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A Decision-Support System That Helps Retailers Decide Order Quantities and Markdowns for Fashion Goods Author(s):

A Decision-Support System That Helps Retailers Decide Order Quantities and Markdowns for Fashion Goods Author(s): Murali K. Mantrala and Surya Rao Source: Interfaces, Vol. 31, No. 3, Marketing Engineering (May - Jun., 2001), pp. S146-S165 Published by: INFORMS

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A Decision-Support

Retailers

Decide

System

that Helps

Order

Quantities

and

Markdowns

for Fashion

Goods

MURALI

K. MANTRALA

murali.mantrala@zsassociates.com

1800

ZS Associates

Sherman

Avenue

Evanston,

Illinois 60201

SURYA

surya@fisofex.com

RAO

14

Eighth

FI Sofex Ltd. Main

Malleswaram

Road

Bangalore, India 560003

We

developed

MARK,

a stochastic

dynamic-programming

model-based

retail-store

chandise

mented

on

retailers'

users7

decision-support

of

quantities

fashion

an

system,

specifically

to help

mer

imple

that

with

systems.

runs

the

buyers

as

goods

decide

on optimal

prices. We

program

integrated

order

MARK

and markdown

software

be

interactive

personal

point-of-sale

computers

(POS)

and

can

and

other

information

As

we

show

in

an

actual-case

illustration,

MARK

improved

profitability and managers'

problems. MARK also provides valuable insights into the in

understanding

of

the decision

terplay

between

order-quantity

For

mean

example,

lower

higher

profits.

markdown

and

dynamic-pricing

percentages

do

not

decisions.

necessarily

The

bottom-line

profitability

of

fashion-goods

stores,

retailers,

specialty

is affected

for example,

stores,

by

the

and

managers

department

catalog

inventory-order-quantity and pricing deci

and merchandising

sions

retailers,

buyers

make.

have

Fashion

short

(or seasonal-style) uncertain

seasons,

goods

and

selling

nonstationary

functions,

end

of

demand

and

little

selling

(price

response)

value

at

Ideally

salvage

seasons.

the

buyers

their

would

order

inventories

of

such

goods

in

response

to observed

demand.

Unfortu

nately,

lead

in many

instances,

times

or other

supply

long

delivery

constraints

rule

out

the possibility

of

reorders

and

quick

Copyright ?

2001

INFORMS

MARKETING?RETAILING AND WHOLESALING

0092-2102/01/3103/S146/$05.00

PROGRAMMING?DYNAMIC,

1526-551X electronic ISSN

APPLICATIONS

This paper was

refereed.

INTERFACES

31: 3, Part

2

of

2, May-June

2001

(pp. S146-S165)

A DSS THAT HELPS RETAILERS

replenishment

son

of

inventory

1990;

Iyer

buyers

inventory

item

during

and

often

the

sea

de

[Hammond

and

order

on

Bergen

must

1997]. Consequently

cide

season

well

for

the entire

goes

on

before

the

uncertain

uncertain

retail

prices

sale,

relying

at planned

forecasts

[Eppen

of demand

and

Iyer

1997].

In practice,

lacking

quick

resupply

op

tions,

chandise

casts while

buyers

tend

to buy

inventory

stocks

of mer

according

planning

excess

to their

tomark

optimistic

down

to stimulate

potential

fore

de

mand

the

and

season.

sell

out

(Here, we

the excess

are

by

the end

specifi

referring

of

cally

downs

to clearance

t o c l e a r a n c e

and

not

or permanent

mark

temporary

markdowns

that

are

offered

example,

tail price

ten demand

the

Mother's

returns

falls

buyer

must

in a special

sale

period,

Day,

after which

the

for

re

to

short

its original

level.)

of projections,

Of

and

take

the markdowns

nec

essary

to clear

out

the

stocks

as possible.

quantity

Like

decision,

the original

determining

as profitably

order

the optimal

timing

downs

and magnitude

is complicated

of

by

sequential

uncertain

mark

and

nonstationary

costs

tory

associated

too quickly

demand

with

or

functions

selling

late.

too

out

These

decision

challenges

have

and

the

in

the

inven

creased

during

the

last decade

as demand

unpredictability

uct

has

grown

[Fisher

because

prod

on

have

the

supply

diversified

et

al.

