DOES MACY'S HAVE A PRAGMATIC E-COMMERCE STRATEGY?

Macy’s Fights Downward Spiral With Bet on Off-Price Backstage Stores

Famed department store seeks answers as sales slide; CEO tries discount stores

ENLARGE

Macy's Herald Square store has been hurt by a decline in tourism. Fewer international travelers are visiting the U.S. because of the strong dollar. Photo: Michael Nagle/Bloomberg News

By

Suzanne Kapner

Suzanne Kapner
The Wall Street Journal
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• BiographySuzanne Kapner
• Suzanne.Kapner@dowjones.com

Nov. 11, 2015 9:16 p.m. ET

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For more than a decade, Macy’s Inc. M -2.99 % boss Terry Lundgren has defended the traditional department store—gobbling up other retailers, testing out new selling formats and trying to clamp down on discounts, to name a few tactics.
Now, after years of strong growth, Macy’s faces a crisis. On Wednesday, the company said sales declined 5.2%, worse than analysts had feared. And the retailer, which is heading into the crucial holiday season with piles of unsold goods, also warned that it expects comparable sales this fiscal year to decline, compared with previous guidance for sales to be unchanged.

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By Wednesday afternoon, shares of Macy’s fell 14% on the news, to $40.44; the stock has dropped nearly 40% this year.
“The retail industry is going through a tough period,” said an unflustered Mr. Lundgren on a conference call with analysts. Later, he added, “I’m certain we will come up with some creative ideas that will surprise people.”
He noted that while consumer spending seems healthy, many shoppers are buying goods and services that department stores don’t carry, such as cars, electronic gadgets and home improvement items.

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But with the stock falling to its lowest level in two years, some retail veterans wonder how many surprises Mr. Lundgren has up his sleeve.
“Macy’s has been so successful for so long with its core format that it blinded them to the ways that consumer shopping behaviors were changing,” says Craig Johnson, president of Customer Growth Partners, a research firm. “Terry and the board have since had a ‘come to Jesus’ moment,” he adds, noting that “the fix isn’t going to happen overnight.”

Activist pressure

Adding to the pressure, Mr. Lundgren may now find himself facing off against activist investor Starboard Value LP, which took an undisclosed stake in the retailer this summer. The fund has urged the company to spin off its real estate, a move it previously said could lift shares above $125. Macy’s said on Wednesday that it had ruled out creating a real-estate investment trust, because it didn’t want to be saddled with extra debt and expensive lease payments.
An official at Starboard declined to comment.
The Macy’s board is so far rallying around Mr. Lundgren, believing that he needs time for his plans to pay off, according to a person close to the situation. “It’s a tough environment. It’s a reboot time,” the person added.
“The fact that Terry has had one bad year is not an indication that he’s been in the job too long,” said Allen Questrom, who has run Macy’s, J.C. Penney JCP -8.92 % and other retail chains and helped recruit Mr. Lundgren to his first retailing job, at Bullock’s. “What Terry is doing, unlike a lot of people, is trying different things as the market changes.”

ENLARGE

Under Mr. Lundgren, Macy’s has rarely been a company in a hurry. It took the company three years to build a feature that shoppers could add to their Facebook FB -0.86 % page. The innovation was soon disabled after no one used it. In a stark example of the retailer’s slow decision-making pace, its latest concept—now hotly touted by executives—was debated for six years before finally getting the green light.
The new business, called Macy’s Backstage, is meant to compete with T.J. Maxx, Marshalls and other off-price chains. It could potentially address the overflow of goods on Macy’s floors while helping to bring in coveted new customers who don’t relate to old-line department stores.
Some analysts say it will be hard for Macy’s to find equilibrium, even as it meanders into the competitive off-price business. “It feels like too little, too late,” says Joan Payson, a Barclays analyst.
Other department-store chains, after all, have long embraced the outlet concept. First there was Nordstrom Rack, followed by Neiman Marcus Group’s Last Call. Saks now has 90 Saks Off 5th locations—no-frills stores that sell name brand goods at deep discounts.
Mr. Lundgren and his lieutenants had thought about jumping into the fast-growing market back in 2009—but stalled.
“Macy’s didn’t need a new concept at that time,” recalls Peter Sachse, the retailer’s chief for innovation and business development, who presented the off-price idea at a 2009 board meeting. “We had plenty on our plate,” he adds, noting the company was still digesting its merger of America’s biggest department store chains. Instead, it opened outlet stores for its smaller Bloomingdale’s unit.

