A Penney Saved

A deft turnaround buys time, but what's in store long-term for the venerable retailer?

In retail, finance follows fashion. In what other business would a Goldman Sachs analyst ask a CFO (in this case, Federated Department Stores CFO Karen Hoguet) whether the “acceptance of the early fall color palettes — lavenders and berry and green and so on” — constitutes an earnings risk?

But the gloss of fashion belies the vicious shelf-to-shelf combat among Federated, Penney, Kohl’s, Dillard’s, and Sears. Midrange department stores are fighting for a shrinking pie. “Retail is a zero-sum game,” explains Asaeda. “Each gain in sales for one store equals a loss for another.”

“Middle-to-upper-middle-income consumers are trading up to higher-end retailers,” observes PiperJaffray analyst Jeffrey Klinefelter. At the same time, discounters like Target and Wal-Mart are eating away at sales of fashion “basics.” (As Wal-Mart CEO Lee Scott recently remarked to the Wall Street Journal, “even CEOs” buy their underwear at his stores.) And as in fashion, strategies in retail are constantly changing and easily copied.

Where Penney Fell Short

Today’s retail reality took the venerable Penney by surprise.

Company founder James Cash Penney was famously frugal. A replica of his first store counter — built from the packing crates in which his merchandise arrived — is on display at the company’s headquarters. But elsewhere in the sprawling office park, built in 1992, is evidence of a more recent period of management complacency.

“That’s the Penney of the 1990s,” explains longtime investor-relations executive Eli Akresh, after this reporter returned from a trip to an expansive private bathroom in a darkened, empty executive suite.

Even more emblematic of that era is a state-of-the-art television studio. Penney was one of the last retail chains to leave control of merchandising decisions in the hands of local store managers. From the studio, buyers would broadcast the selection of wares to store managers, who decided whether and how much to buy. “The centralized merchants did not have authority over how much to buy or how to promote it,” recalls Cavanaugh. Many stores also made independent purchases. “Anyone with a van could sell to our stores,” he says.

That setup was the legacy of the “Penney Partnership,” an expansion model used until 1929 in which managers of new stores put up one-third of the equity capital. “In the old culture,” recalls Cavanaugh, “everyone was told, ‘You are working for the stores.’ The stores knew what was right because they served the customers. Today, everyone is working for the company.”

What worked beautifully for 90 years became a disaster in the mid-1990s, as competitors began perfecting centralized merchandising and inventory systems, which permitted daily updates on sales of individual items in each store. (Ironically, the man who pioneered the new supply chain — Sam Walton — got his start at Penney.) By contrast, says Cavanaugh, “we didn’t know what any store had.”

Worse, the decentralized system stretched out lead times. “Fashionability was changing much more rapidly,” says Cavanaugh. While competitors filled shelves with a single hot-selling item, Penney’s store managers hedged their bets with variety. Unwanted items swelled inventory, while popular items quickly ran out.

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