Role of CFOs in pricing in the retail industry
Dr Ozgur Duymaz- 10 December 2020, Thursday
Role of CFOs in Pricing in the Retail Industry
Especially in the textile retailing sector, it is known by everyone that the products in the store should be sold quickly and turned into cash. While the products are sold at the highest price that can be sold during the season, it is aimed to clean the inventories by applying discounts on the prices as the season goes on. How should the price be determined, particularly when the season of the product is coming to an end?
For example, let a product that is targeted to be sold between September and January have a cost of 100 units of currency until it arrives in the warehouse and be offered for sale at 170 units of currency. By November, when it is observed that consumers no longer pay 170 units of currency for this product, a markdown will be inevitable. As the end of the season comes, the amount of time the consumer can use the product for the current season will decrease, so it will be necessary to continue price reductions, otherwise, the product in question will not be sold until the next season, which will cause additional stocking costs. At this point, the cash flow projection of the company will play a vital role in determining the discount rates. In some cases, the product can be sold even below its cost.
While preparing cash flow, which is one of the most important duties of CFOs, maximizing sales revenues is an important issue in order not to damage the company's debt repayment capacity. It is very important for the sales team to work closely with the company's CFO, especially in the retail industry, while markdowns are offered to customers. A CFO must interfere with the proposed discounted prices, taking into account the holding costs and cash needs. For example, in the example given in the above paragraph, let's assume that 1,000 items are left in stock and can no longer be sold for 170 units of currency. The sales team estimates that 700 units could be sold for 140 units of currency in the current season, and 300 units could be sold for 90 units of currency in the next season, or the entire product could be sold for 115 units of currency until the current season ends. The 1-year holding cost per product is 20 units of currency.
In the first scenario;
Current season revenue = 140 x 700 = 98,000 units of currency (+)
Next season revenue = 90 x 300 = 27,000 units of currency (+)
Holding cost = 20 x 300 = 6,000 units of currency (-)
Total cash flow = 119,000 units of currency
In the second scenario;
Current season revenue = 115 x 1,000 = 115,000 units of currency
While the total net cash inflow is expected to be 119,000 units of currency in the first scenario, it is expected to be 115,000 units of currency in the second scenario. At first glance, although the first scenario seems more appropriate, the cash inflow in the second scenario is higher in the short run. When the cash flow projection is examined by the CFO, he/she will argue that the second scenario should be applied if it is clear that the company is unable to pay its short-term obligations.
If pricing is left only to the sales team, sometimes there will be no second and third scenarios and the results of the first scenario will be reflected in the cash flow, which can lead the company even into bankruptcy. As a CFO, it is of great importance to be involved in the pricing policy and to evaluate the issue in terms of cash flow management for the company.