Marginalism in Retailing: The Lessons of a FailureAuthor(s): Roger DickinsonSource: The Journal of Business, Vol. 39, No. 3 (Jul., 1966), pp. 353-358Published by: The University of Chicago PressStable URL: http://www.jstor.org/stable/2351852 .

Accessed: 21/06/2014 03:57

Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at .http://www.jstor.org/page/info/about/policies/terms.jsp

.JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range ofcontent in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new formsof scholarship. For more information about JSTOR, please contact support@jstor.org.

.

The University of Chicago Press is collaborating with JSTOR to digitize, preserve and extend access to TheJournal of Business.

http://www.jstor.org

This content downloaded from 62.122.78.77 on Sat, 21 Jun 2014 03:57:57 AMAll use subject to JSTOR Terms and Conditions

MARGINALISM IN RETAILING: THE LESSONS OF A FAILURE

ROGER DICKINSON*

I. INTRODUCTION

IGHT years ago, many progressive I department-store executives were

moving hopefully toward the em- bodiment of unequivocally marginal prin- ciples in their accounting systems, under one or another of the family of methods known as Merchandise Management Ac- counting (MMA).1 Nevertheless, the subsequent history of MMA has failed to bear out its apparently bright promise: Few firms have actually adopted MMA, and those few are generally dissatisfied with the system.' The entire episode deserves the consideration not only of retailers and students of retailing but also of economists and businessmen.

The failure of MMA has been difficult for many analytically minded observers to understand because it seems so obvi- ous that marginalism in some form is essential to the optimal solution of a variety of retailing problems. This paper argues that the MMA experiment was not a general test of marginal principles. Instead it provided a demonstration that not every step toward marginalism is a

clear improvement over existing practice, especially when the new system of ac- counts had high installation and opera- tion costs.3

II. MERCHANDISE MANAGEMENT

ACCOUNTING AND ITS

DEFICIENCIES

MMA is a family of systems developed by many individuals for installation in a variety of situations.4 Nevertheless, all MMA systems share these features: (1) separate treatment of variable and fixed costs and the use of a measure of con- tribution profit at both the department and store levels; (2) a further effort to determine and account for variable costs and contribution profits for individual items of merchandise or for homogeneous lines of merchandise, rather than for only entire departments; and (3) a form of calculation that emphasizes the con- trollability and effects on contribution profits of retail price, volume, and spe- cific elements of cost.

Although no accounting method can really prevent a manager from paying at- tention to those things he considers im- portant, MMA did differ from the older "retail system" of merchandise account- ing in the ease with which it allowed a manager to see changes in prospective and in the way it realized contribution

*Lecturer, School of Business Administration, University of California (Berkeley).

I The Journal of Retailing devoted an entire issue in the spring of 1958 to Merchandise Management Accounting. See also Malcolm P. McNair and Elea- nor G. May, "A Practical Approach to Merchandise Management Accounting," Stores, XL, No. 5, 30-50.

2 See Peggy Heim, "Merchandise Management Accounting. A Retailing Experiment in Explicit Marginal Calculation," Quarterly Journal of Eco- nomics, LXXVIII (1963), 671-75. See also Douglas J. Dalrymple, Measuring Merchandising Perform- ance in Department Stores (New York: National Retail Merchants Association, 1964).

3 Heim, op. cit. 4 For two accessible descriptions of MMA sys-

tems, see Malcolm P. McNair and Eleanor G. May, "Pricing for Profit," Harvard Business Review, XXXV (May-June, 1957), 105-22; and Robert I. Jones, "Objectives and Basic Principles of MMA," Journal of Retailing, XXXIV (Spring, 1958), 2-15.

353

This content downloaded from 62.122.78.77 on Sat, 21 Jun 2014 03:57:57 AMAll use subject to JSTOR Terms and Conditions

354 THE JOURNAL OF BUSINESS

profits from decisions on individual mer- chandise items. Furthermore, the older method, in which profit targets and costs were expressed as percentages of the planned retail price, made it difficult for a manager to work out some of the possi- bilities for varying selling prices and/or retail services in the search for increased contribution profits. Finally, under the older system, and especially in the case of the department store, the percentage markons which were supposed to repre- sent costs and profits were suspected of having become both rigid and inflated to such a degree that the older retailers were an easy prey for price-cutters, dis- counters, and specialists in narrow lines and high turnover.

The proponents of MMA hoped that the new system would both require and facilitate a new look at the conventional ideas about merchandise lines, selling services, and cost behavior. They saw MMA as a feasible way to transform the department, with its traditional orienta- tion toward percentage markons, into a profit center with its attention focused on dollars contributed toward its own and the store's overhead and profit. From this, they hoped for a revitalization of department-store trade position and earnings.

