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BACK IN FASHION

A TURNAROUND IS UNDER WAY, BUT SOME SAY DEPARTMENT STORES STILL HAVE WORK TO DO

By Joel Groover

American department stores once seemed sadly outmoded, like expired coupons clipped from a yellowed newspaper. Not content to be yesterday’s news, however, a few chains vowed to reinvent themselves and win back the shoppers who had spurned them for mass-market discounters and upscale specialty stores. Those strategic overhauls are still playing out, of course. But this diverse sector, which includes such ritzy retailers as Neiman Marcus, Nordstrom and Saks, as well as mid-tier mainstays such as Macy’s and JCPenney, is actually growing again, observers say. “This is the beginning, hopefully, of a new era for these stores,” said Wendy Liebmann, president of WSL Strategic Retail, a New York City-based consultant firm.

Over the past year or so, in fact, the department store sector has outperformed the rest of the retail universe, says Robert Keiser, president of proprietary research at Stamford, Conn.-based Thomson Financial. At Saks, comparable-store sales shot up an impressive 24.7 percent year on year in February. Nordstrom posted particularly strong same-store sales increases of 11.4 percent in January and 9.1 percent in February. Both chains focus on luxury shoppers with lots of disposable income, but even less-selective department stores have enjoyed rosier returns of late.

Macy’s Group (formerly Federated Department Stores) posted sales increases of 8.5 percent for November and 8.6 percent for January. Even Kohl’s, down a rung or two on the price ladder and thus in competition with Target and Wal-Mart, managed to post consistently healthy comps, including an increase of 8.7 percent for January, says Keiser.

Sales for department stores overall have risen since March 2006, hitting a peak of 8.8 percent in September. Comps for other retail sectors, by contrast, have cooled since their crest at 6.3 percent in April 2006. “The department stores are recovering even as the retail universe overall seems to be downshifting,” Keiser said. “The story from our perspective is that, to some degree, the department stores have been immune to the slowing of the economy.”

Department stores cleared the way for this upsurge by forging ahead through years of upheaval and uncertainty, says Craig Johnson, president of Customer Growth Partners, of New Canaan, Conn. “The sector in general is consolidated, but it is healthier because of that consolidation,” he said. “I call it ‘shrink to grow.’ ” Last year, for example, Saks sold its 38 Parisian stores to Belk for $285 million and its 142-store Northern Department Store Group, which included Bergner’s, Herberger’s and Younkers, to The Bon-Ton Stores for $1.1 billion. These moves helped the company refocus on its core shoppers: those with enough purchasing power to frequent Saks Fifth Avenue.

“Now Saks is off to strong growth,” Johnson said. The former Federated, for its part, grew significantly through its $17 billion acquisition of The May Co. in 2005 (as of last September, it had converted about 400 May stores to the Macy’s brand), but it also took the key step of ridding itself of underperforming stores. “They basically trimmed the combined fleet by about 10 percent or so,” Johnson said. “They’re looking this year to begin really growing the franchise again.”

For companies like Macy’s, consolidation has translated into greater buying power that allows them to market more aggressively, and into new efficiencies that enable them to clean up their logistics, says Michael C. Appel, managing director of Quest Turnaround Advisors, Purchase, N.Y. The result is that they are more competitive, he says. But if department stores are better off today than they were a decade ago, getting lean is just one part of the explanation, he says. In their quest to recapture shoppers, JCPenney, Macy’s, Nordstrom and others took a second look at nearly every aspect of their operations. The ensuing changes ranged from small touches like adding juice bars or redoing fitting rooms to major overhauls like putting in new purchasing systems or reversing course on fashion.

“They had to improve and update their offer to shoppers,” said Liebmann. “Look at Nordstrom, which for a time got quite dowdy and seemed to focus not so much on merchandise but on service. Saks overtly came out and said, ‘Mea culpa — we tried to make it younger, and that clearly was not who our customer was.’ Now they’re moving back and recognizing that she’s not 20-something; she might be 30-something, but at heart she is 40- or 50-something.”

Fashion priorities for Saks shoppers, in other words, do not include exposing the midriff, wearing low-cut jeans or piercing anything beyond the earlobes. Gleaning such critical information is precisely the reason department store chains have ramped-up research efforts geared toward helping them understand their shoppers, Liebmann says.

Nordstrom’s outreach revealed a strong desire among its core shoppers — women 25 to 54, with yearly household income in excess of $100,000 — to be able to shop online or by catalog and find the same merchandise available at the chain’s brick-and-mortar stores. The Seattle-based chain is responding: Over the next three or four years, it will spend up to $100 million to beef up its multichannel business, said CFO Michael G. Koppel during a conference call. “Expanding on the Internet, more designer apparel in our stores, improving our women’s apparel — those were all based on what the customer tells us she wants,” Koppel said.

