Black Friday ‘Discount’: Secret can be Dirty !!

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When shoppers head out in search of Black Friday bargains this week, they won’t just be going to the mall, they’ll be witnessing retail theater.

Stores will be pulling out the stops on deep discounts aimed at drawing customers into stores. But retail-industry veterans acknowledge that, in many cases, those bargains will be a carefully engineered illusion.

The common assumption is that retailers stock up on goods and then mark down the ones that don’t sell, taking a hit to their profits. But that isn’t typically how it plays out. Instead, big retailers work backward with their suppliers to set starting prices that, after all the markdowns, will yield the profit margins they want.

The red cardigan sweater with the ruffled neck on sale for more than 40% off at $39.99 was never meant to sell at its $68 starting price. It was designed with the discount built in.

Buyers don’t seem to mind. What they are after, especially in such a lackluster economy, is the feeling they got a deal. Retailers like J.C. Penney Co. JCP +7.69%who try to get out of the game get punished.

The manufactured nature of most discounts raises questions about the wisdom of standing in line for the promotional frenzy that kicks off the holiday shopping season. It also explains how retailers have been able to ramp up the bargains without giving away the store.

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The number of deals offered by 31 major department store and apparel retailers increased 63% between 2009 to 2012, and the average discount jumped to 36% from 25%, according to Savings.com, a website that tracks online coupons.

Over the same period, the gross margins of the same retailers—the difference between what they paid for goods and the price at which they sold them—were flat at 27.9%, according to FactSet. The holidays barely made a dent, with margins dipping to 27.8% in the fourth quarter of 2012 from 28% in the third quarter of that year.

“A lot of the discount is already priced into the product. That’s why you see much more stable margins,” said Liz Dunn, an analyst with Macquarie Equities Research.

Retailers including Best Buy Co.BBY -0.03% , Wal-Mart Stores Inc.WMT +0.31% and Macy’s are warning this will be an unusually competitive holiday season and that all the deals could hurt margins. That can happen when chains have to fight hard for sales or get stuck with excess inventory and have to take heavier-than-planned markdowns. Stores also field loss leaders, true bargains that pinch profits but are aimed at getting customers into their stores. Most deals, however, are planned to be profitable by setting list prices well above where goods are actually expected to sell.

Retailers could run into legal trouble if they never try to sell goods at their starting price. Otherwise, there’s nothing wrong with the practice. Companies can be pretty frank about how things work.

Here’s how it works, according to one industry consultant describing an actual sweater sold at a major retailer. A supplier sells the sweater to a retailer for roughly $14.50. The suggested retail price is $50, which gives the retailer a roughly 70% markup. A few sweaters sell at that price, but more sell at the first markdown of $44.99, and the bulk sell at the final discount price of $21.99. That produces an average unit retail price of $28 and gives the store about a 45% gross margin on the product.

Retailers didn’t always price this way. It used to be that most items were sold at full price, with a limited number of sales to clear unsold inventory. That began to change in the 1970s and 1980s, when a rash of store openings intensified competition and forced retailers to look for new ways to stand out.

 

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