Backstage stores

The first five Backstage stores opened this fall, and Macy’s said on Wednesday that it plans to roll out 50 more over the next two years. Mr. Lundgren is also tiptoeing into China with an online store, and expanding Bluemercury, a successful chain of high-end beauty stores the company bought earlier this year. The CEO plans to close 35 to 40 weaker Macy’s locations and redevelop dozens of others to make them more productive.
“You can’t just stop and assume that growth will continue without doing things differently,” the 63-year-old Mr. Lundgren said in an interview earlier this year.
Not long ago, Macy’s was in a much more favorable spot. In the years following its 2005 merger of Federated Department Stores Inc. and May Department Stores Co. that created the current company, it saved millions of dollars by consolidating divisions. It enjoyed economies of scale in everything from marketing to merchandising.
As the first department store chain with a coast-to-coast footprint, it reaped the benefits of national advertising and used its size to win exclusive deals from suppliers. It also bet heavily on five core brands: Ralph Lauren, Calvin Klein, Tommy Hilfiger, Michael Kors and the private-label INC.
But even as Macy’s solidified its position as the leading department-store chain, it wound up consolidating a shrinking pie. Macy’s had a 44% share of department store sales in 2013, up from 33% in 2006, according to the latest Census Bureau data. Over that period, department stores’ share of general merchandise sales had fallen to 9% from 15%, a $20 billion drop.
At the same time, off-price chains were appealing to the frugality of consumers, who had remained price-conscious even years after the recession—something that Macy’s had noticed in its own department stores.

ENLARGE

Macy's CEO Terry Lundgren stands outside a Macy's Backstage store in Queens. He hopes the new format will help attract younger shoppers. Photo: Dorothy Hong for The Wall Street Journal

To borrow industry lingo, Macy’s shoppers had long had an “opening price mind-set,” which means they often waited for sales. During a meeting in the fall of 2014, the team in charge of men’s store-brand sweaters noted that customers were waiting for the nicer items to get marked down to the same price as more basic sweaters before buying them.
Off-price retailers didn’t make shoppers lie in wait—and it showed. Their sales grew 44% to $39 billion from 2009 to 2014, according to Customer Growth Partners. TJX TJX -5.07 % Cos., parent to T.J. Maxx and Marshalls, now has a market value more than triple that of Macy’s—even though TJX’s sales, at $29 billion, are only slightly higher than Macy’s $28 billion in sales.
Still, Macy’s stayed on the sidelines.
A week before the 2014 Labor Day weekend, Vanessa LeFebvre, who was overseeing junior sportswear for Macy’s, received a call from Mr. Sachse asking her to attend a meeting with about a half dozen colleagues. Ms. LeFebvre had worked for TJX and Daffy’s, another off-price retailer, and Mr. Sachse wanted her input on whether Macy’s should launch an off-price chain.
That fall the group commissioned a study from Bain & Co., which asked consumers who shopped at off-price chains which retailers they had stopped visiting in the past year. The No. 1 answer: Macy’s.
The message sank in. “If we’re going to donate share to the off-price market, I’d rather donate share to ourselves,” says Mr. Sachse, about Macy’s decision to finally jump into the off-price business.
Mr. Lundgren, a self-described clothes horse who designed his wife’s wedding dress in 2005, often jokes that he has been hearing about the death of the department store since he started his career in 1975 at a Bullock’s store in Los Angeles.
In the late 1990s, when he was CEO of Federated, he pulled together a group of executives and charged them with reinvigorating the format. Their ideas, which were tested in a store in Columbus, Ohio, included installing a day care center where customers could drop off their children while they shopped and adding shopping carts, both of which flopped.
A few of the changes caught on and were adopted in all the stores, including better signs to make the vast stores easier to navigate and scanners where shoppers could check prices.

