Chapter IXRetail Merchandising –Costing systems

Amongst many functions that a retail merchandiser carries out, costing and pricing are important. He

costs the product when he is buying and prices when he sells. This is a dual function and if the same

person handles, there is a possibility that the pricing decision may be sometimes clouded. Therefore,

buying is an independent function and selling is entrusted to a different individual in a retail

organization.

The traditional function of retail buying and costing continues even today albeit with the assistance of

information technology. A new dimension in retailing is the growth of global retailing both buying and

selling. Retailers like Wal-Mart, Carrefour, Marks & Spencer, H&M, GAP, C&A are venturing into the

Asian countries like India and China with their tested formats or innovating new ones to suit the needs

of the host country. At the same time with in India, retailing is evolving fast into an organised industry

from the traditional Mom & Pop stores and the City Super Market.

The advent of organised retailing in India initially found the consumer lapping up whatever was

offered. The initial foray of Food World was an example. Chain stores like Subhiksha and Trinethra

gave stiff competition that forced Food World to open its hypermarket Giants – Hyper store. However,

Big Bazaar with its Everyday Low Price strategy made rapid in roads even into tier II cities and Towns

in the country. Simultaneously growth of malls across the country paved way for domestic corporate

houses like Reliance, Aditya Birla Group, Tatas to enter the retail chain. Today the retail operations in

India cover almost all commodity segments. Hence, retail buying and costing is an exciting subject.

In this chapter, we will discuss retail costing with reference to clothing. While traditional clothing

retailers dealt with buying ready-to-wear garments from small manufacturers often with no label, the

new entrants today are re-defining the market place with a brand and accompanied service. Size, color,

finish, fabric, label and returns are a part of the retail merchandiser’s daily world.

So how does he cope with all these issues and offer the shirt that you look for in store at the price you

want?

Does he continue to buy as his predecessors were doing?

How does he cost the garment for the store?

Before we proceed with costing practices in the retail market, let us familiarize with some of the terms

that are commonly used in the industry.

Cost = the cost of goods

Retail Costing = selecting the right product with the right cost that accommodates profit and sells

Cost-oriented method = a method for determining the retail price by adding a fixed percentage to the

cost of the merchandise. Also known as Cost plus pricing

CVAT = Central Value Added Tax paid to the central government

Sales Tax = a tax imposed by the state government

Entry Tax = a tax levied by the local authorities

Education Cess = levied by the central government

Service Tax = levied by the central government on services offered to customers for gain

EDLP = every –day -low – price which is between the regular nonsale price and the deep discount

price

of competitors

Fixed Assets = assets that require more than a year to convert to cash

Fixed Expenses = expenses that remain constant for a given period of time

Flexible Pricing = which allows consumers to bargain over selling price

C & F = where the shipper of the goods is responsible for transportation

FOB origin = where the retailer takes the responsibility of transportation from the point of origin

GMROI (gross margin return on investment) = gross margin money divided by average (cost) inventory

Markdown = percentage reduction in the initial retail price

Markup = increase in the retail price after the initial markup percentage applied but before the product

is placed on the selling floor

Multiple unit pricing = offering two or more similar products at the price of one

Net Invoice price = net value of the invoice or total invoice minus all other discounts

Odd Price = a price ending with an odd number or just under a number like 99 or 199

One price = at a given time all customers pay the same price for any given item of merchandise

Prestige price = on the assumption that consumer will not buy at prices perceived to be low

Price bundling = two or more different products for sale at one price

Price lining = offers a limited number of pre-determined price points within a classification

Skimming = high price strategy for newly introduced categories

Value pricing = establishing prices based on fair value for both retailer and consumer

Did you notice the difference? The terms used in production costing and these. There we talked bout

raw materials and productivity. Here it is cost price and gross margin. In other words, the product that is

costed and supplied by production merchandiser becomes the costed profit for the retail merchant. He

adds his operating expenses and margin of profit before the product is placed on the store floor. This is

the basic pricing. Several pricing practices are used by retailers. Some of these are- Everyday Low

Pricing (EDLP) – The retailer prices the merchandise between a non-sale price and deep discount sale

price. The term low price does not mean lowest price, nor is it lower than the price of competitors and

the wholesaler. It is only indicative of a stable price without significant fluctuation. In certain cases, a

retailer may offer a low price guarantee by which he will match or better any lower price in the local

market. However, EDLP cannot be used for every product category. If the label or brand enjoys a high

consumer loyalty and has a high market share, it may benefit from EDLP. Price cannot always be a

product promoter.

