By and  on April 12, 2006

NEW YORK — From practically day one on the job as J.C. Penney chairman and chief executive officer, Myron Ullman 3rd felt his store needed to generate some real buzz. Now Penney's is ready to rock the industry with a plan to open Sephora shops inside Penney stores.

The LVMH Moët Hennessy Louis Vuitton-owned Sephora and J.C. Penney announced Tuesday that they are forming a joint initiative that will entail installing Sephora-branded store-in-store departments in Penney's units, taking Penney's back into beauty after a three-year absence. The departments are expected to be substantial —1,500 to 1,800 square feet — and will carry many of the brands that are sold at Sephora. Sephora carries more than 250 prestige brands, from high-end hair products from Frédéric Fekkai to lipsticks by Clinique, Lorac and Stila.

The first departments under the deal are expected to bow as early as this fall and will continue to roll out through next year. No locations were disclosed, but Ullman said that next year, the focus will be on opening Sephora shops in new Penney's locations. Penney's expansion is focused on off-mall sites.

Ullman said it was not a leased arrangement or a vendor retail arrangement. He described it as a joint venture that's "jointly incentivized."

Penney's exited much of the beauty business — keeping only a few color cosmetics gift sets and a few skin care brands and salon space in some of its stores — in early 2003, giving its accessories departments bigger play. In retrospect, Ullman acknowledges that this may not have been the best choice — and first said so publicly in January 2005, just 44 days into his job at Penney's.

"The traditional department store has really owned prestige beauty brands," said Ullman. "We have to take a look. We have one of the biggest salon businesses in the country and we might want to think of some aspects of beauty that we don't have in the salon."

On Tuesday, clearly ready to reenter the category, Ullman emphasized that the lessons learned last time around would aid Penney's beauty efforts going forward. "We learned that beauty wasn't successful for us last time — but we also learned that our customer had not given up on the beauty category, and she wanted us to be carrying it," said Ullman. "When we began discussions, Sephora made a compelling, exciting case for putting their concept in our stores."Beauty is familiar ground for Ullman, who dealt with the beauty market during stints at LVMH Moët Hennessy Louis Vuitton and Duty Free Stores. In fact, Ullman, while reporting to Bernard Arnault at LVMH, hired Sephora USA's current president and ceo, David Suliteanu, to manage Sephora's transition to the American market, which it entered in 1998 with a SoHo store here. Earlier in their careers, both men worked at Macy's and Foley's.

By proceeding slowly, the pain may be eased, and cosmetics brands and Sephora will be able to carefully gauge the impact of the Penney's program, and also allow Penney's to tweak the in-store shops before deciding on a full-scale rollout. According to Ullman, Sephora in Penney's "will be exactly the same presentation as a Sephora mall store, but obviously smaller. It will have the same look and feel," with Sephora open-sell gondolas and wall linears, allowing customers easy access to products. The shops will be staffed with product consultants trained under the Science of Sephora education program. Ullman also said that the Sephora U.S. team, led by Suliteanu, will assort the Sephora shops. "Obviously the merchandising, animation and much of the marketing expertise will be primarily from the Sephora side," whereas operations and customer contact will be Penney's domain. Running the business will be a team effort, Ullman said. "Essentially, David and his team will assort the store as they would any other Sephora store," he said, adding that "the 15 most important brands to Sephora are 100 percent behind the venture."

Added Suliteanu: "The Penney's spaces will be smaller and they will have a different footprint, but they will carry the same brands at the same price points as we sell them in traditional Sephora stores."

Sources did note that Penney's Sephora presentation will be much smaller than other department stores. One source said that department stores typically allocate from 5 to 8 percent of total selling space, meaning a 200,000 square foot store will devote about 10,000 to 15,000 square feet. A major flagship, such as Saks Fifth Avenue here and Bloomingdale's at 59th Street, devotes 25,000 to 30,000 square feet to cosmetics.

Traditionally, prestige brands largely have restricted their distribution to better department and specialty stores such as Bloomingdale's, Macy's, Saks Fifth Avenue, Neiman Marcus and Nordstrom. With Sephora soon to sell Penney's, cosmetic brands are likely to hear from the stores to which they have long sold. However, Suliteanu is not expecting major resistance from Sephora's brand partners. "The brands that I've spoken to personally see this move as universally positive," he said. "They see it as yet another way to grow their businesses and add distribution in a way that's consistent with their brand strategies.""I think it's a good idea with a lot of potential," said Edgar Huber, president of the luxury products division at L'Oréal USA, on Tuesday. "It's a very smart move for Penney's to sub-contract their cosmetics department, and I think [Ullman] has a clear vision to make it successful." Huber said he has not yet discussed with Sephora which, if any, of his products will enter the Sephora at Penney's doors; the retailer currently sells the L'Oréal-owned Lancôme, Shu Uemura and Biotherm brands, as well as the Giorgio Armani and Ralph Lauren Fragrances lineups.

