To say that major changes are afoot at J.C. Penney would be an understatement. In June, the company announced that Ron Johnson, head of retail at Apple, would take over the helm of the $20 billion department store chain when CEO Mike Ullman retires at year-end. We visited Mike at the Penney headquarters in Plano, TX, for a discussion on the many initiatives – Mike calls them attractions – at the new and improved retailer, and how the thousand-door-chain fared during the Great Recession.
Q: Before getting to the more general and specific JC Penney business, can you comment on the Ron Johnson hire, what it means and what your plans are during the succession?
A: Any CEO’s ultimate desire is to have a strong and capable successor. Whatever you think you accomplished during your tenure is for naught if the next person doesn’t take it to the next level and improve upon it. We’ve had an interest in Ron for over two years, and fortunately early this year when our new investors had the right to designate a third director, we had the collective thought of inviting Ron to be a director of the company. Then once he’s in the board room maybe we close the door and not let him out. In the conversations over the several months we talked with Ron about taking on a more involved role. It’s very exciting. He had a distinguished career at Target as a merchant, where he reinvented the home store with the Michael Graves brand and a number of other initiatives, and then from a blank piece of paper created the most dynamic and successful retail concept of the last decade at Apple. I think he’s excited to get back into a more department store and discretionary spending format, but I think the next 3-4 months are going to be full of getting him up to speed with what we’re doing now so he can define what the next chapter is.
Q. I know you’ve put a lot of stuff in place based on your vision when you came here in 2004. What was some of that vision, what were some of the major strategies that you put in place, and how was that direction playing out prior to the financial and economic collapse?
A. We’ve built a base of trust and integrity that the company has earned in over 100 years. And terrific people. So the issue was really a matter of trying to define what the next chapter would look like. A turnaround is not a strategy. It implies something needs to be fixed. Now that you’ve fixed it, then what? The strategy we defined in the first 6 months I was here was having an emotional connection with the customer. Like a love mark, a neurological connection to put it in your terms. The brand has to have meaning, whether it’s Southwest Air, Container Store, or Starbucks. When you say the word, something emotional happens. It can’t just be a logical brand, it has to mean something. The second thing is it has to be an exciting and easy place to come and shop. We had to differentiate from just running the store. Running the store just wasn’t good enough. The third piece was it had to be a great place to work, we wanted people to want to invest their career with us, not just work for us for a day.
We have terrific people. We wanted it so that we’d invest in them, they’d invest in us. We also wanted to be in the top quartile of financial performance. Those four things were pretty simplistic, and everyone could remember them, and it kind of started from there. We got up to almost 10% operating profit in the next two years after that. Fundamentally there were 2 big ideas that underlied those strategies. One was to be the preferred place to shop, getting chosen over other alternatives. We wanted to attract a younger customer where we were under-indexed, the 18-35-year old. People also have choices of where to work, and if we couldn’t attract the people we wanted, we wouldn’t be able to execute the exciting initiatives.
The attractions – Sephora, Mango, Aldo, People Stylewatch, Liz Claiborne – all new business initiatives we have since launched – would be tied to the emotional connection, more spending per existing customers, and the younger demographic. We were already doing business with half the families in America, so we wanted to get more business from them, create more additional visits, get them to do cross shopping once they’re there. We also made a huge investment in our private brands to turn them from labels into brands.
Q: So these four macro strategies that you put in place were faring well, then comes the recession. Can you give us the scenario of how JC Penney and your strategies fared during the downturn? With revenues of about $20 billion in 2006, they dropped to about $17.5 billion in 2009, which then led to your annual investors meeting in April of 2010 where you laid out your 5-year plan, targeting revenues of $23 billion by 2014. Can you give us an update on the status of that plan?
A. Quarterly earnings were about $5 per share before the recession, and our aspiration is to get back there, which requires rebuilding the volume base in a very difficult economic climate. Our customers tend to have a job – both spouses have a job – they’re typically more urban, more ethnic, but have moderate income, so they need and expect sharp price points. They’re impacted by inflationary costs, if they had equity in their home it’s probably at risk, but have little exposure to the stock market. The sentiment for that consumer turned decidedly negative. Our average price point is $15. It’s not exactly investment dressing. Our customer needs to put the wardrobe together for $300 – $400 for a season. Mixing the fashion, the most desirable merchandise, with the basics that they’re used to is obviously the opportunity for us.
