Marginalism in Retailing: The Lessons of a Failure

Author(s): Roger Dickinson

Source: The Journal of Business, Vol. 39, No. 3 (Jul., 1966), pp. 353-358
Published by: The University of Chicago Press
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MARGINALISM IN RETAILING: THE LESSONS OF A FAILURE

ROGER DICKINSON*

clearimprovementover existingpractice,
when the new system of acespecially
IGHT years ago, many progressive
had
counts
I department-storeexecutives were tion costs.3 high installation and operamoving hopefully toward the embodimentof unequivocallymarginalprinII. MERCHANDISE MANAGEMENT
ciples in their accountingsystems, under
ACCOUNTING AND ITS
one or another of the family of methods
DEFICIENCIES
known as MerchandiseManagementAcMMA is a family of systems developed
counting (MMA).1 Nevertheless, the
many individualsfor installation in a
by
subsequenthistory of MMA has failed to
of situations.4 Nevertheless, all
variety
bear out its apparently bright promise:
share these features: (1)
systems
MMA
Few firms have actually adopted MMA,
of variable and fixed
treatment
separate
and those few are generally dissatisfied
a measure of conuse
of
costs
and
the
with the system.' The entire episode
both
at
the department
tribution
profit
deserves the consideration not only of
a
further
effort to
(2)
and
store
levels;
retailers and students of retailing but
for
costs
determine
and
account
variable
also of economists and businessmen.
for
individual
profits
and
contribution
The failureof MMA has been difficult
for many analytically minded observers items of merchandiseor for homogeneous
to understandbecause it seems so obvi- lines of merchandise, rather than for
ous that marginalism in some form is only entire departments;and (3) a form
essential to the optimal solution of a of calculation that emphasizes the convariety of retailingproblems.This paper trollability and effects on contribution
argues that the MMA experiment was profits of retail price, volume, and spenot a generaltest of marginalprinciples. cific elements of cost.
Although no accounting method can
Instead it provideda demonstrationthat
prevent a managerfrompaying atreally
not every step toward marginalismis a
tention to those things he considers im*Lecturer, School of Business Administration,
portant, MMA did differ from the older
University of California (Berkeley).
"retail system" of merchandiseaccountI The Journal of Retailing devoted an entire issue
ing in the ease with which it allowed a
in the spring of 1958 to Merchandise Management
manager to see changes in prospective
Accounting. See also Malcolm P. McNair and Eleanor G. May, "A Practical Approach to Merchandise and in the way it realized contribution
I. INTRODUCTION

Management Accounting," Stores, XL, No. 5, 30-50.

See Peggy Heim, "Merchandise Management

Accounting. A Retailing Experiment in Explicit
Marginal Calculation," Quarterly Journal of Economics, LXXVIII (1963), 671-75. See also Douglas
J. Dalrymple, Measuring Merchandising Performance in Department Stores (New York: National
Retail Merchants Association, 1964).

3 Heim, op. cit.

4 For two accessible descriptions of MMA systems, 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

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354

THE JOURNAL OF BUSINESS

other applications6and to the limitations

of MMA as a pricingmethod, it remains
true that MMA has been largely represented to retailersas a method of pricing,
and it is taken as such by most retailers
today.
The difficultieswith MMA as a pricing
tool are that it emphasizesthe 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-centersystem under which
lower-levelmanagersare exposed to the
concept of contribution profits and are
given increaseddiscretionin department
operationand pricing. As it arises in the
retail setting, the difficulty is that the
departmentstore is somethingmorethan
the simple sum of its parts. Success may
thus depend on the recognitionand unified handling of the opportunities for
interaction among departments and on
maintainingsome storewidestandard of
goods, services,prices, etc.
Out of considerationsof this sort has
come a recognizedneed to define rather
carefullyeach executive'srole and degree
of freedomin the pricing process.In one
earnings.
formation, the pricing process is broken
The remainderof this sectiondescribes down into stages.7The executives of the
the deficiencieswhich were encountered storesmust decidethe role that priceis to
as users tried to realize the benefits of
5E.g., McNair and May, "Pricing for Profit."
MMA.
See also William R. Davidson and Paul L. Brown,
profits from decisionson individualmerchandise items. Furthermore,the older
method, in which profit targets and costs
were expressed as percentages of the
planned retail price, made it difficultfor
a managerto work out some of the possibilities for varying selling prices and/or
retail services in the searchfor increased
contribution profits. Finally, under the
oldersystem, and especiallyin the case of
the department store, the percentage
markonswhich were supposed to represent costs and profits were suspected of
having becomeboth rigid and inflatedto
such a degree that the older retailers
were an easy prey for price-cutters,discounters, and specialists in narrowlines
and high turnover.
The proponents of MMA hoped that
the new system would both requireand
facilitate a new look at the conventional
ideas about merchandise lines, selling
services, and cost behavior. They saw
MMA as a feasibleway to transformthe
department,with its traditionalorientation toward percentage markons, into
a profit center with its attention focused
on dollars contributed toward its own
and the store's overhead and profit.
Fromthis, they hopedfor a revitalization
of department-storetrade position and

PRICING

The greatest emphasis of most presentations of MMA has undoubtedlybeen

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 chapterson
pricing.5 Although some of the early
treatments of MMA gave attention to

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 Maximizing Concepts of Pricing."
6

See especially Jones, op. cit.

