CLEARANCE SALES: WHY RETAILERS HAVE THEM – AND WHY FLEXIBLE MANUFACTURING MAY MAKE THEM LESS COMMON

Limited stocks and uncertainty about demand are the reasons why firms prefer clearance sales of seasonal goods to selling policies where prices remain constant or increase over time. In a study published in the July 2007 issue of the Economic Journal, Professors Volker Nocke and Martin Peitz show that as production becomes more flexible, clearance sales should become less common. A prime example is the vertically integrated clothing company Zara, which now uses clearance sales only rarely.

Clearance sales are an established selling policy, commonly used by retailers of seasonal goods. Take winter or summer clothes and seasonal outdoor products, such as skis and camping equipment. These are typically liquidated before the season ends.

Since producers are limited in their ability to increase production at short notice, sellers have to decide on stocks before the beginning of the season, thus being uncertain about which items will prove more popular and which less so. Unsold items are then marked down in the middle of the season when summer or winter sales typically start.

What makes clearance sales so attractive to firms? If a consumer is interested in a particular item, he or she may buy at a high price early in the season or decide to wait for a lower price. Importantly, consumers anticipate that price cuts will occur later in the season, but they are aware of the risk that the particular good they want to purchase may no longer be available by then.

Those consumers who are particularly desperate to have the item buy it at the regular price before the sales start whereas others whose happiness depends less on obtaining the particular item or who cannot afford it at the regular price are willing to wait. The firm is thus able to discriminate between these different groups of consumers, which results in higher profits.

Linking clearance sales to limited stocks and uncertain demand, Nocke and Peitz’s analysis makes the prediction that as production becomes more flexible, clearance sales should become less common.

Looking at the clothing industry, they observe that in the past, lead-times for clothing have been significant. Flexible manufacturing and advances in the use of information technology have reduced this lead-time. This has allowed vertically integrated clothing companies – Zara being the prime example – to replenish stocks rapidly. Interestingly, as the theory predicts, Zara uses clearance sales only rarely.

The theory has implications for products other than seasonal items, for example, tickets for concerts or football matches. Even if the full season or festival ticket may seem overpriced for somebody who is only interested in selective events, it may nevertheless pay to get it when it is offered in advance before tickets for individual events are sold.

The reason is that total supply is given while demand for tickets is uncertain. Waiting for the individual ticket sales involves the risk of not obtaining the ticket for a particular event. Buying the season ticket in advance eliminates this risk. As the research by Nocke and Peitz shows, such a selling policy is in many instances optimal for the firm.

ENDS

Notes for editors: ‘A Theory of Clearance Sales’ by Volker Nocke and Martin Peitz is published in the July 2007 issue of the Economic Journal.

Volker Nocke is Reader in Economics at the University of Oxford. Martin Peitz is at the University of Mannheim.

For further information: contact Romesh Vaitilingam on 07768-661095 (email: romesh@compuserve.com) or Volker Nocke via email: volker.nocke@economics.ox.ac.uk