In April Cincinnati-based Macy’s announced plans to spend $100 million this year and next on its direct-to-consumer businesses. Those channels, which include Macys.com and Bloomingdales.com, raked in $620 million in sales last year. Macy’s is counting on them to break the $1 billion mark by 2008. Like Nordstrom, Macy’s is listening intently to its shoppers, says spokesman Jim Sluzewski. Last year alone the company received 600,000 mail and e-mail messages from consumers, he says. “They were all carefully studied, dissected, organized and reported store-by-store,” Sluzewski said.

This kind of feedback led directly to one of Macy’s key strategic goals: getting rid of newspaper coupons and selling an ever-larger proportion of its merchandise at a fixed price. “When we started our process of reinventing the department store, what the customers were telling us was that they had no idea what something cost in our store,” Sluzewski said. “If they walked in, there was a regular price, but it may have been 25 percent off to start with, then another 10 percent off if you used your credit card, and then they had a coupon from the newspaper.”

Macy’s other upgrades, such as installing directional signage, adding juice or coffee bars, and putting shopping carts in home departments also make its stores friendlier and more convenient for today’s time-starved shopper. “There are a lot of what I would call 35-plus and baby boomers who appreciate the convenience of shopping in department stores,” Appel said. “The department stores are doing a better job [of providing that convenience]. That’s why their business is better.”

Efforts by developers to bring lifestyle center conveniences such as drive-up parking or open-air entertainment districts to traditional malls are an overlooked factor in department stores’ recent success, says Liebmann. “The mall operators have realized that they have to bring something to the party to create the traffic as well,” she said. “They’re recognizing the changes in the competitive environment and, more importantly, the changes in lifestyle and shopping behavior of consumers.”

The Macy’s at Del Monte Shopping Center, in Monterey, Calif., illustrates the role traditional mall anchors can play in today’s convenience-oriented paradigm. The store is a throwback to the era when department stores were king, and yet it is also the centerpiece of a $20 million, lifestyle-focused repositioning of the 626,000-square-foot mall, which was built in 1962. According to John Chamberlain, CEO of San Diego-based American Assets, which bought the property in 2004 from San Francisco-based Divco West, the 220,000-square-foot Macy’s draws shoppers from as far away as Santa Cruz and San Jose.

“They have expanded twice into surrounding shop space in the past two and a half years,” Chamberlain said. “They brought in their home furnishings concept at 20,000 square feet and then doubled it. Then they added a 10,000-square-foot Macy’s women’s store and a second women’s store, which was also about 10,000 square feet.”

American Assets is signing the likes of Williams-Sonoma and Pottery Barn as part of the repositioning. The presence of Macy’s has made the lease-up far easier, Chamberlain says. “It has given the lifestyle tenants a comfort level that this is the location they want to be in,” he said.

In recognition of today’s convenience imperative, JCPenney’s strategy is to build all its new stores off the mall, Liebmann says. The Plano, Texas-based chain, which saw operating profit jump 17.8 percent last year, has also made strides in transforming itself into a savvier apparel retailer. “They’ve really upgraded their assortments,” Appel said. “They’ve gotten a lot more aggressive and gone a lot more upscale.”

Of course, “upscale” means something very different for the sector’s glamorous set: Bloomingdale’s, Neiman Marcus, Nordstrom and Saks. Taken together, these luxury-focused chains account for the vast majority of department store sales growth, says Keiser. The trouble is, even if U.S. Department of Commerce statisticians count these retailers as department stores, retail insiders do not. “They are focused on the luxury business, and they view themselves as specialty stores,” said Howard L. Davidowitz, chairman of Davidowitz & Associates, a New York City-based retail consulting and investment banking firm. “Saks owned a collection of bedraggled department stores. They got rid of them to Bon-Ton. Now Saks is focused on luxury and doing well.”

At the lower end of the scale, meanwhile, Wal-Mart and Target could control up to a third of all apparel sales by 2010, according to Robert S. Drbul, a Lehman Bros. analyst. This points to what Johnson describes as the barbell-shaped spending pattern in the bifurcated U.S. economy, in which sales are most concentrated among retailers focused on either the rich or the poor. “In 2006 our luxury store index rose 11 percent, [and] the discount end rose 9 percent, but the mid-tier declined 2 percent year-to-year,” he said. That’s not exactly a good omen for Macy’s. “Wal-Mart’s increase in sales — increase — will be more than all of what Federated does in 2007,” Davidowitz said. “I rest my case.”

Furthermore, any growth in the department store sector must be understood in the context of its radically reduced market share. “You go back into the mid-1990s, and department stores accounted for about 6 percent of retail sales,” Johnson said. “Now they’re 2.9 percent, according to the Department of Commerce figures. And so that is a decline on a share of market — of spend — of 50 percent.”

Little wonder that Liebmann takes a wait-and-see approach on the future of U.S. department stores. “There’s still a lot of work to be done,” she said. “Now we’ll see what they’re really made of.”