The remainder of this section describes the deficiencies which were encountered as users tried to realize the benefits of MMA.

PRICING

The greatest emphasis of most pres- entations of MMA has undoubtedly been on its usefulness in pricing decisions. Many of the articles on the subject have had "pricing" in their titles, and books have often put MMA in the chapters on pricing.5 Although some of the early treatments of MMA gave attention to

other applications6 and to the limitations of MMA as a pricing method, it remains true that MMA has been largely repre- sented to retailers as a method of pricing, and it is taken as such by most retailers today.

The difficulties with MMA as a pricing tool are that it emphasizes the cost-price mathematics of the short run at the expense of attention to the longer-run problems of cost behavior, marketing policy, and reactions of competitors. These are, of course, the usual objections to the installation, anywhere, of some sort of profit-center system under which lower-level managers are exposed to the concept of contribution profits and are given increased discretion in department operation and pricing. As it arises in the retail setting, the difficulty is that the department store is something more than the simple sum of its parts. Success may thus depend on the recognition and uni- fied handling of the opportunities for interaction among departments and on maintaining some storewide standard of goods, services, prices, etc.

Out of considerations of this sort has come a recognized need to define rather carefully each executive's role and degree of freedom in the pricing process. In one formation, the pricing process is broken down into stages.7 The executives of the stores must decide the role that price is to

5E.g., McNair and May, "Pricing for Profit." See also William R. Davidson and Paul L. Brown, Retailing Management (New York: Ronald Press, 1960), in which MMA is mainly discussed in the chapter entitled "Pricing Principles and Practices"; and John W. Wingate and Joseph S. Friedlander, The Management of Retail Buying (Englewood Cliffs, N.J.: Prentice-Hall, Inc., 1963), in which MMA is presented in a technical appendix for "Profit Maxi- mizing Concepts of Pricing."

6 See especially Jones, op. cit.

7See Alfred R. Oxenfeldt, "Multi-Stage Ap- proach to Pricing," Harvard Business Review, XXXVIII, No. 4 (1960), 125-33.

This content downloaded from 62.122.78.77 on Sat, 21 Jun 2014 03:57:57 AMAll use subject to JSTOR Terms and Conditions

MARGINALISM IN RETAILING 355

play in the store's marketing mix and de- velop policies to accommodate the types of customers to whom the executives have decided to appeal. One of the poli- cies that will be set forth is the competi- tion that the store will meet and, per- haps, the store's pricing relationships to stores with which it does not directly compete. While a degree of latitude is open to the buyer on prices not controlled by the manufacturer, the latitude is not large, and his price decisions are constrained by the policies established by the store. The multistage approach to pricing emphasizes the long-term and intangible aspects of pricing and puts mathematics in its proper perspective.8

MMA does not make explicit recogni- tion of the reactions and potential reac- tions of competitors, particularly over time. Thus, a price that maximizes con- tribution in the short run may not maximize contribution in the long run. This may be true even within the range of discretion offered by the multistage approach.

The result of this emphasis on short- run and marginal factors is that MMA generally leads to lower prices if the buyer is a profit-maximizer and if he is given no other guidance. This is not to suggest that prices in certain areas should not be lower or that marginalism as such is biased in favor of prices that are too low. It merely points out that the al- ternative systems in general use tend to yield higher prices than MMA does. For example, most department stores allo- cate fixed costs, or some major element of fixed costs, to the departments on the basis of past or current sales volume. To the department, then, these behave like

variable costs, and this is conducive to higher prices.9 In many instances, the lower prices may increase the contribu- tion to overhead and, therefore, the total profits of the firm in a given period; but the store should be conscious of the fact that adoption of an MMA system will probably lead to lower prices. This may lead to unplanned changes in the store's way of doing business and in its long-run profitability.

Despite its limitations, there is no reason to doubt that a store's pricing can, in some instances, be improved by margi- nal thinking. The degree of improvement will not be large, however, unless the marginal system replaces a completely arbitrary system, and few systems in use today are this arbitrary.1" If a marginal system replaces a system by which the buyer sets prices at the highest level consistent with adequate volume and then explores the effects of downward price adjustments,11 the amount of the improvement will not be large.

DEPARTURES FROM MARGINAL PRINCIPLES

Although it must be recognized that no practical accounting system can be "purely marginal," MMA is not as mar- ginal as it could be or as it should be for a number of important decisions. McNair and May made many concessions to the

I The constraints on the buyer are indicated by Heim when she states that department-store execu- tives "were unwilling to raise prices independently of other stores" (see Heim, op. cit., p. 673).