Alfred R. Oxenfeldt, "Multi-Stage Approach to Pricing," Harvard Business Review,

XXXVIII, No. 4 (1960), 125-33.
7See

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MARGINALISM IN RETAILING

play in the store'smarketingmix and develop policies to accommodatethe types

of customers to whom the executives
have decided to appeal. One of the policies that will be set forth is the competition that the store will meet and, perhaps, the store's pricing relationshipsto
stores with which it does not directly
compete. While a degree of latitude is
open to the buyer on pricesnot controlled
by the manufacturer, the latitude is
not large, and his price decisions are
constrained by the policies established
by the store. The multistageapproachto
pricing emphasizes the long-term and
intangible aspects of pricing and puts
mathematics in its proper perspective.8
MMA does not make explicit recognition of the reactions and potential reactions of competitors, particularly over
time. Thus, a price that maximizes contribution 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 shortrun and marginal factors is that MMA
generally leads to lower prices if the
buyer is a profit-maximizerand if he is
given no other guidance. This is not to
suggest that pricesin certainareasshould
not be lower or that marginalismas such
is biased in favor of prices that are too
low. It merely points out that the alternative systems in general use tend to
yield higherprices than MMA does. For
example, most department stores allocate fixed costs, or some majorelementof
fixed costs, to the departments on the
basis of past or currentsales volume. To
the department, then, these behave like

355

variable costs, and this is conducive to

higher prices.9 In many instances, the
lower prices may increase the contribution to overheadand, therefore,the total
profits of the firm in a given period; but
the store should be consciousof the fact
that adoption of an MMA system will
probably lead to lower prices. This may
lead to unplannedchanges in the store's
way of doing business and in its long-run
profitability.
Despite its limitations, there is no
reasonto doubt that a store'spricingcan,
in some instances,be improvedby marginal thinking.The degreeof improvement
will not be large, however, unless the
marginal system replaces a completely
arbitrarysystem, and few systems in use
If a marginal
today are this arbitrary.1"
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,11the amount of the
improvementwill not be large.
DEPARTURES FROM MARGINAL PRINCIPLES

Although it must be recognized that

no practical accounting system can be
"purelymarginal,"MMA is not as marginal as it could be or as it shouldbe for a
number of important decisions. McNair
and May made many concessionsto the
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.
10Interviews with over twenty-five departmentstore merchants in five cities indicated that there is
substantial flexibility in the application of percentages 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 procedures provoked by the debate over MMA.

I The constraintson the buyer are indicatedby

11See Alfred R. Oxenfeldt, Pricing for Marketing
execuHeim whenshe states that department-store
tives "wereunwillingto raise pricesindependently Executives (San Francisco: Wadsworth Publishing
Co., 1961), p. 75.
of other stores" (see Heim, op. cit., p. 673).

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356

THE JOURNAL OF BUSINESS

existing accountingsystem of the store."2 nize the longer-runvariability of many

Jones adopted standard costs."3Since "fixed"costs. A cost does not have to be
Jones is said to have come the closest to currently or fully controllable in order
a purely marginalapproach,14it is inter- for it to vary with volume. Thus, a buyer
esting to review his treatment of certain may have no control over the compensaimportant elements of cost and to com- tion of the merchandise manager, and
pare these with a truly marginal ap- yet this may be almost fully variable
with volume over a period of a year or
proach.
a
is
as
standard
two. A fully marginalaccountingsystem
Selling cost treated
a
is
so
would count these costs as variable for
cost. However, long as department
minimum
numthose decisions to which they were relea
area,
a
assigned specific
to
of
be
vant.
required
ber
salespeople will
adof
In
service it, regardless volume.
DEFECTIVE GOALS
dition, at certain times of the day and
An MMA system representsa big step
week, salespeoplewill be very busy; at
a profit-centerorganization,with
toward
other times, they will have little to do.
a
consequently
large revisionin the manMarginal selling cost, therefore, varies
ner
in
which
the
store guides and judges
with the time of day and the day of the
Yet departdepartmental
performance.
week. Furthermore,there is the fact that
mental
measurements
and
of
standards
a salespersonwill generally service the
never
been
MMA
have
clearly
estabsecondand third customerat one time in
a smaller additional time than was re- lished. Jones maintainedthat "real profit may be properly measured only in
quired for the first customer. This and
other situations raise the problemof the terms of earningpower on invested capirole of fixed standards,since it is known tal. To accomplishthis, the profitability
that the greaterthe urgency,the greater ... must be combinedwith the turnover
will be the productivityof many groups."5 factor."' A similar point was made iniAlso, even within a departmentit is true tially by McNair,17 carried somewhat
that some lines or items require dispro- further by Holton,18and supported by
portionately more or less selling effort the NRMA in its RetailAccountingManthan is assumed under any standard or ual.19The more specific actions of some
of the designersof MMA systems, howset of standards.
ever, have not always adhered to this
Selling cost is not the only standard
capital-budgeting approach, and from
that creates problems. Markdowns and
the discussion so far, it should be clear
advertisingare two other areas in which
the applicabilityof standardsis frequent- that the principle of return on investly questioned. MMA deals with both of ment is far from adequate for resolving
such conflicts as those between longthese by the use of averages.
Finally, MMA systems do not recog- and short-run considerations.The older
16Jones, op. cit., p. 7.

