Economics of near 100% discount

When I visited Genting Premium Outlets in May, many shops were offering an almost 100% off on their goods. Like 70% off+ 30% additional off. At least 70% discount was standard in all outlets. I asked how can the shops make money at 70-80% off, got a big smile in response.
In this post I am making an attempt to explain the mathematics behind the massive discounts some fashion stores/brands offer.

Assume a brand has produced 1000 pieces of a new dress, at a cost of 1000 rupees per pair. Total investment: Rs 10,00,000 or Ten lakhs. Of course they are no fools to price it closer to cost price for a small profit- such dresses will be priced NOT at 1500 or 2000 rupees, but easily at around 10000 rupees or more (10x the cost price)

There will be many rich people following latest trends, fashion shows and they will readily buy without any discount. Assume 100 units are purchased by these super rich at their list price of 10000 Rs each- that is  Rs10 lakhs and all the cost is fully recovered.

How what to do with remaining 900? They can sell it all for Rs 1000 and make 900000 INR more- 9 lakh rupees more or an almost 2x return. But selling at cost price will be foolishness. Brands will still attempt to sell them at Rs 3000 or 4000 after offering some 60-70% off under some festival or event or some other excuse. There're so many upper middle class people who aspire to live life of super rich, but they find the original price tag of 10000 Rs a bit too high for their affordability. When same stuff is being sold for Rs 3000, psychology tells them it is a steal and they should grab as much as possible, even if it means exhausting their credit card limits. Even if say 500 units could be sold at Rs 3000 each, that is 15,00,000 INR or 15 lakh rupees- more money than what they would have made (9 lakhs) if everything was to be sold at cost price.

Many brands prefer to burn/destroy their unsold inventory, than sell it at cost price- they do this to retain the pricing power. Read this news for proof.

In above example, the remaining 400 units will probably destroyed as they get old occupying shelf space and not getting sold. If it is sold for less, those who paid Rs 3000 would now know that this dress could be available later for Rs 1000 and overall sales will drop. Those who paid 10000 Rs a piece will stop buying the brand if there're 100s of people on the street flaunting same brand, most probably by paying lot less. So reputed brands need to retain their premium image and pricing power for overall profitability, even if it means destroying some of the unsold goods. Read this and this for more on brands destroying millions worth of their own products.

If your LPG distribution company says "An LPG Cylinder costs 10000 Rs, we are giving 90% discount-Give us only 1000Rs" will you happily agree? No. Because you know last retail price was around INR 700, so you will question why we should pay 300 extra. But when it comes to shoes, bags, cloths, there is no reference price for us to compare and decide- it is all about perception management, value as seen good in the eyes of a potential buyer and how smartly brands can attract better paying customers.

Other things to note:
Big discounts are on items whose cost price is hard to guess. For example, Bata's hawai chappal is around 100 Rs. Ever seen 50% discount on it? No. 50-80% discounts are on some overpriced shoes whose original price is hard to guess.

70%+30% additional off: The additional off is not on the full price but on the payable amount. MRP 10000, after 70% it is 3000 and additional 30% is on the 3000. So payable price is Rs 2100, most of the time still more than the cost price.

Artificial fear of scarcity: While consumer goods like bags, dress materials etc are available in plenty, many shops induce limited number of items on a sale, to create a sense of urgency among customers. Urgency blocks rationale and people end up buying more than they need. Customers queue up before shop opens thinking they are going to save big, while shop owners go laughing all the way to the bank.

There're some shops that run discounts all through the year. Even wondered when exactly they sell stuff without a sale? Well known fact that no shop closes down after a deep discount sale. They will be back with more goods to sell. Above numbers are for illustration only. There will be overheads like shop rental, staff salary, transportation etc. Most brands work on a franchise model when franchise takes are of all local expenses in exchange for a commission on sale. Retail commission usually is around 20-35% depending on various factors.

Let me know your thoughts.
Also read: Consumer is no longer a king

2 comments:

  1. Excellent Article Shrinidhi.

    I have been exporting fashion garments for the past 21 years to EU. Even Walmart breaks even if 1/3 of their garments are sold at full price. After that - it is all profit. That is why Walmart have almost copyrighted the phrase "Everyday Low Prices"

    ReplyDelete

Appreciate your efforts and interests to comment. Comments may be moderated due to increased spam. Will ideally respond to comments within few days.Use Anonymous option if you don't wish to leave your name/ID behind- Shrinidhi

Powered by Blogger.