9Some merchandise executives interviewed by the author have said that they would lower prices if indirect costs were not charged to the department on the basis of volume.

10 Interviews with over twenty-five department- store merchants in five cities indicated that there is substantial flexibility in the application of percent- ages in pricing and in the prices themselves. It is probably true that some of this flexibility has been introduced since 1956, when MMA originated, as one result of the re-examination of existing proce- dures provoked by the debate over MMA.

11 See Alfred R. Oxenfeldt, Pricing for Marketing Executives (San Francisco: Wadsworth Publishing Co., 1961), p. 75.

This content downloaded from 62.122.78.77 on Sat, 21 Jun 2014 03:57:57 AMAll use subject to JSTOR Terms and Conditions

356 THE JOURNAL OF BUSINESS

existing accounting system of the store."2 Jones adopted standard costs."3 Since Jones is said to have come the closest to a purely marginal approach,14 it is inter- esting to review his treatment of certain important elements of cost and to com- pare these with a truly marginal ap- proach.

Selling cost is treated as a standard cost. However, so long as a department is assigned a specific area, a minimum num- ber of salespeople will be required to service it, regardless of volume. In ad- dition, at certain times of the day and week, salespeople will be very busy; at other times, they will have little to do. Marginal selling cost, therefore, varies with the time of day and the day of the week. Furthermore, there is the fact that a salesperson will generally service the second and third customer at one time in a smaller additional time than was re- quired for the first customer. This and other situations raise the problem of the role of fixed standards, since it is known that the greater the urgency, the greater will be the productivity of many groups."5 Also, even within a department it is true that some lines or items require dispro- portionately more or less selling effort than is assumed under any standard or set of standards.

Selling cost is not the only standard that creates problems. Markdowns and advertising are two other areas in which the applicability of standards is frequent- ly questioned. MMA deals with both of these by the use of averages.

Finally, MMA systems do not recog-

nize the longer-run variability of many "fixed" costs. A cost does not have to be currently or fully controllable in order for it to vary with volume. Thus, a buyer may have no control over the compensa- tion of the merchandise manager, and yet this may be almost fully variable with volume over a period of a year or two. A fully marginal accounting system would count these costs as variable for those decisions to which they were rele- vant.

DEFECTIVE GOALS

An MMA system represents a big step toward a profit-center organization, with a consequently large revision in the man- ner in which the store guides and judges departmental performance. Yet depart- mental measurements and standards of MMA have never been clearly estab- lished. Jones maintained that "real prof- it may be properly measured only in terms of earning power on invested capi- tal. To accomplish this, the profitability ... must be combined with the turnover factor."' A similar point was made ini- tially by McNair,17 carried somewhat further by Holton,18 and supported by the NRMA in its Retail Accounting Man- ual.19 The more specific actions of some of the designers of MMA systems, how- ever, have not always adhered to this capital-budgeting approach, and from the discussion so far, it should be clear that the principle of return on invest- ment is far from adequate for resolving such conflicts as those between long- and short-run considerations. The older

12 McNair and May, "Pricing for Profit," pp. 118-19.

13 Jones, op. cit., p. 15. 14 McNair and May, "A Practical Approach to

Merchandise Management Accounting," p. 36. 15 On the foregoing points, see Herman F. Bell

and Louis C. Moscarello, Retail Merchandise Ac- counting (New York: Ronald Press, 1961), p. 255.

16Jones, op. cit., p. 7. 17 McNair and May, "Pricing for Profit." 18 Richard Holton, "A Simplified Approach to

Capital Budgeting," California Management Review, III, No. 3 (1961), 82-104.

19 Controllers' Congress, National Retail Mer- chants Association, Retail Accounting Manual (New York: NRMA, 1962), chap. ix.

This content downloaded from 62.122.78.77 on Sat, 21 Jun 2014 03:57:57 AMAll use subject to JSTOR Terms and Conditions

MARGINALISM IN RETAILING 357

system, with its objectives stated in terms of markup, may have dealt with this problem about as well as MMA.

COSTS AND OUTPUTS OF AN MMA SYSTEM

An MMA system is often fairly costly to set up when related to the potential benefits.20 It is not just that the account- ing procedures are both generically dif- ferent and more elaborate in order to produce contribution figures by mer- chandise items. In addition, a new in- stallation calls for a thorough restudy of cost behavior, both to increase the ef- fectiveness of the new system and to in- crease its acceptance by those who are going to use it and who will be judged by it.