High / Low Pricing – Some retailers offer prices that are above their competitors’ EDLP. They

advertise intensely to promote their merchandise. By this strategy, the retailer targets the value

conscious customer. A strategy is adopted through advertising to declare scarcity so that customers are

encouraged to buy at full price.

Although retailers maintain a continuum from everyday low price to high/low price, they intersperse

these with other strategies such as coupons, rebates, leader pricing, price bundling, multiple-unit

pricing, price lining and odd pricing.

Coupons as the name denotes entitles the holder of the coupon to a reduced price or is eligible to save

few rupees off the actual price. These are issued by retailers and manufacturers through newspapers and

magazines, at point of sale or through mail.

Rebate is money returned to the customer based on the purchase price. Some retailers adopt this

strategy to encourage customer loyalty.

Leader Pricing is a strategy used to promote certain frequently bought items, which are priced very low

to encourage increased customer visit to the store thereby inducing them to buy other complementary

products. In fact, some products are maintained as loss leaders by the retailers who sell them as

complementary with other high priced items. A high priced trouser with a very low priced shirt as a

complementary.

Price Bundling is a practice that offers two or more different products for at a single price. For example

a Gillette razor bundled with blade cartridges, shaving gel and after shave.

Multiple-Unit Pricing is similar to price bundling but the products bundled being similar such as toilet

soaps or a pack of shirts.

Price Lining is used to offer limited number of price points within an item class. For example, a shirt

retailer offers three prices - low, middle and high. He classifies the shirts by their label, fabric and style

into these three price points.

Odd Pricing is adopted where a price ends with an odd number or price. It was originally used to

prevent store theft by salespeople. Due to the odd number, the account reconciliation can easily point to

the loss.

Let us now see how a basic retail costing is made with cost, competition and demand oriented methods

of setting a retail price. We start with the cost-oriented method.

Case I

Angelina is entering junior college. She wanted a shirt and pant for her birthday. She went with her

mother to shop. Mother took her to Big Bazaar to select. Collections there did not interest her. Next

store they visited was West Side. No choices there too. After browsing at Central, the mother and

daughter finally decided to go to Lifestyle. Angelina decided on a pastel blue front placket shirt with a

princess seam. A light beige pant with four pockets and low waist, she picked up complemented the

shirt. She was happy with her selection, paid the bill, and walked out with her new clothes.

What made her visit so many stores before she could pick her choice? Is it the collection, or the sizes or

the fit or the prices or the brands?

In all these stores, it is the merchandisers, who buy and place their products on the sales floor. Perhaps

she did not like the collection of shirts and pants at Big Bazaar. It is to do with the colors and fabrics.

She was looking for a plain poplin branded shirt with a little bit of stretch. Similarly, in a pant she was

very particular about the fit and the fabric. She wears a size 30 waist and fabric she likes most was

tussore. As she did not find both she moved to the next store.

West Side offered own brand, but no national brands. That was why she moved to Central. At Central,

she found the brand she likes among shirts. However, Angelina did not like the available styles. Among

pants, her color was not available.

That is when the mother and daughter decided on Lifestyle store. The collection of shirts was wide and

the brands like Allen Solly, Van Heusen, Louis Philip, Provogue, and Sykes were available. Among

pants, they have all these brands and Dockers. The Allen Solly shirt with a princess seam in 2% lycra

poplin was fitting her perfectly. Among all the pants that she tried only Dockers was fitting he

perfectly. What is more, her color was available and in low waist style. What more can she ask for?

Now if we analyse the case, we will observe that fabric, color, size, fit, style and brand are the criteria

for Angelina. Of course, there are many more customers with their choice and preference and the retail

merchandiser has to understand these and provide.

So how does he cost if he were to consider all these parameters? His objective is to maximize profit for

the space that his merchandise occupies on the sales floor. That is the area provided to him to display

his products. That is the place where his customers visit. The productivity of sales depends on the profit

margin gained per square foot. He follows certain retail finance principles in costing his merchandise.

To begin with, he considers the cost of the product. In this case, he has to offer not one shirt but a

collection of them by brand, color, fabric, size and price. These are the factors for consideration in a

style. There will be more than one style, of course.

For example, style 1 has six brands. In each brand, there are 4 fabric options. In each fabric, there are 5

colors. Each color assortment has 4 size options. Therefore, the retail merchandiser has to buy 480

shirts per style.

