MARKET WATCH: What’s Happening? Department stores are struggling. Even amid a strengthening retail sector and a holiday-season revenue boost the sector has been a laggard. Many firms are welcoming in the new year with a round of disappointing sales reports, job cuts, and store closures.
Our Take: The sector’s best days are behind it. Consumers just aren’t connecting with the product lines that department stores sell—or even with the whole idea of the middle-class mainstream that these stores stand for. Meanwhile, online-only firms have cannibalized department store revenue growth. That said, a couple of firms—particularly those working downmarket—could turn the tide by doubling down on what they do best.
Not even the holiday shopping season could give department stores a much-needed dose of good cheer.
Macy’s (M) reportedly will slash more than 10,000 jobs and close nearly 70 stores in the next year as part of a major companywide overhaul. Barring a late Christmas miracle, the chain is poised for its eighth consecutive quarter of same-store sales declines. Shares of Kohl’s (KSS) recently plunged 20% after its earnings completely missed the mark, with some retail analysts—including our own Brian McGough—saying that the company is “on the road to extinction.” Sears (SHLD) plans to close 150 stores by April 2017—amounting to roughly 10% of the company’s properties.
The industry has been a major letdown for investors who expected that stronger retail sales figures and a holiday traffic boost would translate into bigger department store profit margins. Overall, yes, retail is looking up. Census projections indicate that overall retail sales posted their third consecutive month of growth in November. Meanwhile, the National Retail Federation forecasts that retail sales climbed 3.6% YOY over the holiday season, greater than the 3% boost that took place last year.
But by all indications, department stores aren’t taking part in this boomlet.
The downward arc started well over a decade ago—long before the Great Recession. In fact, you need to go back to the Clinton ‘90s to find a really healthy growth year for department stores. That was back when we were still building malls and when malls were still cool in the eyes of teen “mall rats” (all Gen Xers) who wandered around in movies like Clueless.
Those days are long gone. As a whole, department stores have only had a handful of quarters of positive sales growth since the dot-com bubble burst. Millennials, unlike Xers, equate department stores with slow extinction and think of malls as places to not be seen (see deadmalls.com).
The long-term decline of department stores has been a real drag on malls. While stores like Sears were once the cornerstone of the mall, department stores have become more like a millstone—an inescapable leased-in burden that simply eats up precious mall real estate.
DEPARTMENT STORES BY TYPE: DISCOUNT CHAINS FARE BEST
It’s useful to divide department stores into three basic tiers: upscale, middle, and discount. All tiers have performed poorly over the last 15 years, but some have done better than others.
Overall, the discount tier—including Target (TGT) and Walmart (WMT)—has done the best. These stocks kept their value better during the recession, and they have dropped less since last spring.
The upscale firms like Saks Fifth Avenue, Nordstrom (JWN), Dillard’s (DDS), and Neiman Marcus have done less well. Though these firms—plus Macy’s, which owns Bloomingdale’s—fared better than most until the middle of 2015, they have since nosedived.
And as for middle tier stores like JC Penney (JCP), Sears, and Kohl’s, by all accounts they’ve been getting hammered. JC Penney shares sit below $8, nearly the lowest price in the company’s 30-plus year history. Problem for the middle tier: they can’t beat the upper tier on quality, and they can’t beat the lower tier on price.
WHY IT’S HAPPENING: DRIVERS
Unfavorable product lines. One obvious drag is that department stores happen to be dominated by precisely those product categories where sales growth throughout the economy has been weakest in recent years: clothing and accessories (up just 0.1% YOY in Q3 2016), sporting goods, hobby, books, and music (+0.4%), and electronics and appliances (-6.1%). Quite simply, department store sales are harnessed to the weakest horses.
Sure, the product-line picture isn’t totally bleak. Many stores sell furniture and home furnishings (+3.0% YOY in Q3 2016). Yet most of this growth has been captured by specialty stores. Department stores tend to target the nonspecialized mainstream. And here, the sharing economy rules. Shoppers who might otherwise spend hundreds on a brand-new, average-looking couch at Walmart or Macy’s can now buy a slightly used one on Craigslist for a sliver of the price.
An ever-shrinking middle class. The one sweet spot of department stores has always been the middle-class consumer. But as America increasingly transforms into an hourglass economy, those middle-earning households represent a smaller share of all spending.
Pew Research reported that in 2015, for the first time ever, fewer consumers lived in households earning between two-thirds and double the median income (120.8 million) than in lower- and higher-earning households (121.3 million). Another Pew study found that, between 2000 and 2014, the middle class lost ground in nearly nine out of ten U.S. metro areas.
Generational change. It’s not just the “middle class” as an income bracket that’s waning—but also the “middle class” as a collective self-image.
From their very origins in the late-19th century, department stores have always targeted the “middle-of -the-road” consumer with standard fare at standard prices. (Thanks to the economies of scale provided by catalogues and railroad delivery, Sears, Roebuck & Company was the Amazon-like behemoth of its day.)
After World War II, these firms enjoyed a new growth spurt with the G.I. and Silent Generations, who embodied Middle America in every sense. The young adults of the American High saw department stores as a way to infuse order and efficiency into the wild west of Mom-and-Pop retail. As consumers, they craved uniformity and mass-produced goods—stuff that would allow you to fit in happily with your suburban neighbors on a “Pleasant Valley Sunday.”