Add to that the fact that our catalog business which had been at one point over $4 billion, was dwindling, so we really had to manage out of that volume. Much of our online success had been catalog customers who entered their catalog orders online. In the online business, we had to change the engine of the locomotive while it was running from a diesel to a turbine. We had a very conservative customer who was ordering online, but the 27 million who were buying our merchandise in the store were not shopping online with us because the merchandise wasn’t the same. Much of the change in the business over the last several years has been painstakingly detailed and more or less a construction project during a time when the customer didn’t have much forgiveness. It’s a relatively easy thing to run a business, but it’s harder to transform one, particularly during a typhoon. Those are not excuses, those are just the circumstances in which we find ourselves.
The good news is that the growth initiatives that we identified are all ahead by double digits – Liz Claiborne, Sephora, Spring by Aldo, etc. MNG by Mango has done well in terms of the customer acceptance. We just launched the new collection in 500 stores at the separate MNG product and pricing. We’re the only department store to have fast fashion. It takes a long time to build attractions, because they’re not just brands, they’re a feeling. Sephora, for example, brought in a younger customer. How do we get her to cross-shop? We need design-driven brands. We’ve hired 200 designers in the past 5 years to build design-driven brands. When I was at LVMH, we had a CEO for each brand. St. John’s Bay and Arizona are over $1 billion now, and rank in the top 10 of all brands in their category. They have legitimacy because the customer knows what they are.
Q: On more tactical and short-term matters, as the issue of inflating costs becomes a reality in the second half of the year, do you believe unit volume of non-essentials will drop, and if so, will that result in a corresponding wave of promotional activity to shed excess inventory?
A. Well, we tried to get ahead of it. We did a lot of sheltering of costs for the first half of the year. It’s accurate to say that a lot of us have had to absorb some amount of cost increases for the back half. We’ve been able to mitigate some of that by keeping prices sharp in the opening price points, but increasing a bit in the better and best price points. Customers are going to have to recognize that they’re going to have to make choices. They may shop at the opening price points, but some of the best selling merchandise is the fashion merchandise. Interestingly enough, Sephora is the best-selling category in the store. We compete vigorously for everybody – with Macy’s, with Target in classifications. We compete with Kohl’s – they’re off mall, more value-oriented. It’s an open plank. There’s no barrier to entry in our business.
Q: Finally, on the issue of pricing and the Internet, how does a retailer stick to a pricing strategy in a world of technologically instantaneous price comparisons, in some cases resulting in bartering? Does this accelerate your pursuit of exclusive brands? And what percent of your business might exclusive or private brands one day reach?
A. Over 50% of merchandise in our store is non-price-competitive, because no one else has it. If you’re in the commodity business, like selling big screen TVs, you run the greater risk of being the museum, and then the customer shops price elsewhere. Pricing between the store and the internet do not have to be exact. They’ll forgive you if there’s a one-day sale where an item is a little cheaper on sale in the store vs. the internet. The higher the price, the higher the likelihood that they’ll wait, so it gives us incentive to run a temporary promotion. A third of what’s on the internet is at a different price that it is in the store. About 10% of what we offer online is not available in the stores.
Q: Regarding the Internet, mobile and social media, how would you rank JC Penney among your competitors in terms of “best practices”? And, what are some specific initiatives that you believe are resonating with that consumer segment? Do you have “site to store” initiatives? And, if so, is it a meaningful traffic builder?
A. I would give our IT group high marks. Several years ago we were the 6th best technology company overall, not just in retail. We were early to understand the internet had to converge with mobile technology. About 6 years ago, we put in a quarter-billion-dollar investment so that every POS device is dot-com available. Our sales associates had the tools to reach additional sizes for our customers in the store, so that we can satisfy the customer from the store. There are multiple layers of this. Second layer was to use it as a selling tool. Third is to allow the customers to access it with a mobile device. Fourth, social media played into this because people are now connected with their friends, so they can recommend JCP to a friend for something.
Starbucks, where I’m on the Board, uses social media to spread the word to connect customers or get them to spread the word on social media. They started to amplify, use the viral aspect of email or Facebook to get the word out. We went from 12,000 fans to 1 million fans in six months. We held our board meeting at Facebook that year, just so I could show our board how fast the world is changing. The customer is so over yesterday. If you think you’ve gotten something cornered, it’s only a matter of time. They want something different, new and exciting. One thing that makes Sephora so successful is it’s always changing. There’s no fixed product, it’s the hottest, latest stuff that’s working. That’s where traditional department stores have been stuck in the island mentality, the gift-with-purchase mentality of beauty. 17% of their market share has gone to Sephora, because the customer has voted on what she wants.
