Innovative store concepts are buying some time, but brands like Macy’s and J.C. Penney need a lot more to reverse the falloff in sales.
By Russ Banham
Five of Canada Goose’s 11 stores feature a “cold room,” where the temperature is -27 degrees Fahrenheit. Inside, walls look and feel like icy rock formations. The floor simulates the sound of cracking ice, and holograms and laser projections reproduce frigid 3-D environments like the Arctic, replete with falling snow.
Menswear clothing company Todd Snyder just opened a store in a landmark 1809 building in New York. The store hosts member events such as curated art exhibits and rare wine and whiskey tastings. So-called “private client style advisers” are available to provide personalized shopping experiences and bespoke suiting. “It’s part clubhouse and part clothing store, offering customers the opportunity to immerse themselves into what we’re all about,” says Alejandro Rhett, vice president of merchandising at Todd Snyder.
These two retailers are not alone in trying to turn the conventional notion of a store upside-down. “Almost every retail client in our portfolio is trying something unusual,” says Rod Sides, vice chair of Deloitte and leader of the firm’s retail and distribution consulting. “The old growth trajectory called for opening more stores. Today, growth is about opening an innovative store concept and seeing if it will scale.”
The risk of failure is not dampening the wildest imaginings of today’s chief merchandising officers (CMOs), who are determined to “wow” customers. “Merchandising and marketing keep coming up with ever-more outlandish experiments to entice customers in the door,” says Craig Rowley, a senior partner in Korn Ferry’s retail practice.
Customer experiences, however, are costly, says Antony Karabus, CEO of retail consulting firm HRC Advisory. “The CMO needs a robust business case before rolling out a concept. Finance has to hold the executive team accountable for the investments they’re promoting.”
Indeed, the survival of traditional brick-and-mortar retailers that are ailing financially will require a lot more than attractive stores: these companies have to reverse falling sales while cutting expenses ruthlessly. That will be tricky. Only the most exceptional of the 90 or so CFOs Karabus has worked with can counterbalance the wishes of a CMO, holding their feet to the fire “before rolling out every wild idea. It’s a very delicate balance.”
Precarious might be a better word than delicate. The long-predicted retail apocalypse has dawned. A record 9,300-plus retail stores closed in the United States in 2019, a near-60% jump from the year before. Shoe store Payless, in liquidation, is shutting thousands of locations. Luxury retailer Barney’s New York has said goodbye to all but its outlet stores, while Gap is bringing down the curtain on 230 stores. Forever 21 is closing 111 stores, Dress Barn 650, Shopko 371, and Gymboree more than 800. Bankrupt Sears closed 96 stores in 2019, leaving 182 in a portfolio that once boasted 3,500. In total, nearly 5,000 more retail stores closed than opened in 2019.
Saddled with debt and plagued by shrinking margins, many of these companies displaced by the online retail explosion are exiting once-core product and lowering capital expenditures to right-size their businesses.
J.C. Penney, for example, is $4 billion in debt and had a debt-to-EBITDA ratio of 8.3x as of last November; it projects same-store sales to drop 7% to 8% in 2020.
CFO Bill Wafford says the retailer is taking “positive and proactive” measures to improve the long-term health of its balance sheet. That means closing six more stores this year and mothballing a 234-employee call center in Lenexa, Kansas. Near-term debt maturities, fortunately, are low—$105 million in unsecured debt comes due in June.
Once-venerable Macy’s is in even hotter water. Net decreases in cash and operating cash flow are an ominous sign, as is management’s decision to stop paying down its long-term $5 billion debt, according to Kenra Investors. While Macy’s stock nearly halved in mid-2019, it kept paying its $465 million in dividends to shareholders. It desperately needs its multi-year productivity program, “Funding Our Future,” to lift operating margins. As part of the program, Macy’s is cutting and reallocating marketing resources. In the supply chain, it’s building a third-party vendor base to outsource product packaging and shipments. The company is also testing in-store self-service solutions.