Bowen

1994;

variety

and

the demand

has

exploded

tastes

side

on

consumer

side

Pashigian

1988; Pashigian

and

1991]. This is reflected

the ratios of markdown

in the

steep

amounts

rise

in

(dollars

foregone

price)

on

to net

units

sales

sold

in US

at

the

reduced

department

and

May-June

2001

S147

specialty

stores

a g e , markdown

age, markdown

since

the

amounts

around

six percent

of net

1960s. On

have

aver

grown in the mid

from

sales

1960s

with

to over

markdown

to 40 percent

ments

[Fisher

26 percent

by

percentages

in apparel

and

the mid-1990s

as

as high

dress

depart

et

al.

1994; Levy

and Weitz

30

1995].

The

large

much

and

press

surge

small

in clearance

has

retailers

sales

by

received

attention

[Associated

Press

both

1997]. However,

sales,

while

erode

the discounts

profits

retailers

aids

selling

boost

they

better

also

1997]. Most

[Wall Street

know

they

Journal

need

decision

to cope with situations

such

unpredictable

[Pearson

1994].

We

developed

MARK,

a computer

model-based

(DSS),

that

make

markdown

more

decision-support

decision-support

can help

judicious

system

system

buyers

and

fashion-retail

fashion-retail

opening

buy

decisions

that

account

for

demand-function

uncertainty

and

nonsta

tionarity. Typically, set of discrete

at which

the

be

at

off)

the

50 percent

during

store

policies

levels

sold.

that

specify

points)

price-off

item

can be

may

full

or

be

(price

For

the

(zero

of

selling

either

price

these

an

example,

item

can

percent

25

or

per

store

sold

price

policy

the

regular or at markdowns

the

off

season.

regular

Considering

missible

to decide

price

points,

the optimal

with

the markdown

MARK

order

can be

quantity

plan

and

budget

used

along

for

the upcoming

and

ning

budget

are

merchandise

season.

The markdown

plan

important

sales

and

inputs

for plan

for negotiat

ing with

vendors

for markdown

allow

ances [Levy and Weitz

Jouxnal 1998]. Further,

1995; Wall

the

at

during

can use MARK

season

buyers

Stxeet

selling

the

start

of

each

period

to review

and

determine

a

MANTRALA, RAO

the optimal markdown

remaining season based on revised de

strategy

over

the

mand

estimates

and

the

current

inventory

position.

MARK

In deriving

can

take

into

these

solutions

account

a number

of

complicating

ample, inventory

costs,

pated

or damage).

supply-side

of

carrying

sales

returns,

of

shrinkage

In this

article,

factors,

costs,

and

(losses

we

for ex

stockout

costs

costs

antici

from

theft

on

focus

MARK'S

use

to

address

preseason

order

quantity

Several

and markdown-planning

recent

papers

concern

issues.

the prob

lem

of marking

down

style

goods.

Gallego

and Van

Ryzin

[1994]

formulated

involving

a

a current

continuous-time

price-dependent

model

Poisson

demand-arrival

process

ory

a function

and

applied

intensity-control

price

and

the

as

of

to determine

of

the

Feng

the optimal

stock

and

level

Gallego

path

length

the horizon.

[1995] used

a similar

determine

model

a single

and analytical approach

dura

(markdown

the optimal

price

timing

change

and

tion

of

to

or

markup).

developed

Bitran

and Mondschein

a continuous-time

model

[1997]

in

which

Poisson

a seller

arrival

faces

a nonhomogeneous

of

customers

whose

arrival

rate varies

with

the way

a store

 

business

over

the

season,

combined

Weibull

probability

distribution

of

vation

prices.