China partnership

In 2014, the CEO toured China with Victor Fung, the chairman of Li & Fung LFUGY -2.76 % Group, which sources products for Macy’s. From those conversations came a partnership between Macy’s and a Fung subsidiary that enabled Macy’s to sell products online in China beginning last week. Mr. Lundgren also reopened the discussion about launching an off-price chain.
“We’re either going to have a share of that business or let it happen around us,” Mr. Lundgren says.

ENLARGE

By the end of October, Mr. Sachse’s handpicked group had presented their off-price plan to the executive committee. Board approval came in November, and Macy’s began looking closely at how off-price retailers operated.
At a December meeting, executives told a group of about 100 employees to make sure they visited outlet stores when they shopped the competition, according to a person who was there. In the past, comparison shopping had mainly focused on direct rivals such as J.C. Penney Co. and Nordstrom, this person says.
The executives also showed slides of T.J. Maxx merchandise displays and talked about how the chain wasn’t afraid to bet big on specific items and “really stand for something,” this person says.
By April, five months before the first store was scheduled to open, the new concept still didn’t have a name, so executives asked Macy’s employees to choose one. Several employees came up with Backstage, which was meant to convey the thrill and entertainment of shopping.

Market Talk

Macy’s to Open Some Backstage Stores in Existing Department Stores
Of the 50 Backstage stores that Macy’s plans to open, 10 will be located in its existing department stores—an unusual strategy that poses risks for the chain. Retailers have preferred to keep their off-price stores separate from their full-price stores so as not to tarnish their mainline brands. Off-price stores sell many of the name brands carried at full-price stores but at steep discounts. Macy’s CEO Terry Lundgren said he could envision carving out 20,000 to 30,000 square feet in the apparel sections of underperforming stores for the Backstage locations in an attempt to make those stores more productive. (suzanne.kapner@wsj.com)
Market Talk is a stream of real-time news and market analysis that is available on Dow Jones Newswires.

Buyers were soon scouring manufacturers’ showrooms for trendy merchandise like fringed leather handbags and cowboy boots to stock the new stores.
But while the Backstage stores will function as a clearance outlet for Macy’s goods, they will differ from some other department-store outlets by carrying brands that aren’t sold at Macy’s—including those aimed at younger customers such as E.l.f. cosmetics, Haute Hippie and Splendid. Ms. LeFebvre, who was named senior vice president of Macy’s Backstage, says that the mashup is meant to attract millennials and other shoppers who don’t spend much time in department stores.
One secret to the success of T.J. Maxx and other off-price chains is their buyers have the authority to make deals on the spot, industry executives say.
“At Macy’s everything is done by committee, and it can take two-to-three weeks to get a decision,” says Stephen Milstein, a senior executive with Burlington Stores Inc. BURL -5.83 % from 1978 until 2006. “I don’t know if Macy’s has the mentality to pull off an off-price chain.”
Mr. Lundgren says Backstage executives all have experience working at other off-price chains and know how to operate on short lead times. Ms. LeFebvre says her buyers operate independently from those at Macy’s. She argues that Macy’s has the advantage of already having deep relationships with suppliers—ensuring that it gets first dibs at overruns and other off-price products.
On a recent morning, a Backstage store in Queens, New York had “finds” that shoppers have come to expect from off-price chains, including a Cinzia Rocca wool coat priced at $699.99 compared with the regular retail price of $1,047.
But most of the goods were far less expensive. The low prices appealed to Janice Erandio, 41 years old, who was buying a pair of $20 Rampage boots for her daughter. “The prices are really cheap,” said Ms. Erandio, who works for a film distributor.
Meanwhile, the shopping carts that flopped at Macy’s have made a comeback at the new Backstage stores. With bright lights, banks of registers and a single-story layout, the stores have a bare-bones aesthetic.
That didn’t seem to bother Patricia Garcia, a 54-year-old housekeeper, who was browsing at a Backstage store in Queens on a recent afternoon. “I feel like I’m in a T.J. Maxx.”

—David Benoit and Joann S. Lublin contributed to this article

Write to Suzanne Kapner at Suzanne.Kapner@wsj.com

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