By  on January 19, 2007

Things appear to be clicking so far for J.C. Penney and Sephora.

After only three months of selling, the chiefs at Penney's and Sephora are not about to break out any projections or pass judgment on their groundbreaking experiment in melding the two retail cultures together with a series of in-store Sephora boutiques. But clearly they are encouraged by the initial results.

One of the brightest spots in the preliminary data comes via the Internet. Higher than expected traffic of customers through Penney's giant Web business and onto the link with the Sephora site suggests that Penney's customers are at least curious about Sephora, and it may further indicate an affinity for the more upscale Sephora merchandise mix. A number of the beauty chain's star vendors, who also are participating in the boutique experiment, say many of the same products that sell in the general prestige market are also being snapped up by the Penney's customer, suggesting a degree of compatibility between the cultures.

Myron E. Ullman 3rd, chairman and chief executive officer of the $18.7 billion Penney's, described the site traffic as "terrific" and said he is "pleased." For the boutiques, in general, the contents of the typical shopping basket of purchased products represent more of a selection usually found in Sephora's freestanding stores than in Penney's. He also noted that fragrances are achieving a higher proportion of sales than is found in Sephora's other freestanding stores and the number of male customers is higher than was expected. "We want to look at the men's business," Ullman added, noting that the boutiques have entrances on four sides, making them more accessible.

The first five boutiques opened at the end of September. One was a 2,000-square-foot unit in a new off-mall Penney's in the Alliance Town Center in northern Fort Worth. Others opened in the Queens Center Mall in Queens, N.Y.; the Aventura Mall, north of Miami; Arden Fair Mall in Sacramento, Calif., and the Glendale Mall in Glendale. Calif. The in-store boutiques average between 1,500 square feet to more than 1,800 square feet, with some measuring 2,000 and 3,000 square feet — making the average boutique about one third the size of a 4,500-square-foot traditional Sephora store.The average boutique stocks more than 50 brands, with 3,000 stockkeeping units, compared with 8,000 for a typical Sephora. The merchandise mix is eye-opening for a midtier giant like Penney's. The assortment ranges from kicky cool girl staples like BeneFit Cosmetics to newly emerging niche darlings like Bare Escentuals to the highbrow derm brand N.V. Perricone to loads of designer and celebrity fragrances.

Ullman said that the second wave of installations in 19 stores is now under way. "We have plans beyond the spring," he said, adding that the details have not been released. In addition, Sephora has another 142 freestanding stores outside of Penney's orbit.

When the two retailers were planning the first five installations, three immediate objectives were critical in their minds, said Ullman. First, the organizations wanted to build units that had the Sephora look and feel— "that wasn't just a couple of counters." Second, they wanted a balanced and compelling assortment of makeup, skin care and fragrance, "so the business could seek its own level." Third, the selling associates had to be as well-trained, knowledgeable and helpful as those found in the regular Sephora stores.

On all three measures, Ullman declared, the experiment scored "an A-plus."

"Customers comment that the installations 'look just like Sephora,'" he noted. In terms of assortment, "We have everybody we needed and wanted to get." For the third test, Sephora sent in its crew of undercover shoppers and the results were as good or better than in Penney's regular stores.

In terms of initial volume, he described sales as "ahead of plan," without offering figures. However, he cautioned, "It is the early days."

There of course has been some grumbling in the market from observers who thought the business should be stronger. And some industry sources complain that adding two retailers together results in higher margin demands. Asked to comment, Ullman was forthright. If a margin is a few points higher than normal, Ullman said, it's because the company is providing additional services, such as training the staff, instead of letting the vendor do it. "The net to investment that the vendor gets is the same or more favorable," he said.The collaboration between the two companies is unusually interlaced and sophisticated. One Wall Street analyst, Bob Buchanan of A.G. Edwards & Sons, who covers J.C. Penney, said, "I believe the whole approach and process would be simpler if Penney's would let Sephora run the show," adding that the specialty retailer brings the beauty merchandising and selling expertise that Penney's lacks. He noted that U.S. department stores are gun-shy about leasing space to vendors, but that a number of retailers in Canada, Europe and Asia successfully turn over sections for their stores to vendors.

David Sulitaneau, president and ceo of Sephora in the U.S., sees added meaning in the Web site traffic. Eighteen months before Sephora opened its first Canadian store in 2004, shopping was opened up north on the Web site. "It was extremely predictive," Sulitaneau noted, implying that a similar boom could be in the offing in the Penney's venture.

