The price of fashion: JCPenney plots return to form

American department store JCPenney has struggled to survive since its modern business approach saw sales plummet in 2011. When Marvin Ellison takes over as CEO next year, the company must establish a sustainable strategy

JCPenney is seeing a resurgence after a decline which saw losses hitting almost $1bn. Ron Johnson, the man behind Apple’s innovative retail strategy, had unsuccessfully tried to apply the tech giant's experimental approach to the chain 

After a disastrous 17 months under modern retail guru Ron Johnson, recent times have seen a renewed focus for American department store JCPenney – with sales rising under incumbent CEO Myron (‘Mike’) Ullman. But a quick glance at the rise masks the darker side, and despite optimistic forecasts, incoming CEO – Home Depot executive Marvin Ellison, set to take the helm in August 2015 – has a lot of work to do before the struggling, 1,100-store retail giant can return to profitability. A large part of this comes down to whether he can learn to tread the fine line between tradition and innovation – that is, whether he can strike a balance between Johnson’s forward-thinking approach and Ullman’s successful pricing strategies.

In its prime, middle-market department store chain JCPenney was one of the retail industry’s biggest players. “You could certainly compare them to businesses like Macy’s,” says Dwight Hill, partner at American retail consulting firm McMillan Doolittle. The retail giant was floating up there in the dizzy heights of other $18bn department stores in the 1990s and early 2000s, when American consumers were hungry for red-tape deals and convenient, all-in-one shops. But as the age of the internet got into full swing, shopping habits began to change.

Then-CEO Ullman continued to draw in value-conscious customers on the hunt for a bargain. His strategy was to flood customers with coupons, slash prices with constant sales and fill the shop floor with red pen markdowns. He also formed unprecedented partnerships with the sophisticated likes of cosmetics retailer Sephora, fashion designer Ralph Lauren and clothing line Liz Claiborne. When news of a 10-year exclusive deal with the latter was released in 2009, the design company’s stocks shot up by 28 percent and JCPenney’s reached a 52-week high; Ullman was creating buzz in the nationwide chain.

JC Penney Total Sales graph
Sources: Valuewalk, JCPenney, Nomura. Notes: Figures for 2014, Nomura estimate

Catastrophic decline
Ron Johnson, the entrepreneurial mind behind Apple’s innovative retail strategy as its Senior Vice President between 2000 and 2011, believed JCPenney’s reputation was dwindling – its former golden days losing out to images of dowdiness. Sales had only risen 0.7 percent from December 2010 to 2011, against a 2.7 percent increase the year before, while in the same year competitor Macy’s enjoyed a 5.4 percent rise.

Replacing Ullman after seven years at the helm in 2011, Johnson spotted an opportunity and ran with it – a little too rapidly. He decided to apply Apple’s experiential approach, including its signature empty stores and quirky in-shop features like the Genius Bar, which he was the brain behind, to JCPenney. His vision, as declared in the company’s annual report that year, was to “return to the golden age of department stores, when retailers offered truly special experiences that customers loved.”

“He had a grand plan that he was going to turn JCPenney into some sort of upmarket store,” says Neil Saunders, Managing Director of retail research agency and consulting firm Conlumino. Scrapping discounts in favour of everyday low costs, Johnson slashed prices by around 40 percent, restricted sale tags to a few select items and introduced two dedicated discount days per month. He also implemented specialty shop-in-shops, introduced designer brands like Levi’s and got rid of staff formal dress codes in favour of a far more casual approach.

Q2 sales, 2014







The transformations came at a hefty cost; he projected a monthly expenditure of $80m on the ambitious project, which included plans to open new stores and introduce monthly services such as free haircuts and ice cream giveaways in the summer, mirroring Apple’s emphasis on the experience. His aim was to capture a younger target audience and bring the store in line with a technologically advancing world. “One of the key challenges is, how do you take a 110-year-old company and make it relevant?” he asked in the 2011 report.

However, ditching the coupon-based strategy Ullman had implemented, while reducing stock to create a more minimalist atmosphere, backfired and the company fell into decline and revenue loss. “The unfortunate reality was that he underestimated the level of addiction the American consumer has to sales and discounts,” says Hill. “When you factor down the prices and the promotions, the prices were probably about the same. But it was the psychological factor.”