Style No. of Brands

No. of Fabrics

Colors Sizes Total Multiple factor

Total Units

1 6 4 5 4 480 4 1920

2 4 3 6 4 288 6 1728

3 2 2 7 4 112 8 896

4 4 10 5 4 800 8 6400

5 4 10 5 4 800 10 8000

6 5 8 4 4 640 15 9600

7 8 5 4 4 640 15 9600

8 10 5 10 4 2000 20 40000

9 10 5 10 4 2000 20 4000010 12 4 12 4 2304 25

57600Total            

175744

Example 1

How many styles should he buy? How will he know what color or style will sell? What are investments

and returns? Let us see the financial strategy that he needs to adopt. He needs to consider the total sales

that he intends to achieve, the cost of goods planned to buy and the profit margin. He will consider the

strategies adopted by competitors in the market, the cost of the garment by the brand manufacturer,

discounts offered by the manufacturer. He will also analyse the style trends in the market and the

fashion forecasts for color and style for the season. He will consult the sales for the previous season.

Based on these factors, he will plan the budget for buying. He will have to consider factors like

payment terms, cost of transport, delivery schedule and the vendors both domestic and overseas. The

purchase plan reflects the critical stock to be maintained and the replenishment time required. Discounts

from suppliers for volume buys and staggered buys are considered. Finally he will work out the return

on assets (ROA) based on net profit margin and asset turnover. The strategy can be represented as in the

equation below :

The retail merchandiser will take into consideration the above factors to both increase the net profit

margin as well as return on assets in his costing.

He will start with vendor selection as described in the earlier chapter on sourcing. He will receive

quotes from manufacturers, licensed to manufacture and supply. Through a process of cost and

performance evaluation, the merchandiser selects the vendors. Amongst the factors for selection are like

trade discount, exclusive discount and cash discount; and terms of payment and delivery. The cost

evaluation process will be somewhat similar to what is described below:

Example 1 : Table 1 – Style selection, volume plan and list / quote price cost

Style No. of Labels No. of Fabrics Colors Sizes Total Multiple factor Total Units Quoted RateINR

Cost INR

1 6 4 5 4 480 4 1920 450 864000

2 4 3 6 4 288 6 1728 500 864000

3 2 2 7 4 112 8 896 550 492800

4 4 10 5 4 800 8 6400 350 2240000

5 4 10 5 4 800 10 8000 300 2400000

6 5 8 4 4 640 15 9600 275 2640000

7 8 5 4 4 640 15 9600 290 2784000

8 10 5 10 4 2000 20 40000 225 9000000

9 10 5 10 4 2000 20 40000 200 8000000

10 12 4 12 4 2304 25 57600 175 10080000

Total             175744   39364800

The multiple factor in the table above is based on current planned buy plus buffer or safety stock.

Quoted cost of total units planned to buy = Rs.39, 364,800, which is higher than the budget allocated to

him. Hence, the merchandiser needs to negotiate with the label manufacturers. For style # 1 he will

negotiate a discount of 20% over the trade discount of 10% on the quoted price. For style # 2 it will be

15% and so on as in the table below:

Example 1: Table 2 - Discounts Style No. of

LabelsTotal Units

Quoted RateINR

Cost before discountsINR

Trade Discount

CostINR

Negotiated Discount

Final Price INR

1 6 1920 450 864000 10% 405 20% 324.00

2 4 1728 500 864000 10% 450 15% 382.50

3 2 896 550 492800 10% 495 10% 445.50

4 4 6400 350 2240000 10% 315 10% 283.50

5 4 8000 300 2400000 10% 270 10% 243.00

6 5 9600 275 2640000 10% 247.5 10% 222.75

7 8 9600 290 2784000 10% 261 10% 234.90

8 10 40000 225 9000000 10% 202.5 10% 182.25

9 10 40000 200 8000000 10% 180 10% 162.00

10 12 57600 175 10080000 10% 157.5 10% 141.75

  175744   39364800    

So the final costs are agreed with an additional cash discount of 2% for payment within 30 days. Example 1:

Operational Expenses

Operational Expenses per unit =

Total Operational Expenses Total Units

Rs.2,231,711175744=Rs. 12.70

Style Total Units Quoted RateINR

Trade Discount

Negotiated Discount

Final Cost per unit INR

Total cost after cash discountINR

1 1920 450 10% 20% 317.52 609638.4

2 1728 500 10% 15% 374.85 647740.8

3 896 550 10% 10% 436.59 391184.64

4 6400 350 10% 10% 277.83 1778112

5 8000 300 10% 10% 238.14 1905120

6 9600 275 10% 10% 218.295 2095632

7 9600 290 10% 10% 230.202 2209939.2

8 40000 225 10% 10% 178.605 7144200

9 40000 200 10% 10% 158.76 6350400

10 57600 175 10% 10% 138.915 8001504

175744   31133471

Example 1: Table 4 – Operational Expense

Item Rate AreaTotal Op.

