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IS PENNEY’S TURNAROUND STRATEGY STARTING TO WORK?

By Karen M. Kroll

Not everyone’s health starts improving at 100, but J.C. Penney seems to be managing it. Efforts to revive the Plano, Texas-based company, which celebrated its centennial in April, show signs of working.

“They’re moving in the right direction,” said Robert A. Michaels, president and COO of Chicago-based General Growth Properties, explaining that in December he met Penney’s executive team and visited several stores. “Their merchandise is looking much better, and it’s displayed better.” Approximately 100 of General Growth’s malls include a J.C. Penney store.

For a time, though, the chain of about 1,100 stores and 2,650 fashion stores was looking decidedly doddery. Shoppers, especially young ones, were deserting in droves during the 1990s, turned off by outdated merchandise that lacked style. They were going over to such competitors as Kohl’s, Old Navy and Target, which were building reputations on their ability to offer fashionable, trendy items at bargain-basement prices. In the past five years, the retailer’s popularity has dropped by 40 percent among young shoppers, and only 5 percent of teens and 20-somethings identified it as their first stop for clothes, said Irma Zandl, head of New York City-based trend research firm The Zandl Group.

Critics say the store still has a ways to go.

“There is not any part of the store that is unique or serves as a magnet,” said Arun Jain, a professor of marketing research at the University at Buffalo, New York. The lone exception may be window treatments, a category for which Penney is more recognized than any other store, according to Allen I. Questrom, the chain’s chairman and CEO.

Management’s reliance on private-label goods also contributed to the company’s decline, noted Edward Fox, associate professor of marketing and director of the JCPenney Center for Retail Excellence at Southern Methodist University. “They had fallen in love with private-label margins.”

While private labels can provide higher margins, they’re typically not marketed with the same vigor as national brands. Retailers need to provide a reason for shoppers to come into the store in the first place, and national brands, backed by hefty promotional budgets, bring shoppers in.

“Kohl’s is heavily oriented to national brands,” said Fox. “They’ve taken a chunk from J.C. Penney.”

Throughout the 1990s, financial performance at the moderately priced retail chain deteriorated. While sales grew from about $20 billion to $32 billion between 1994 and 2000, return on shareholder equity declined from 20 percent to –8 percent. In 2000, earnings before interest, taxes, depreciation and amortization had dropped to 3 percent of sales, versus about 9 percent in 1996.

In September 2000, the company brought in Questrom to change course. He is widely credited with having led the turnarounds at both Federated Department Stores and Barneys New York, and the expectations are that he can do the same at Penney.

“If anyone can turn their fashion around, he’s the person that can,” said Jim McComb, president of the McComb Group, a Minneapolis-based retail consulting firm.

Also new on the executive team is COO Vanessa Castagna, who joined the company in 1999. Castagna previously held merchandising positions at Target, TJX Cos. and Wal-Mart Stores.

The combination is powerful, said Fox.

“[Questrom] is one of the merchant princes,” he said. “Castagna’s very operations-focused and has been improving store operations and discipline. It’s been a fortunate mix.”

Several changes introduced by the new management team are already showing results. In February 2000 management rolled out a centralized buying system; previously, store managers were primarily responsible for purchasing, making it difficult for the chain to gain economies of scale and present a unified image from one store to another. With a centralized purchasing system, buyers can better respond to customer demand and get fashionable items into the stores more quickly. In addition, they’re better able to reorder merchandise while it’s still in season and exploit strong sellers, said Tim Lyons, a Penney spokesman.

At the same time, management has slashed in half the number of inventory items, according to a report by Daniel Barry, a retail analyst at Merrill Lynch & Co. Stores have a cleaner look and are easier for consumers to navigate. Also contributing to the cleaner look are the upgrades that are under way. During 2000 and 2001 the company spruced up 250 stores with new paint, improved lighting and fixtures.

The result: For the 52 weeks ended Jan. 26, same-store sales inched up 3.3 percent. Though the increase comes off a fairly low base, it has nevertheless occurred in a difficult retailing environment.

For 2002, management is focusing on upgrading the cash register areas, consolidating them into larger clusters on the main aisles to ease checkout for customers, Lyons said. In addition, about 15 to 20 stores will be entirely remodeled.

Meanwhile, Penney is holding its own online. The company said it currently enjoys one of the highest online conversion rates — the number of customers who end up buying from a store after a visit to its Web site — among department stores operating on the Web, although it does not provide numbers to back that up. During the 2001 fiscal year, online sales totaled $323 million, up from $294 million the previous year.

As for the company catalog, which contributed about $4 billion in sales in 2001, management has taken steps to improve profitability there, too: It is reducing its size of the catalog and changing the paper used.

Management is also focusing more heavily on high-margin clientele and last year removed from the company database some 300,000 customers with the highest tendency to return goods. This, the retailer said, will save about $10.5 million in marketing costs.

Dramatic changes are also paying off at the Eckerd drugstore division, which contributed $13 billion in sales during 2000. Led by Eckerd Chairman and CEO Wayne Harris, management is steadily upgrading the stores. By 2003 approximately 80 percent of all locations will have received a face-lift. The chain has also cut prices on about 5,000 items.

Annualized sales per square foot for the reconfigured stores are $283, versus $252 for the rest.

Some analysts have speculated that Penney might spin off the Eckerd division.

But though recent results at both Eckerd and Penney are promising, management still has more to do, experts say. Sales per square foot hover at about $153, versus $280 for Kohl’s and $270 for Target.

To draw teens back, the stores need to find unconventional ways to stay a step ahead of the trends. One idea: to work with designers who have “more style than capital,” said trend researcher Zandl.

“With ‘value shopping’ all the rage, designers like Cynthia Rowley or Isaac Mizrahi or even Kenneth Cole might find it cool to serve the masses by hooking up with J.C. Penney,” she said.

Penney needs to replicate the success it has had with the Arizona label, the chain’s private-label jeans line that Questrom has identified as a $1 billion business.

Penney’s improving financial condition should give management time to make the improvements it needs, observers say. The company ended 2001 with $2.8 billion in cash investments, with funds coming from improved store performance and the sale of J.C. Penney Direct Marketing Services, among other things. The sale of that unit, which sold insurance and travel and auto club programs, netted the company about $1.1 billion in cash.

Comparable department store sales increased in nine of the past 12 months. The stock was up 69 percent, from $13 in February of last year to $22 in mid-February of this year.

“Penney’s has demonstrated that they have a loyal core of traditional customers,” said Bernie Sosnick, director of research at Fahnestock & Co., New York City. “When they’re offered discernible values, there’s a response.”

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