But this all changed with Boomers, who wanted authentic products made just for them. Today, Boomer and Gen-X shoppers are either “trading up” for better quality or “trading down” for better price. Department stores check neither box. In response to Boomers and Xers, department stores have been gradually ramping up on the diversity of its style and brand selection—until all the diversity practically pours out of the shelves onto the floors.
This decades-long strategy has had mixed results at best. On the one hand, stocking up on the endless variety that Boomers and Xers crave is not something that department stores are well suited for. And on the other hand—and here’s the irony—most Millennials don’t want more choice. Plenty would rather shop at a specialty store that effectively chooses the right product for them than at a sprawling department store that offers forty different brands of handbags scattered down three separate aisles. (For more on how a growing number of Millennial consumers view choice as a downside, see: “When Less is More.”)
The rise of e-commerce. Online platforms allow consumers to get exactly what they want without ever leaving the couch. E-commerce sales now make up nearly 70 cents for every dollar spent at brick-and-mortar stores, up from around 30 cents per dollar back in 2000. The gap between e-tail revenue growth and department store revenue growth is on the order of 15 to 20 percentage points annually. It’s not even close.
E-commerce transactions are not just convenient, but fast: Why trek out to the mall when Amazon Prime will deliver what you need within the day—or even the hour?
HOW DEPARTMENT STORES ARE RESPONDING
Upper- and middle-tier firms are going cheap. In a grab for consumers with less purchasing power, Macy’s is experimenting with “Backstage,” an outlet store built into a handful of its existing retail locations. (JC Penney’s experiment with no sales and no promotions was a disaster, which should have told them something about who their customers are.)
Luxury firms are no strangers to this strategy, either. At Saks Off 5th, shoppers can get Saks quality for a modest price. As for Nordstrom, the company’s Nordstrom Rack discount outposts now outnumber its legacy stores. Who can blame them for the shift? While Nordstrom’s full-priced sales ticked up by just 0.9% YOY in Q2 2016, its discount business grew 3.9%.
Goodbye, soft goods. Department stores are branching out into hard goods to escape the doldrums of apparel sales. JC Penney announced in late 2015 that it would start selling appliances again for the first time in decades. Macy’s added added consumer electronics in some of its stores through a partnership with Best Buy.
Sears is taking it one step further: The firm recently opened a 10,000-square-foot outpost in Colorado packed only with appliances.
Investing in private labels. At a time when bestsellers are hard to come by, department stores are hanging onto their homegrown cash cows for dear life.
Kohl’s offers 20 exclusive private labels, three of which generate more than $1 billion annually—including its star-performing Sonoma brand.
Under new CEO Marvin Ellison, JC Penney has gotten back into in-house labels as well: Ellison expects the company’s house brands to account for 70% of the chain’s total merchandise sales by 2019.
Emulating e-commerce giants. Macy’s, Bloomingdale’s, and Nordstrom have taken a page out of Amazon’s playbook by rolling out same-day delivery in select locations.
That’s a good start, sure, but these firms should go a step further by exploiting things that brick-and-mortar does better than e-commerce: high-touch customer service, perhaps, or maybe specializing in large, complex purchases that beg for a knowledgeable salesperson. With in-store analytics married to Big Data, physical retail can at last know as much about its customers as digital retail.
IS IT WORKING?
Not yet—but the industry still has hope. There may be room for one or two traditional department stores that play their cards right. As for the rest, some will disappear (receivership, merger) and others will exit the genre by becoming high-end specialty stores or big-box category killers.
So which firms have the best shot of surviving and prospering?
The middle tier is in the toughest position. It will be difficult for any of them to turn the tide without completely reinventing themselves to compete with either the Nordstroms of the world on quality or the Walmarts on price.
High- and low-end firms are better positioned to exploit what they do best. Many of the high-end stores will survive by specializing in fewer product lines. Most discount stores don’t have that option—and will be hardest pressed by e-tailers.
Yet precisely because they have no alternative, discount stores will be most likely to figure out how to grow their bottom line while still maintaining their department store identity. They will do so in part on the strength of their brand connection with the fast-growing share of Americans (40% in 2014, up from only 25% in 2008 according to Pew Research) who self-identify as “lower” or “lower-middle” class. The generation most responsible for this shift is today’s Millennials, who also happen to be tomorrow’s middle class. Hip young Gen-Xers flocked to edgy boutiques. Hip young Millennials flock to one-size-fits-all thrift shops.
Already, a couple of the big discount brands are aligning themselves well. Target and Walmart rank among the top 10 favorite Millennial brands—with Target coming in at #2, behind only Apple.
Why these two companies in particular? Target has combined a bright, upmarket atmosphere with basics-first selection and downmarket prices. In other words, Target offers what Millennials want. And with a P/E under 12, it’s a relative bargain for investors.
But Walmart may be worth the added cash that it would take to buy in. (Its P/E sits above 14.) For one, Walmart beats everyone on price—which is an identity in itself. More importantly, Walmart is investing heavily in its stores and its e-commerce business, going all-in to combat Amazon and the rest of its online competitors. Just look at its $3.3 billion purchase of e-commerce site Jet.com last year. Whether this strategy ultimately will work is up in the air—but unlike Target, Walmart is taking the fight to Amazon.
