Markdown – Definition

Cite this article as:"Markdown – Definition," in The Business Professor, updated August 1, 2019, last accessed December 4, 2020, https://thebusinessprofessor.com/lesson/markdown-definition/.

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Markdown Definition

Markdown is a business math term that refers to a reduction of the original retail sales price in order to increase sales. In other words, it is a process where the price list is permanently changed to a reduced price. Salespersons usually offer commodities at a reduced price so that they can stimulate a commodity’s demand.

A Little More on What is Markdown

When it comes to the security market, there are two types of prices; bid prices and ask prices. Bid prices, in this case, refers to the prices that buyers are offering on securities, while ask prices are prices that the person selling the securities is offering. To get a bid-ask-price, you need to find the difference between the highest and the lowest bidding prices.

Note that it is the difference between the dealer’s price charges to a retail customer in exchange for security and the inside market price that is referred to as markdown. Markdown in when the difference in price is negative while markup is when the difference in price is positive.

Markdown Works [Example]

Suppose a broker desires to increase the volume of his or her stock sales in a stock market. To achieve this, the broker will decide to sell the stocks at a markdown price (reduced price).  In other words, the decision of a broker to sell stocks to investors at a lower price than the current selling price in the stock market is referred to as the markdown.

For instance, let’s say broker X sells shares of ABC stock to buyers at a rate of $20 per share. In the broker market, the original price of these shares was $40 per share. In this case, the broker will markdown on the shares when he sales will be; $20 – $40 = $20.

Types of Markdown

Markdown exists in several types as discussed below:

  • A sale/event: This type of markdown happens when you place an offer on your sale. For instance, you can have an offer like say Buy 2 Get 2 free, which translates to 50% off. This 50% off is meant to lure customers to buy the commodity, hence increasing your business’ cash flow.
  • Permanent price Change: This is where the price lists of commodities are permanently changed to a lower price. For instance, let’s assume that you have different styles of shoe in 4 colors and selling them at $100 each. After a period of two months, you have managed to sell two of the colors including a few of the third color. However, when it comes to the fourth color, none has been sold. Now, you find yourself in a situation where the customers are declining to buy the fourth color of shoes at $100. You are then forced to lower the price so that you can attract the customers to purchase them.

Basically, you are only taking a markdown on the commodity that is not selling while that which is selling you maintain the original price. When the price is reduced, the customers will compare the color and the price then be prompted to buy the color that has not been selling.

Mark Down and Disclosures

Basically, when it comes to markdown, the principal transaction’s disclosure is not a requirement. It is, therefore, obvious for an investor to be in the dark about the difference in prices. Note that a principal transaction happens when security is sold out by a dealer usually on its own risky account.

On the other hand, an agency transaction takes place when there is a transaction between a customer and a given entity facilitated by a broker. Many companies in the United States merge the broker and dealer’s role to come up with what is called broker-dealers.

In general, the principal or agency transaction is purchased from a broker-dealer. The principal transaction will either include markup or a markdown. It can also be an agency where a broker-dealer’s benefits are the charges from the commissions.

Note that broker-dealers have an obligation of disclosing the completion process in any trade confirmation together with the charges from the commissions. Nonetheless, they are not needed to disclose markdown apart from under given circumstances.

Why is Markdown Important?

Markdown helps to stimulate the trading activities among customers with believing that the numerous commissions will lead to higher sales which will, in turn, offset the loss incurred in the negative spread.

References for “Markdown”

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