Expenses INRRent / sq.ft 2.5 20,000 50,000

Salaries 695,000

Utilities 17,150

Promotion 3% 1,020,781

Shortage 0.5% 155,667

Interest 10% 293,113

Total 2,231,711

The taxes that the retailer pays differ from place to place and country to country. In some countries

there is single tax called Value Added Tax or VAT, which is paid to the federal or central government

and a local or municipal tax that is paid to the local government. In India, there is no uniform tax, but a

multitude of taxes that a retailer pays. The manufacturer pays for excise duty to the central or federal

government. While the retailer pays a central value added tax or C VAT and a sales tax paid to the

respective state government. Over and above this, an entry tax is paid to the local body or municipality.

All these taxes are paid on the cost of goods. Transport of the merchandise from the supplier to the

retailer’s warehouse is an expense to be paid and costed in the merchandise. If the goods or as in our

example the apparel are imported from overseas, there are certain formalities to be followed. The

supplier’s cost must indicate whether it is inclusive of transport or not. In case it is inclusive, it is

known as C&F price or Cost and Freight. Often a premium of insurance is added to this, so it is called

CIF. On the other hand, if the retailer needs to bear the cost of freight the price quoted by the supplier

or manufacturer is called as Free on Board or FOB. If the vendor is a domestic supplier, then the terms

will be FOR which is free on road if the transport is by road or free on rail if it is by railroad. There are

also other expenses in case of imports. These are the customs duty and port charges at the port of

destination, brokerage charges to be paid to the cargo-clearing agent and inland freight charges. A

common term used by retailers is LDP, which is landed duty paid.

Continuing with our example, the transport and taxes are computed for domestic sourced merchandise

as below and the final cost price per style is:

Example 1: Table 4 – Transport + Taxes + Operating Costs & Final Unit Cost

The merchandiser now needs to decide the mark up to achieve as per the objectives of the organization.

Among the many pricing strategies that are adopted by retailers, the more prominent ones are – cost

oriented method, competition oriented and demand oriented. Under the cost oriented method, the retail

price is determined by adding a fixed percentage to the cost of goods. In the demand oriented method,

the retail price is based on the demand for the product or what the customers are willing to pay. We

discuss below the cost oriented method.

Initial Mark Up

The merchandiser plans an initial mark up of 50% for each style. This mark up is proposed based on the

Example 1: Table 5 – Initial Mark up &Retail Price

following considerations:

a) The target customer

b) Location of the stores

c) The image of the Brand or Label

d) Competition

e) Season

Based on the markup in our example the net margin that the retailer worked out for the first style will

be as in the diagram below :

PROFIT MARGIN MODEL  

NET SALES

StyleTransport Cost INR

Total cost of transport INR

C VAT Rate

 C VAT INR.

Sales Tax Rate

Sales Tax INR.

Entry Tax Rate

 Entry Tax INR

Total Tax per unit INR.