12McNair and May, "Pricing for Profit," pp.

118-19.
13 Jones, op. cit., p. 15.

18 Richard Holton, "A Simplified Approach to

14 McNair and May, "A Practical

Approach to
Merchandise Management Accounting," p. 36.
15On the foregoing points, see Herman F. Bell
and Louis C. Moscarello, Retail Merchandise Accounting (New York: Ronald Press, 1961), p. 255.

Capital Budgeting," California Management Review,

III, No. 3 (1961), 82-104.
19 Controllers' Congress, National Retail Merchants Association, Retail Accounting Manual (New
York: NRMA, 1962), chap. ix.

17McNair and May, "Pricing for Profit."

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MARGINALISM IN RETAILING

system, with its objectives stated in

terms of markup, may have dealt with
this problemabout 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.20It is not just that the accounting proceduresare both generically different and more elaborate in order to
produce contribution figures by merchandise items. In addition, a new installation calls for a thorough restudy of
cost behavior, both to increase the effectiveness of the new system and to increase its acceptance by those who are
going to use it and who will be judged
by it.
Contributingto this cost-and simultaneously detractingfrom the benefitsof
an MMA system-is the fact that actual
MMA systems fail to segregate important decisions from unimportant ones.
The buyer ought to be able to take more
time to establish or verify the marginalcost estimates for the more important
decisions, but the system tends to treat
all decisions in about the same way. Inevitably, some of the data inputs are too
refined and others too crude for the
purpose to which they will be put in a
particularinstance.
III. THE NEED FOR MARGTNALISM

Despite the deficienciesof MMA and

its lack of success up to now, there is a
genuine need for the applicationof marginal analysis to a variety of retailing
problems. Some of these problems call
for analysis by individual merchandise
items, the major focus of MMA. However, other important problems call for
marginal analysis at the level of the department or the entire store.
Item analysis is called for in determin20

Heim, op. cit.

357

ing the value of a change in pricing, advertising, or the extent and nature of
vendor concessions-for example, service, sales guarantees,provisionof backup
stocks, etc. It is also required in any
decision about adding or dropping an
item and in the setting of inventory
goals and reorderpoints which balance
the risks of markdowns with the contribution of profits from having wanted
merchandisein stock. There will be, of
course,many cases in which the problem
cannot be resolvedby 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 frameworkof marginalanalysis
involving many items, but even here an
item analysis is a necessary start.
At the department level, marginal
analysis is needed for additional decisions. The buyer has to decide how many
people to use in selling, in clericaloperations, 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-weeksalesperson worth $50 more than a $75-perweek salesperson?He has investment decisions about display facilities and departmental layout. He has, finally, the
related problems of departmental size,
space requirements,and location.
The store as a whole is concernedwith
marginal analysis of those services or
characteristicswhich are uniformfor 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 approach.
This very brief reviewof the majorapplications of marginal analysis makes it

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358

THE JOURNALOF BUSINESS

clear that marginalismis indispensable

to the properanalysis of many decisions
at any level. Furthermore,there is no
doubt that many stores could benefit
from replacingpresent approacheswith
a more marginal analysis. To the questions just reviewed, for example, buyers
and store managerstoday 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 desirableto build marginal analysis into the store's accounting
system, especially at the level of the
individualitem. Many decisionproblems
ariseinfrequentlyand seldomin the same
way. This is obviouslytrue of investment
decisions, but it is also true of many
decisionsabout staffing,sales promotion,
and the stocking and pricingof individual items. A system which emphasizes
item analysis tends to provide too much
informationtoo often and to demand so
many costs estimates that even the important ones are made superficially.Finally, any accounting system that seeks
to embody marginal principles encounters the difficulty that what is marginal
for one decision may not be for another
at the same level.
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.

Not all of these decisionproblemscan

or shouldbe providedfor in the design of
the store's accountingsystem. The buyers and other store executives must be
free to make intensive and special-purpose 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 carefully. They must be free to include evaluations of intangiblesand unknownsand
also estimates of quantities which would
not be available from any accounting
system.
This suggests that the importantsteps
in introducinga greater degree of marginalism into the store's decisions are to
train executives to think marginally, to
use whatever accounting data are available and relevant, and to originate or
secure whatever other kinds of data are
required,includingestimates and subjective evaluations.The accountingchanges
requiredby all this would appear to be
minor, consisting mainly of changes in
the inputs to the buyers' operatingstatements. The costs of such a program
would be the initial training costs and
the subsequentcosts of whatever higher
level of departmental and central staff
would be devoted to producingthe greater quantity and quality of input data and
analysis. These costs might not be small,
but they would at least be incurredfor
the right purpose.

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