Contributing to this cost-and simul- taneously detracting from the benefits of an MMA system-is the fact that actual MMA systems fail to segregate impor- tant decisions from unimportant ones. The buyer ought to be able to take more time to establish or verify the marginal- cost estimates for the more important decisions, but the system tends to treat all decisions in about the same way. In- evitably, some of the data inputs are too refined and others too crude for the purpose to which they will be put in a particular instance.

III. THE NEED FOR MARGTNALISM

Despite the deficiencies of MMA and its lack of success up to now, there is a genuine need for the application of mar- ginal analysis to a variety of retailing problems. Some of these problems call for analysis by individual merchandise items, the major focus of MMA. How- ever, other important problems call for marginal analysis at the level of the de- partment or the entire store.

Item analysis is called for in determin-

ing the value of a change in pricing, ad- vertising, or the extent and nature of vendor concessions-for example, serv- ice, sales guarantees, provision of backup stocks, etc. It is also required in any decision about adding or dropping an item and in the setting of inventory goals and reorder points which balance the risks of markdowns with the con- tribution of profits from having wanted merchandise in stock. There will be, of course, many cases in which the problem cannot be resolved by analysis of a single item because of the interactions among items within a department. For example, a theory of variety can only be developed within a framework of marginal analysis involving many items, but even here an item analysis is a necessary start.

At the department level, marginal analysis is needed for additional deci- sions. The buyer has to decide how many people to use in selling, in clerical opera- tions, etc. He has to make what is often a most important determination about skills and salary levels of his salespeople. For example, is a $125-per-week sales- person worth $50 more than a $75-per- week salesperson? He has investment de- cisions about display facilities and de- partmental layout. He has, finally, the related problems of departmental size, space requirements, and location.

The store as a whole is concerned with marginal analysis of those services or characteristics which are uniform for all departments-for example, the provision of credit, the level of housekeeping, or delivery policies-and with decisions to add or drop entire departments. At this level, the store faces the full range of major capital-investment opportunities, most of which call for a marginal ap- proach.

This very brief review of the major ap- plications of marginal analysis makes it 20 Heim, op. cit.

This content downloaded from 62.122.78.77 on Sat, 21 Jun 2014 03:57:57 AMAll use subject to JSTOR Terms and Conditions

358 THE JOURNAL OF BUSINESS

clear that marginalism is indispensable to the proper analysis of many decisions at any level. Furthermore, there is no doubt that many stores could benefit from replacing present approaches with a more marginal analysis. To the ques- tions just reviewed, for example, buyers and store managers today can often offer little more than rules of thumb, many of which are not simply rough but grossly misleading."

The question remains of how far it is either possible or desirable to build mar- ginal analysis into the store's accounting system, especially at the level of the individual item. Many decision problems arise infrequently and seldom in the same way. This is obviously true of investment decisions, but it is also true of many decisions about staffing, sales promotion, and the stocking and pricing of individu- al items. A system which emphasizes item analysis tends to provide too much information too often and to demand so many costs estimates that even the im- portant ones are made superficially. Fi- nally, any accounting system that seeks to embody marginal principles encoun- ters the difficulty that what is marginal for one decision may not be for another at the same level.

Not all of these decision problems can or should be provided for in the design of the store's accounting system. The buy- ers and other store executives must be free to make intensive and special-pur- pose analyses as dictated by the nature and importance of the problems that arise. They must be free to make small decisions cheaply and large ones care- fully. They must be free to include eval- uations of intangibles and unknowns and also estimates of quantities which would not be available from any accounting system.

This suggests that the important steps in introducing a greater degree of mar- ginalism into the store's decisions are to train executives to think marginally, to use whatever accounting data are avail- able and relevant, and to originate or secure whatever other kinds of data are required, including estimates and subjec- tive evaluations. The accounting changes required by all this would appear to be minor, consisting mainly of changes in the inputs to the buyers' operating state- ments. The costs of such a program would be the initial training costs and the subsequent costs of whatever higher level of departmental and central staff would be devoted to producing the great- er quantity and quality of input data and analysis. These costs might not be small, but they would at least be incurred for the right purpose.

21 In an early version of a 1964 buyer's manual, one leading and progressive store was still urging the buyer to be very careful of increased costs on the grounds that a $4.00 increase in cost could only be offset by a $100 increase in sales if the department usually showed a profit of 4 per cent of sales.

This content downloaded from 62.122.78.77 on Sat, 21 Jun 2014 03:57:57 AMAll use subject to JSTOR Terms and Conditions