"It's an interesting development in light of all of the changes in our distribution going on at the moment," said William Lauder, president and ceo of the Estée Lauder Cos. He declined to comment further.

Donald Loftus, president and ceo of P&G Prestige Products Inc., said, "We recognized that there is room in the retail landscape for another giant."

Industry analyst Allan Mottus said, "It's a brilliant strategic move."

The middle-market department store market has become hotly contested territory for prestige and mass market beauty manufacturers lately, particularly in the wake of the Federated Department Stores-May Department Stores merger last year. That merger has resulted in the closure of about 80 doors to date — eliminating overlap in malls and satisfying governmental regulatory concerns — and more cuts are likely. Prestige companies, in particular, have been actively searching for ways to make up that lost revenue, making Penney's 1,019 stores in the U.S. and Puerto Rico increasingly attractive to marketers. At the time that it pulled most beauty brands out of its stores, Penney's was generating about $300 million in cosmetics sales annually. The last major beauty project for Penney's was a short-lived partnership with Avon to distribute BeComing, which took the moderate beauty brand — which included color cosmetics, aromatherapy and skin care — into an open-sell environment in 90 Penney's stores from fall of 2001 to the beginning of 2003. Sales at Penney's fell short of expectations and the two organizations dissolved their partnership.

The BeComing boutiques were smaller than the planned Sephora installations — 400 to 1,000 square feet for BeComing, as compared with the 1,500 to 1,800 square feet being planned for the Sephora departments. While Sephora's freestanding locations greatly vary in size, Sephora's larger stores are generally 4,200 to 4,500 square feet.The Sephora partnership is clearly a win for J.C. Penney, for whom the deal will be all plus business. It's less clear why the move is a win for Sephora, although several analysts speculated that LVMH's pressure on its divisions to grow by double digits likely contributed to the decision (see related sidebar). "Certainly, the cosmetics brands will face pressure from department stores, which are very zealous about their dominance in the branded cosmetics industry," observed Arnold Aronson, managing director of retail strategies at Kurt Salmon Associates.

"This is a big, big problem," said one department store executive. "Cosmetics companies have got themselves one hell of an issue. It's upmarket for Penney's, down-market for Sephora and substantially down-market for the quality brands inside Sephora. Some will have to make a decision about whether that is what they want to do with their brands. The problem is the cosmetics guys have been hurt by the number of May doors disappearing."

"It's a very inspired move on their part, but the devil is in the details," said Isaac Lagnado, president of the consulting firm tactical.org. "I'm not sure in the short term it will be a major contributor to sales and margins. But when you get Sephora, you get the whole package of major prestige brands. That's been the bugaboo for Penney's for decades. This is a win for J.C. Penney. They're about to plug a long-standing hole in their assortments. The ability to compete toe-to-toe with department stores at the main entrance with credible brands is a major leg up. It builds up traffic and the fashion image and will be a calling card for synergies throughout the fashion divisions of the store."

"Our core strategy is to continue to aggressively open more Sephora stores," said Suliteanu. "That core strategy has not changed a bit. We will continue to open 30 or more stores a year, and the Penney's deal is completely incremental to that strategy.

"The most important benefit for us is the opportunity to dramatically expand the presence of the Sephora brand," continued Suliteanu. "And one of the nice things about this deal is the way that our stores are situated. There will not be a lot of overlap [between freestanding Sephora doors and Penney's Sephora departments]. There are millions of potential clients that we can touch, people we are not necessarily touching right now."Added Betsy Olum, senior vice president of marketing for Sephora: "J.C. Penney is a retailer in transformation — they are doing very exciting things, they have a loyal customer base and they're looking to add new brands. It's an excellent opportunity to reach new customers, for both Sephora and our brand partners."

Olum noted that the team would be an all-hands-on-deck structure, at least for the present time. "We're not in a hurry," she said. "We have a lot of learning to do and we want to make sure that we're doing everything right for all of our clients," she said. The Sephora Web site also will be referenced on the J.C. Penney Web site, which is said to garner more than three million hits a day.

Sephora was founded in France in 1969 and was acquired by Paris-based LVMH Moët Hennessy Louis Vuitton in 1997. Sephora Americas operates more than 125 stores in the U.S. and Canada. Sephora Europe has more than 400 stores in 11 countries and recently expanded into China. In the U.S., Sephora currently operates in 25 states, as well as on sephora.com, and expects to end this year with 144 stores in the U.S., 25 more than it operated at the end of last year. The most recent Sephora to open is in Nashville, the retailer's first location in Tennessee. While Sephora does not disclose sales numbers, industry sources estimated that the retailer could do about $1 billion in sales volume in the U.S. by yearend.

In addition to the Penney's deal, Sephora USA announced in March that it was teaming up with Klinger Advanced Aesthetics to begin offering spa services to Sephora customers. The first location — a unit that will be installed adjacent to an existing Sephora store — under the union is expected to launch in Dallas' NorthPark Center this summer.

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