Q: Do you envision the possibility of a growth brands division rolling out specialty stores with your private brands as nameplates (ie. Arizona, etc.)?
A. When I was at Macy’s, we had Aeropostale as a private brand. We had a slightly different philosophy about private brand then, we used it for price points, and we forced the amount of private brand that the buyer had to buy, so they didn’t have to compete. A better way is to treat the private brand as a real brand rather than a weak sister. Private brands had a higher sales increase and much higher gross profit than non-private brands. Arizona has a lifestyle aesthetic, it could work, but it’s a question of allocation of capital. In German department stores, Levi’s are 90 Euros. We could do Arizona jeans in Europe at 17 Euros. We now have 10 Foundry Big and Tall stores, and the customer has been responding very well.
Q: What strategy scenario for JC Penney or other department stores might lead to the acquisition of existing branded retail specialty chains like Talbot’s, Ann Taylor, Soma or Children’s Place for example (assuming available of course)? Can you envision other specialty retail brands, such as those just mentioned and others someday leasing space and essentially running their own boutiques within JC Penney?
A. I was at LVMH when we bought a lot of brands, whether in retail or pure luxury. Most of M&A doesn’t work out. 80% of acquisitions turn out to not meet expectation. In a discretionary income recession, the best opportunity is in comp store sales growth. Right now is not the time to go out and acquire new trouble. We are a way for Mango to access half the customers in the US, with 500 stores, saving them the $60-$80 per square foot that it would have cost them to open stores. Their challenge was to get to the price point we need. We don’t lease space except to optical and photography.
Q: Are you where you want to be yet with the Ralph Lauren designed American Living brand? If not, what are the issues and how are you dealing with them?
A. American Living, if you keep in mind that our customer didn’t really have access to that aesthetic in our store, didn’t have Chaps or Polo. We learned a lot, because we introduced a premium price point during a recession. Some categories have done well, like dresses, which are up double-digits. It’s in our top 10 brands now, though.
Q: Does JC Penney have a “localization”- type program? And, generally, what is the process?
A. We have a slightly different view than some of our competitors. Our planning and allocation process allows us to localize every store no matter where it is, by size, ethnicity, color, weather, etc. So we work with integrated teams that have a buyer, private brand manager, and representation from store planning, marketing, and supply chain, which allows us to localize assortments. We can do centrally what used to be done locally. We have a quarter of a million items in each store, so it’s really important.
Q: What is your current global footprint and what’s next for global expansion, given the difficulty with translating the department store model there?
A. Well, the department store is a collection of brands, a destination due to the pricing and branding that you have. There are very few examples of success internationally. Galeries Lafayette failed in NYC, because it wasn’t different enough from what was there. Harrod’s might work, though. Generally, department stores should be uniquely local. There used to be 65, now there are 6. They need to be more different. We think there is great opportunity for department stores. Our challenge is with a legacy of 1,000 stores, ranging from 19,000 to 300,000 sq ft. in size. We need consistency so there’s a reliable offering. We’re in the best regional malls, so that’s a big advantage. The small store format for urban markets, like in Manhattan, has done very well. That store is up by double digits, and it’s across the street from the world’s largest department store. The combination of a unique shopping experience and speed of checkout, etc., is a winning combination. Our customer is taking the brunt of a tough economic environment.
Q: Finally, a big picture economic question. Given your directorship of the Federal Reserve Board of Dallas, can you give an opinion on how this economy will play out over the next year?
A. Before the recession, the consumer was spending too much. It was an unsustainable level, based on free availability of credit, using your home to leverage spending on things that last a year or less, which doesn’t make a lot of sense. Now you’ve got baby boomers getting older, and younger customers using digital as much as going into a store. The lower income customer has to focus on the basics. The country is suffering from a jobless recovery. Companies have been using technology to avoid rehiring the people who were let go or to reduce hours of employees. These things are not going to change very soon. Our challenge is to train the next generation of thinkers to figure out how they’re going to conceive of what people are going to spend money on. They’re not going to be middle managers. That’s over. A big part of what people spend their money on is what they want, not need. So, I guess this is as good as it gets for a while, until we find some new engine of growth. We’re in a digital world, where we expect things to happen overnight. But the real estate market isn’t going to recover overnight. We don’t want to be a service economy. We need to be producing something.