Sliver of Hope
For a model of how to run an oldline retailer in the web era, CFOs could do worse than look to Nordstrom. The 119-year-old upscale department store has closed some 140,000-square-foot retail spaces, but it is opening smaller, more focused locations. For example, Nordstrom has been launching “off-price,” or discount stores. Sales at the those stores grew 1.2% in the third quarter, while full-line store sales fell 4.1%. Nordstrom is also opening small-footprint full-price stores in high-priced locales like Manhattan and Beverly Hills. These boutique shops are 2,000 to 3,000 square feet. Personal fashion stylists greet shoppers with a free glass of wine, espresso, or a cold-pressed juice, then sit down for a consultation. Sales associates suggest clothing based on the customer’s interests. A tailor measures for fit, and since there is little in the way of inventory to take home, the item is shipped for same-day delivery.
“People don’t want to spend time going through racks and racks of clothes,” says Deloitte’s Sides. “Stores trade in the cost of holding inventory for personal stylists that help customers find what they need and then ship it. This high-touch customer experience burgeons into a relationship that increases the shopper’s loyalty, sort of like the way retail was 50 years ago when it was local.”
These local Nordstrom’s also serve as service hubs for shoppers to return items, pick up merchandise, and request alterations. In-store order pickups from transactions online drove two-thirds of the company’s digital sales growth in the third quarter of 2019, according to CEO Erik B. Nordstrom. (Digital sales represent 34% of Nordstrom’s business, far ahead of some competitors.)
Clues to how brick-and-mortar retailers will adapt are also visible in the way digital-only brands are popping up on Main Street. Digital natives Bonobos, Wayfair, Warby Parker, Alibaba, and Casper and others will open 850 stores in the next five years, mostly in the largest cities, experts predict.
Digital brands see a physical store as a place to reinforce the online brand, says Will Decker, vice president, brand and retail innovation, at investment firm Plug and Play. “They already have mindshare; now they can give their customers a space to meet, share stories, and post about their experiences online. The physical stores become a massive discovery vehicle for reaching new customers with a low capital investment.”
Small Formats, Big Data
The value in these new retailing concepts is twofold: one, small-format physical stores at 1,000 to 2,000 square feet do not require the supply chain infrastructure that large format locations do. At the same time, they allow for a higher-touch experience, which can mean a better opportunity to harvest information: in-store experiences are a subtle way to capture digital knowledge about a customer.
Service-oriented interactions can collect data on shopper needs, questions, and concerns. Some retailers track in-store customer behaviors using object tracking, emotion recognition, pressure sensitive floors, RFID tags, and gaze tracking software. The tools suggest a customer’s singular shopping interests, much like the movements of a mouse cursor on a website.
“Many in-store merchandising models are extremely innovative, but they’re designed in part to acquire data about the customer experience,” says Joanne Joliet, a Gartner senior research director.
At Ulta Beauty, for instance, associates are trained to respond to sensitive customer questions about personal appearances, such as thinning hair or skin blotches. The associates use hand-held mobile devices to search for products addressing the problem. The same tool captures these interactions as data. “This is all about customer touchpoints,” says Scott Settersten, CFO of the 1,100-store chain. “Our associates are trained to read customer body language to know when to engage with the guest.”
The information collected may include the person’s name, email address, phone number, and a physical address to ship the product for home delivery. “In-store technologies are generating a sea of customer data and analytics, offering up insights that help retailers become more preemptive and prescriptive in their customer approaches,” says Joliet.
Falling Farther Behind?
Tweaking store concepts, closing large sites, and redesigning supply chains will, of course, take a lot of time. While traditional retailers attempt their pivots and rebuild their balance sheets, though, they may be losing more ground to Amazon, the company that created more efficient and cost-effective ways for people to buy pretty much anything.
Consumers spent $517 billion online with U.S. merchants in 2018, up 15% from $450 billion spent the year prior, and about 40% of that spending was on Amazon. The 2019 holiday season was a bust for many brick-and-mortar retailers, but overall digital sales globally rose to $723 billion.
“Both online and offline, every company must prepare for Amazon’s next moves,” says Paul Prendergast, a managing director at Accenture.