JCPenney saw its former customer base fade into the midst of its competitors and its losses hit almost $1bn, with revenue plunging by nearly 27 percent to $12.99bn between February 2011 (when Ullman was still CEO) to February 2012 (see Fig. 1).

The situation was so dire that Johnson, the same man so fervently celebrated for his Apple successes, was ousted in April 2013, just 17 months into his term. Shares had dropped 51 percent, its market capitalisation had plummeted from $6.84bn to $3.49bn according to a report by CNBC, and its comparison store sales slumped (see Fig. 2). “He just tried to turn JCPenney into something it wasn’t, and the result was catastrophic,” says Saunders.

According to a report by Yahoo!, investors didn’t hesitate to celebrate when Johnson was fired; stock shares saw a relatively sharp increase (almost 13 percent) in after-hours trading following the news. JCPenney was forced into making a quick decision, and former success story Ullman was called upon to step in and save the ailing department store. His strategy was to destroy everything that Johnson had implemented and take Penney “back to the future”.

“There was a complete backlash against what Ron was attempting to achieve, and there was very much a focus on going back to the way JCPenney was before,” says Hill. Other former Apple executives left, he got rid of the brands that weren’t working and hauled back the discounts – much to the temporary damage of the business’ margins.

JCPenney continued to suffer and in May 2013 resorted to a five-year $2.25bn loan from Goldman Sachs in order to secure essential funding for the business; the move assured investors that the store would avoid defaulting on its $200m bond debt repayment due for October 2015.

In early 2014 the crisis continued. The company closed 33 stores and made 2,000 staff cuts as part of the turnaround strategy. Ullman started to implement a second layer of initiatives including a renewed emphasis on the retailer’s private brands, a reinvigoration of the home department (which suffered under Johnson) and increased online activity.

JC Penney Comp Store Sales
Sources: Valuewalk, JCPenney, Nomura. Notes: Figures for 2014, Nomura estimate

The turnaround
After months of slogging away to restore the retail chain’s former glory, through a (somewhat uniquely) regressive process, the market began to refocus its attention on the business. Reuters said in May 2014 that the CEO’s turnaround strategy was paying off, with the company reporting a 6.2 percentage point increase in same store sales in the first quarter of the year. That marked the second consecutive quarter rise after nine quarters of falling sales. Going back to the pre-Johnson model saw JCPenney’s shares rise by over 25 percent in after-hours trading.

In August this year JCPenney reported a six percent rise in second quarter same store sales, with total sales amounting to $2.8bn. The Financial Times reported that while competitor Macy’s suffered from a six percent decline in shares in one week in mid-August, JCPenney had the smallest fall at 1.8 percent. Gross margins grew, from 30.8 to 33.1 percent year on year, as a result of a reduction in the number of discounted items. “Clearance sales were less than 15 percent of the total sales for the quarter, in line with historical rates,” the company’s CFO Ed Record said in a conference call to discuss JCPenney’s second quarter performance, stating his belief that they were “on track to re-establish JCPenney as a leading moderate department store in America.”

Then in September 2014 the business struck a $400m unsecured bond. Reuters reported that JCPenney would have been able to pay off its three outstanding debts (totalling $685m) without it, with credit rating agency Moody’s stating that the firm had $847m available cash as of August 2014. A source said the deal was a positive move to prove the company’s ability to draw on debt capital.

Despite the excitement surrounding JCPenney, that bond highlighted the company’s continued reliance on debt. Add that to the fact the company reported a net loss of $352m in May, and in October lowered its third quarter sales guidance, and the picture isn’t quite so rosy. Although some praised Ullman on his strategy, his reputation wasn’t completely without its flaws. When it was announced that he was returning as CEO in 2013, stock dropped 21 percent in after-hours trading and Hill says Ullman was a last resort.

Innovation is key if JCPenney wants to gain further ground in an increasingly competitive and technologically focused market

There are further flaws. As Saunders points out, the supposedly strong rates of sales growth over the past three quarters are relative to sales figures that plummeted to an all-time low. “It’s very easy to see strong sales growth when you’ve had a 20 or 30 percent decline,” he says.

“Analysts have got very excited about these numbers… and I’m a bit more cautious. I think we’ll start to see some pretty weak levels of performance, maybe as we move into next year and come up against strong comparatives.”