Referring to the Penney's experience, Sulitaneau said that "a huge majority of clients are first-time Sephora shoppers on [the Internet site]. We have fairly sizable evidence that these shoppers are not Sephora shoppers." He added, "It's actually better than we had guessed. It feels really strong." On the key question of whether the Sephora and Penney cultures can be married, Sulitaneau is upbeat. "This is largely new merchandise to them, and they looked at it and embraced it in the same way," he said. "The fact that it is comfortable to them, I would say that is very encouraging."

Sulitaneau also gave high marks to the job done on the three criteria and asserted that the organization did "a great job of capturing a distilled version of a larger Sephora." He also seemed pleased on how the service component turned out and the achieved efficiencies in the product pipeline. "We are in stock at a rate as good or better than what we see in our freestanding stores," he said.

But despite the high grades and happy news, Sulitaneau is cautious. He stressed the importance of paying attention to the level of consumer interest, rather than drilling down into the numbers, because many of these in-store encounters are first impression or first purchases. "We have to be careful not to fast-forward," he said, apparently referring to the industry habit of extrapolating projections.Now that the first installations are open, Sulitaneau said this will be the year for fine-tuning the merchandising, both in brand assortment and promotional strategy. Ullman noted that one goal for the future is to nurture skin care as a more important part of the mix. As a former top executive at LVMH Moët Hennessy Louis Vuitton, who shepherded Sephora in its earlier days, Ullman pointed out that the French perfumery chain gradually built its treatment business into a potent segment.

In Sulitaneau's view, 2006 was the year "we dipped our toe in the water. Then in 2007, we're putting the rest of our foot in. The water level will begin creeping up the body in 2008."

The reaction of vendors ranges from optimistic to lukewarm. "So far so good," said Shashi Batra, president of Perricone, who added, "it's slightly better than we thought it would be. The percentage of skin care is good. We continue to rank among the top brands."

Batra noted that Perricone's top seller in the Penney's boutiques — $100 Face Firming Activator — is also the overall top seller for the company. Speaking from a visual standpoint, Batra said the sight of Sephora in Penney's is "like a UFO landed in the store." It was a similar situation, he said, when MAC Cosmetics entered Macy's.

Two of Sephora's star brands — Bare Escentuals and Philosophy — are also TV stars on QVC. Leslie Blodgett, ceo of Bare Escentuals, said of Sephora-Penney's, " I really think this concept is brilliant." Her brand has built consumer awareness on TV, and the company's biggest challenge is to build a distribution network where the customer can find the product. "I have a customer waiting," she said, noting that Penney's and Sephora have yet to roll out a promotion campaign. "Once customers learn about it," she said, "it's going to be incredible."

At Philosophy, Ray Reed, executive vice president of sales and marketing, said, "We are very pleased with our skin care performance." The brand's best seller is the Makeup Optional Skin Care Kit, priced at $68. He added that initial sales are right on projection and that the buying tastes of the Penney's customer "demonstrates a similar purchasing behavior to the regular Sephora customer."Stacey Levine, ceo and co-founder of GoSmile, said she is "very optimistic" about the Penney's venture, considering that its leading seller is a $120 kit. She said, "It's about the future — tapping into a consumer I don't really communicate with right now." Of the Penney's customer, Levine said, "She's bright; she's just careful and cautious. She spends as much on beauty [as a Sephora customer], just not there."

At least one industry executive questioned whether the middle-aged Penney's shopper would warm to the youth-oriented color cosmetics lines favored by Sephora. That point was answered by Jean Ford, co-founder of the decidedly youthful BeneFit Cosmetics. "I've never known a women in her 40s who was not intrigued by makeup," she said, noting that when she visited Sacramento's Arden Fair Mall, she encountered plenty of middle-aged customers who seemed curious about the brand. She described the phenomenon of a 45-year-old woman, who was in Penney's shopping for sheets and also shopping for BeneFit. But she cautioned that it is prudent to withhold judgment until a body of repeat purchases develops, with the formation of a customer base.

Terry Darland, general manager of Christian Dior Parfums North America, a division of LVMH Moët Hennessy Louis Vuitton, said Penney's venture has produced a modest improvement and no negative impact. Dior distributes its fragrances through Penney's vast chain, as well as in the Sephora boutiques. Without quoting numbers, she said the Sephora units are doing twice as well as the regular Penney's doors elsewhere, but only on a par with retailers in the rest of Dior's prestige distribution. "I don't see any negative impact," she said. "It's not like it's taking business away."

With contributions from Molly Prior

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