Each move Amazon makes forces traditional retailers to ponder following suit—which is what happened with e-commerce fulfillment centers. “Longtime retailers that started selling online built these large and expensive fulfillment centers to move goods because that’s what Amazon did,” says Rowley. “Once Amazon started offering next-day and same-day deliveries, they couldn’t keep up.”
Even when they partner with digital natives like Amazon, traditional retailers don’t seem to win. In 2017, Kohl’s and Best Buy signed a deal to allow Amazon customers to return products to their stores. The idea was Amazon could reduce shipping costs related to returns, and Kohl’s and Best Buy would generate foot traffic that could convert into a product sale. However, at least for Kohl’s, the partnership has yet to bear fruit. Comparable sales at Kohl’s slipped 0.2% year over year in 2019, and in the third quarter Kohl’s CEO Michelle Gass admitted that the labor-intensive Amazon returns program added to operating costs.
Wowing customers with unique experiences might draw shoppers back to physical stores, but the formula for retail sales growth will be more about technology and data analytics. Traditional retailers, unfortunately, often have “five or six legacy systems that don’t interact,” Accenture’s Prendergast says. “That creates substantial challenges to collect and analyze customer, supplier, and distributor data to make more informed and accurate decisions.”
If they get their hands on the right data, retailing CFOs might be able to predict customer behavior better and “be more in tune with how sales originate today to inform their capital allocation decisions,” says Dave Richards, principal and America’s retail leader at EY.
That’s a big “if.” Traditional retailers might run out of time and capital before they can make that happen.
Russ Banham is a Pulitzer-nominated financial journalist and best-selling author.
Sidebar: Costco Stays the Course
Costco remains true to its philosophy, which has worked no matter what the competition does.
Longtime Costco CFO Richard Galanti remembers the last reinvention of brick-and-mortar retail, not surprising since Costco lead it. The membership-only chain of warehouse-sized stores opened its first location in Seattle under the Costco name in 1983, one year before Galanti was hired on as vice president of finance (he became CFO in 1985). With its heavily discounted consumer goods and grocery items, Costco hit the ground running, changing the retail landscape.
Through it all, Costco, which tallies 98.5 million members at 776 stores worldwide (up from 592 in 2011), has stuck to its knitting. From the outset, the company has prized the idea of customer experience, well before other retailers gave it much thought. Galanti defines the Costco experience as a “treasure hunt” through the stores’ extra-wide aisles. “Very few product signs are visible—on purpose,” he said. “We want people to take their time browsing each aisle, turning a corner to find something they didn’t expect, like scuba gear or wedding dresses or ski wear in the middle of August. You walk around and go ‘Wow!’”
As other retailers copied its ideas and Amazon sought to dislocate it altogether, Costco remained true to its philosophy, which worked no matter what the competition did. “Six years ago, a survey came out indicating 25% of Costco members had become Amazon Prime members. The next year it was 38%, and the year after that, it was 52%,” Galanti recalled. “One of the company’s analysts asked me how we could compete against Amazon. I told him my family also has Prime.”
His point? “We’re steady as she goes,” he said. “Our quarterly revenues might kick down a tenth of a percent here and there, but—knock on wood—we continue to drive value in what we provide. Our last two quarters produced our highest member renewal rates ever, at 90% or more. We’re in the enviable position of generating more cash to spend in growing the business and trying new things.”
Non-members often think Costco sells everything, which is far from the case. “A supermarket has about 40,000 active items; we have about 3,800,” Galanti said. “We pre-select good merchandise that’s popular, taking our buying power and putting it into fewer items, passing down the cost efficiencies as lower prices.”
Costco’s prices are hard to beat, but they often require buying products in bulk—enough paper towels to last months or a giant tub of ketchup to garnish a million burgers. Vast quantities don’t seem to bother Costco members heaping goods in carts the size of Jeeps.
Recent innovations at Costco are predicated on lowering prices further while improving quality. “We’re investing capital into becoming more vertically integrated,” Galanti said. “For instance, we’re experimenting with owning chicken farms [it recently opened a $400 million poultry complex in Nebraska]. If we can save ten cents per bird for members by doing it ourselves, we’ll do it.”