JCPenney indeed continues to fall behind the big names it once contended with. Macy’s $6.27bn second quarter sales this year dwarf JCPenney’s celebrated $2.8bn – and that’s before someone like Walmart is even considered (boasting sales of $119.3bn for the same quarter). “Ron’s effects are still being felt because it did a lot of damage and it’s going to take a lot of time to win back customers and get them spending,” says Saunders.

JCPenney aimed to cut capital expenditures to a tight $250m in 2014. That’s an ambitious goal given that capital expenditures amounted to $1bn back in the golden days of 2007, and Saunders believes a continuation of those cutbacks in the long-term would have a negative impact. “It’s fine to cut that capex in this period of transition when the business is trying to swing back into profitability, but unfortunately the price of doing business in retail at the moment is that you do need to spend money to innovate,” he says. “Over the medium and long term if you maintain a lower level of investment it eventually catches up with you and you will pay – it will cost in terms of sales.”

Innovation is key if JCPenney wants to gain further ground in an increasingly competitive and technologically focused market, but it’s also what brought the business down in the first place. Like other retailers, the company is caught between a rock and a hard place. It needs to strike a balance between maintaining convention and embracing innovation; between recapturing a more traditional demographic and attracting a younger and more technologically advanced one. JCPenney’s success hangs on Ellison’s ability to walk the line between the two.

Ron Johnson biography infographic

Striking a balance
Johnson’s failure went some way in showing the risks a tech giant can take that a non-tech one can’t. Available funds are first and foremost the make or break. While Apple had strong gross margins, Penney didn’t; while tech shoppers are driven to a store for a specific product, department store customers aren’t; and while Apple can empty its shop floors to create a pristine, design-driven brand, JCPenney can’t.

But Hill believes that such innovation combined with the right pricing strategy – something Johnson is widely conceived to have got wrong – could take JCPenney to the next level. “The key issue with the Johnson administration was not that they came up with these innovative approaches to retail. It’s the fact they did not test.” He cites simple moves such as providing wi-fi so customers can search merchandise information in-store as the way forward, and believes experiential shopping could sit well with clothing stores. “With Apple you get to immerse yourself in the experience – that could certainly live within a department store environment, particularly in the home area.”

That’s a reality big-name retailers are starting to realise. British store Marks & Spencer recently opened an e-boutique in the Netherlands, where customers can view clothing samples in the shop on a digital clothing rack via a life-sized screen and then order products online. Sunglasses brand Chilli Beans launched a flagship concept store in Brazil, where customers can try the brand’s full range in a modern environment that also offers quirks like breakfast, a beer machine and stage shows.

Other large retailers are, like JCPenney, struggling in a changing consumer market; British supermarket chain Morrisons has hit the news repeatedly this year for its decline, while global player Tesco has likewise struggled. Tesco saw a 2.4 percent drop in sales last Christmas from the previous year in like-for-like sales and, according to recent reports, overstated its first and second quarter profits this year by around £250m ($405.8m). These retailers need to adapt their business model in order to regain consumer trust and survive at a challenging time.

Ullman was starting to implement basic innovation through a multi-channel strategy that combined online and store-driven sales; that seemed to be having some effect, with CFO Ed Record reporting a 16.7 percent increase in online sales in the second quarter compared to the previous year. Those sales were still in the negative, however, and those initiatives need to be accelerated by Ellison when he steps in next year if JCPenney is to return to profitability.

Myron Ullman biography infographic

Moving forward
Both Hill and Saunders are optimistic about JCPenney’s future in the long-term. But Ellison needs to go beyond the back to basics strategy taken by Ullman and use the type of experiential and technologically advanced approaches promoted by Johnson, to bring the business forward in an increasingly innovative market. If he can combine them with the right pricing strategy and testing to avoid the pitfalls of both his predecessors, then he may be able to bring Penney back to profitability.

Even then, Saunders believes the era of department stores is over. “They’ve had their heyday and they’re a shopping format that was very relevant to American consumption and we’re not at that point any more,” he says.

But according to Hill, department stores still account for around $180m of a US retail market worth over $4bn, and online sales still only make up approximately 10 to 12 percent of retail sales in the US – which means in-store continues to represent around 90 percent of all transactions. With that in mind, a market surely remains for ailing retailers like JCPenney – the challenge is how to approach it.