Operating cost per unit INR

Unit Cost less discountsINR

Final Cost per unit INR

1 2.15 4128 5% 15.88 2.00% 6.35 0.25% 0.79 23.02 12.70 317.52

353.24

2 2.15 3715.2 5% 18.74 2.00% 7.50 0.25% 0.94 27.18 12.70 374.85 414.73

3 2.15 1926.4 5% 21.83 2.00% 8.73 0.25% 1.09 31.65 12.70 436.59 480.94

4 2.15 13760 5% 13.89 2.00% 5.56 0.25% 0.69 20.14 12.70 277.83 310.675

2.15 17200 5% 11.91 2.00% 4.76 0.25% 0.60 17.27 12.70 238.14 268.106

2.15 20640 5% 10.91 2.00% 4.37 0.25% 0.55 15.83 12.70 218.295 246.827

2.15 20640 5% 11.51 2.00% 4.60 0.25% 0.58 16.69 12.70 230.202 259.598

2.15 86000 5% 8.93 2.00% 3.57 0.25% 0.45 12.95 12.70 178.605 204.259

2.15 86000 5% 7.94 2.00% 3.18 0.25% 0.40 11.51 12.70 158.76 182.9710

2.15 123840 5% 6.95 2.00% 2.78 0.25% 0.35 10.07 12.70 138.915 161.68

Final Cost per unit

INR

Planned InitialMark up

Retail Price Per style INR

414.73 50% 622.09

480.94 50% 721.41

310.67 50% 466.01

268.10 50% 402.16

246.82 50% 370.23

259.59 50% 389.39

204.25 50% 306.38

182.97 50% 274.45

161.68 50% 242.53

142,000.00 GROSS MARGIN

─── 71,000

COST OF GOODS SOLD

71,000NET PROFIT

BEFORE TAX

─── 22,720OPERATING

EXPENSESNET PROFIT

AFTER TAXES

35,500TOTAL EXPENSES

───

15,904

48280 TAXES NET

PROFIT MARGIN

6816 11.20

INTEREST EXPENSE NET SALES

12,780 142,000

However, not all the merchandise is sold at this price. Adjustments to the initial price are required.

These are Markdowns, Markdown Cancellations, Additional Markups, and Additional Markup

Cancellations

Let us discuss each of the factors that are affecting the sale of our style. Based on the considerations

above, the merchandiser plans these adjustments.

Markdowns: These are reductions in the initial retail price. Many of the markdowns occur due to

mistakes. The merchandise is slow moving due to a host of reasons. It may be due to the product being

obsolete or end of season. It is also possible that the initial retail price is higher than competition.

Although the merchandise can be carried forward for sale in the next season, it will become either shop

worn or the carrying cost of inventory will be high.

In fashion retail, timely deliveries of merchandise are critical to reduce markdowns. Although it may

not be possible all the time, small quantities can be tested at the beginning of the season and upon

favorable response can be re-ordered. Early deliveries take a hit in the market as also late deliveries by

the suppliers. Early deliveries and on sale of heavy winter outerwear in July will make the jackets

appear shop worn. Late deliveries at the end of season in January will leave with no option but to

markdown and sell or carry to next season. Markdown value also known as Markdown money is

collected from supplier. According to Robinson-Patman Act, in the USA suppliers need to provide a

percentage of their sale price for the markdowns to retailers.

A retailer takes markdowns based on the (a) type of merchandise that required markdowns in the past

and (b) those that are not selling in the current season. Based on the past performance analysis, the

process of selling, determining the volume of purchases, the cost of goods, and the retail price have to

be considered.

The size of the markdown depends on the type of merchandise. Highly perishable fashion items

typically require substantial markdowns, whereas staple items like dress shirts and formal trousers take

less. For example, a high fashion party wear dress may need a markdown of up to 30%, while a formal

shirt will take 10%. The time and duration of markdowns need to be carefully planned. The slow down

in the sale on a weekly basis is an indication for the start of the markdown for the merchandise.

Generally early in the season when demand is still active is a good time start. This will help clear space

in the store for other merchandise and improve the cash flow. The early markdowns are commonly

offered for short periods as short as weekends. This will help improve the customer traffic and sales of

other merchandise. A storewide clearance sale is generally planned twice a year before the festival

season or at the end of the season. Both these periods are lean for a retailer and markdown sale

improves the general sales and the employee morale.

No matter what you do, there will be some unsold merchandise that will have to be liquidated. This can

be done by consolidating the marked-down merchandise and canceling additional mark-up and offer the

merchandise at a different venue other than the store or auction on internet or carry over to the next

season if the volume is not high and if the merchandise is a staple style.

At the end of the season, it is a common practice to measure the results of the financial results of the

season. We have earlier worked out the net profit margin. Continuing further, let us calculate asset

turnover and finally the returns on assets.

We will create the asset data for this sale model that we developed earlier.

ASSET TURNOVER MODEL

ACCOUNTS RECEIVABLE

11,360

MERCHANDISE INVENTORY

71,000

TOTAL CURRENT ASSETS NET SALES

CASH 110,760 142,000.00

7,100 ASSET TURNOVER

TOTAL ASSETS

1.14

OTHER CURRENT ASSETS

FIXED ASSETS

124,960

21,300 14,200

Based on the net profit margin and the asset turnover, the return on asset will be -

NET PROFIT

MARGIN

11.20RETURN ON ASSETS

X 12.73

ASSET TURNOVER

1.14