts it, "It's not about creating more sales, but creating more value from sales."

Mr. LeHong says that while it's not for all retailers, it's a fit for those that deal in short lifecycle, seasonal products, such as apparel and electronics.

Peter Charness, senior vice-president of marketing and chief product officer for JDA Software Inc., in Scottsdale, Ariz., agrees. "For apparel or stores with seasonal sales, it's important. For a Canadian Tire with sales over short-term intervals or a grocery story that carries the same products for years -- not so much. They would be more interested in other types of revenue optimization."

Richard Jaffe, retail analyst with UBS Warburg in New York City, says the idea of markdown optimization is not exactly new. "The advantages of markdowns were realized 20 years ago by the airlines. They figured out discounting long before retailers." However he adds, "It's more elusive for retailers, because airlines only had one SKU [the airline seat] versus 15,000 to work with."

Hence the need for an application that can do much of the analytical work for you. Mr. Stanek says that with the markdown optimization application, Northern Group can now run different markdowns at different locations depending on how products are selling in particular store clusters or regions. They can also run "what if" scenarios to see how particular markdowns will affect sell-through rates.

He says that this ability to regionalize and tailor markdowns is key. "Typically retailers do markdowns universally across the chain. We realized we could improve our margins by being able to run markdowns differently according to regions."

"We also realized that it would take 15 analysts working full-time with data to do it on our own," he adds.

Antony Karabus, CEO of Karabus Management, agrees that the permutations can be mind boggling if you try to do the math on your own. "If you multiply 1,000 stores by 52 weeks of data by 20,000 items per store - that's how many points of data you could optimize. No human being could figure that out on his or her own."

Mr. Stanek estimates that Northern Group expects to improve gross margins by 2 per cent with markdown optimization software.

Early hits since installing the software in November have shown that they're definitely on track. "The software advised us not apply a 30-per-cent discount on one item in one region based on historical sell-through. We ended up generating $60,000 additional gross margin dollars. Another time, it warned us not to reorder one item and we were able to cancel that order and save inventory costs."

Markdown optimization software is not for the faint of heart -- or budget.

Mr. LeHong estimates that a pilot application can run between $500,000 to $1-million (U.S.) while a full-blown implementation, depending on the amount of data involved, can range anywhere from one to $10-million.

Says Mr. Charness: "When you're dealing with something so highly mathematical, it's a matter of how many PhD mathematicians have to work with your data to get it automated. That's where the cost is."

Even at that Mr. Karabus claims that return on investment can usually be achieved within 12 to 18 months. "Just think about it. A 1-per-cent improvement in gross margin for an $80-million retailer is worth $4- to $5-million to the bottom line over the course of a year."

All this, of course, depends on whether you're using it at the right place, at the right time for the right reasons.

Despite the apparent potential gains, Mr. Jaffe says markdown optimization software has little value if it's being used to repair what's broken.

"If you have a flawed business model in the first place, it won't matter where you take the discounts. "Software will never make high water pants popular. What it can do is bring computerized horsepower to help you do a better job and make better decisions."

As Northern Group is showing so far, when it works, it works well. And judging by Mr. Stanek's engagement diary these days, retailers are eager to hear about it.

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