They

used

this model

rive

and

compare

optimal

continuous

pricing

policies

as

functions

of

time

inventory

with

more

realistic

periodic

pricing

polices.

Smith

and Achabal

developed

and

investigated

optimal

conducts

with

reser

to de

and

[1998]

clear

a

ance

prices

and

impact

end-of-season

that

reduced

inventory

ac

assortment

into

rates. All

management

count

and

the

seasonal

policies

of

take

sales

changes

on

of

INTERFACES31:3

these writers

focused

on

the

form

of

the

optimal

fixed

pricing

policies

of

inventory

operational

for

DSS

selling

of

a style

that

out

a

amount

is an

to address

good.

MARK

used

lem

also

can be

prob

and

this within-season

markdown

problem

quantity

markdown

of optimal

pricing,

the preseason

order

of determining

in conjunction

strategies.

the optimal

with

Model

any

planned

Formulations

MARK

comprises

namic

1 nested

optimization

inModule

[1957] and Howard

two

stochastic

modules

with

dy

Module

2. Following

Bellman

[1960] inModule

1

of MARK,

of

as

any

determining the pricing policy (sequence

of prices)

we

treat

of

the

retail

at

buyer's

the

start

horizon

dynamic-pricing

period

n

problem

an N-period

that maximizes

the

(discounted)

sum

of period

n's

expected

profit

maximized

expected

total profit

and

deriv

the

able

,

programming

n

over

the

N.

+1,

remainder

of

the horizon

This

is a stochastic

problem.

We

call

dynamic

solu

the

tion

is free

as

to

this problem

to go

up

after

the optimal

when

being

the

selling

price

down

(Oli)

marked

unconstrained-pricing

policy,

iOM)

while

policy

the optimal

markdown-only

is the

solution

subject

to

the

constraint

2,

in period

distributions

Pn <

where

in

?

PM_2 for any is the

Pn-1

1). Once

period

price

n

=

N

,

applied

per

the probability

at different

of demand

missible

ibrated

price

levels

(see below),

in each

MARK

period

evaluates

are

cal

the

expected

a period

tion.

The

profit

at each

permissible

by means

of numerical

price

integra

stochastic

dynamic-programming

problem

shown

Module

is formulated

in the appendix. 2 of MARK

and

solved

as

enables

the deter

in

S148

A DSS THAT HELPS RETAILERS

mination

(OI)

of

the optimal

with

total

inventory

t h e dynamically

the dynamically

plan.

Specifi

un

process

nests

is itera

in conjunction (OU or OM)

optimal

cally,

constrained

the Module

pricing

the optimize-inventory?optimal

pricing

1model.

(OI-OU)

The

latter

solved

tively

range

corresponding

of

order

at each

point

of

a discretized

quantity

OL? policy

to determine

and

expected

the

profit

determines

outcomes.

the

The

OI-OU

process

expected

then

cumulative

quantity

way,

profit

the given

order

maximizing In a similar

from

range.

inventory?optimal-markdown-only

the optimize

2

solves

problem

can

(O?

the

subject

be

or

OM)

process

of Module

optimal-order-quantity

to the

marked

constraint

down.

that price

In addition,

only

the optimal

der quantity corresponding

pricing policy

to any

can be

determined

fixed

a

by

third

(OI-GP)

the

optimize-inventory?given-prices

process

capability

of Module

to derive

2. MARK

solutions

these

has

taking

price

into

account

the vendor's

single

as

or quantity-discount

schedule

well

as

any

fixed merchandise

ment

budget

constraint.

The

optimization

models

surements

of

the probabilistic

procure

utilize

mea

period-by

period

ize

demand

the demand

functions.

We

in any

period

conceptual

as

a

multiplicative

function

of

the

following

influences:

(1) The

tion

sales

ize

(2) The

seasonal

the

effect,

given

total

is likely

by

season

the

frac

of

estimated

demand

or

potential

that

tomaterial

in that period.

price

applied

in that period.

(3) A random

the net effects

demand,

on

disturbance

of other

representing

of

possible

the

effects

influences

current

such

as

May-June

2001

S149

prices of competitors weather.

unpredictable

and

other

goods

or

in

We

random

assume

charged

that

disturbances

these

are

period-specific

independent

of

the price

that period

and

intertemporally

indepen

dent.

The

detailed

demand

function

speci

fication

is shown

in the Appendix.

Model

Probabilistic

Demand

In general,

forecasting

well

in advance

of

largely

a subjective

the

Calibration

demand

season

fashion

selling

is

little

process

because

objective

terns

such

data

sales

alone

exists

of

beyond

historical

Relying

pat

on

of

data

similar

is often

consumers'

styles.

impractical

tastes

and

can

unwise

because

change

the next.

items

significantly

Also

past

typically

price

item's

from

sales

one

data

season

to

on

similar

for estimat

time

several

are

the new

inadequate

potentially

for

ing

varying

elasticities

reasons:

(1) For

any

no

objective

would

have

levels

(2) Recorded

other

mand

when

time

period,

there

is usually

information

been

than

at

sales

initial

about

what

different

sales

price

in

several

the one

are

order

actually

less

than

quantities

charged.

de

actual

are

adequate

replenishment.

and

there

is no

scope

for

(3) Retailers

tend

to report

aggregate

unit

sales

Achabal

To

period

from

develop

different

1998].

price

levels

and

[Smith

period-by

plans,

addi

total-season

buyers

forecasts

information

and merchandise

usually

from

such

experienced

tional

gather

fashion

and

barometers

Daily Califoxnia Apparel News, from trade associa

as Women's

Weax

and

tions (such as the National

tion), and from conferences

fashion

coordinators,

and

Retail

with

Federa

vendors,

so

forth. Given

MANTRALA, RAO

baseline

historical

of

brate

seasonal-demand

data,

the

buyers

estimates

from

subjective

judgements

to cali

functions

of

informed

can be used

density

the probability

the demand

distributions

at various

prices

[Lodish

[1992]

1980].

provide

Lilien,

a good

Kotler,

review

and Moorthy

of

the use

managers'

marketing-decision

judgments

in calibrating

models.

of

MARK'S

interactive

software

program

offers two approaches

calibration:

a direct

mand

model-based

to demand-function

approach

approach.

and

a de

In the direct

approach,

buyers

see

graphical

displays

of

Buyers

must

often

order

inventory

season. While

for the entire

discounts

sales,

they

Optimizing

magnitude

compensate

erode

profits.

the timing

of markdowns

for

buying

boost

and

can

errors.

the

prices

category's

and

past

seasons'

trends.

asked

level,

sales

After

to enter

and

they

growth

they

are

of demand

study

these data,

estimates

most

three

or

or most

(the minimum

the modal

pessimistic

likely

timistic

level

be used

level,

level)

in each

and

the maximum

or most

price

ap

op

can

at each

period.

permissible

These

estimates

to parameterize

of

triangular

proximations

the probability

distribu

tions

of demand.

The

direct

approach,

however,

and

and

alternative approach

can become

as

cognitively

difficult

levels

tedious

periods

the number

of price

in an

application is to elicit

increase.

An

the essen

tial

information

needed

to calibrate

the

multiplicative

demand

model

specification

INTERFACES31:3

(Appendix)

Step

estimate

1: The

of

in the

following

steps:

buyer

the

enters

the most

demand

total

season

likely

at

full

price. We

Step

denote

this parameter

enters

asM.

buyer

and maximum

2: The

that

of

the minimum

estimates

or

of M

low

such

chance

or high

has

the

the

true value

within

a 95-percent

range

of

falling

these

low-high

estimates.

Step

cent

month

cases,

based

The

3: The

buyer

the

information

style

historical

of data

familiar

common

and Weitz

enters

of

the

expected

by

per

distribution

for

this

on

kinds

total

classification.

demand

is not

Inmost

subjective