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J.C. Penney to Invest $800M in Revamp

Program will result in $900 million in savings.

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J.C. Penney Co. Inc. has the money to reinvent and the will to cut — everything from staff to vendors to marketing spending.

This story first appeared in the January 27, 2012 issue of WWD.  Subscribe Today.

At least for now, Wall Street likes the message. Penney’s shares were the star performer in the retail sector Thursday, shooting up 18.8 percent on the New York Stock Exchange to $40.72 after chief executive officer Ron Johnson revealed his four-year road map to reinvent the chain and the retailer upwardly revised guidance for the year. The increase in its stock price was the highest for Penney’s in at least 30 years.

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The company disclosed it has set an $800 million capital budget to fund the first year of the reinvention, which is seen running through 2015. Penney’s also said it expects to realize $900 million in annual savings by 2013, largely through cuts in personnel at the Plano, Tex., headquarters, in stores and through reduced marketing expenses. The headquarters has 5,900 employees.

“The $900 million run rate will not be effective until 2013 but we will get a portion of that in 2012,” Michael Kramer, Penney’s chief operating officer, said Thursday during a meeting with analysts where Johnson and president Michael Francis followed up with further details on the retailer’s plans.

“The blueprint Ron and Michael outlined yesterday dramatically simplifies our operations and significantly improves the company’s ability to flow margins through to the bottom line,” Kramer said. “As we transform the business model, our teams are committed to improving sales productivity in our stores, generating 40 percent or better gross margins, while lowering expenses to industry-leading levels. Taken together, this creates a formula for long-term, sustainable profit growth. The $900 million we achieve over two years will allow us to operate at a sub 30 percent SG&A rate in 2013. This goes a long way to help fund the transformation.”

Penney’s has been losing ground to competitors such as Kohl’s and Macy’s and is challenged to raise its relatively low sales productivity of $200 a square foot.

On the merchandise front, Johnson said he’s open to adding categories currently not carried at Penney’s, like greeting cards; that he sees a reduction in private label as a percentage of Penney’s overall volume in favor of more global brands, and that he has no interest in “localization” of the merchandising, a swipe at the strategy adopted by Macy’s.

The $900 million in savings includes $400 million taken out at the store level — with about $100 million in reduced labor — a $300 million cut in advertising, and $200 million that will be carved out of headquarters.

On the brighter side, Penney’s, which has $1.09 billion in cash and cash equivalents on hand, said the reinvent program will be funded through the company’s own cash flow. The $800 million in 2012 for the transformation includes expenditures to create the first 10 new in-store shops and roll them out to all 1,100 Penney’s locations, as well as IT initiatives, merchandise changes and other steps to re-create the store experience. “There’s a lot in there,” Kramer said.

The Penney’s reinvent strategy calls for 100 shop-in-shops for private, national and global brands in the next three-and-a- half years, and a simplified “fair and square” pricing scheme starting Wednesday, with steadier everyday low pricing, month-long values and “best-price Fridays” every first and third Fridays of the month to clear slow-moving items. Also next month, Penney’s begins resetting stores with new merchandise and marketing on a monthly basis. Penney’s will stage 12 promotions a year, versus the 590 it did last year; move from selling 400-plus brands, many of which will be dropped, to 100 shops in the stores, and pare down the infrastructure.

“The reinvent plan dramatically simplifies and enhances the profit formula,” said Kramer. With the new pricing format, “Our merchants will be able to do what they do best — focus on product instead of pricing cadence.” He also said Penney’s suffers from “excessive granularity” and too many levels of management. “We believe in a flatter organization, not a fatter organization.”

Kramer addressed the costs of building shops inside Penney’s stores, stressing the company has been working with design firms and vendors “to really understand the cost relating to 100-shop rollout. I am actually surprised at how low that number is.” The 100 shops are expected to be all done by December 2015.

Going forward, Kramer said Penney’s will provide earnings guidance on an annual basis, rather than quarterly, and will report sales on a quarterly basis instead of monthly. Kramer said Penney’s raised earnings per share guidance for 2012 to meet or exceed $2.16, thereby matching the 2010 level.

While Thursday’s meeting focused on the costs and cuts to reinvent, Johnson didn’t underplay merchandise changes. “You will see improvements in the merchandising in the spring, but it will be dramatically different in the fall,” he stressed.

Prices will be about 40 percent lower than last year, which is where customers ultimately bought in volume after utilizing any discounts, early birds, coupons or doorbusters, Johnson explained. “We started to change our pricing over the last four weeks, reading regular-price selling for the last 30 days,” Johnson said. “On Feb. 1, we will get the first true read of customer reaction to our pricing change.” As the year progresses, “Clearly customers will understand the value of our pricing.”

Johnson said new shops will be designed with “very simple fixtures” and that “the amount it will cost long term will depend on how much we can engineer and how much vendors participate. Vendors are really excited about this idea of price integrity….We are open to having them invest capital to make these shops even better. This is truly in their interest.”

The new shops start getting layered in Aug. 1, at a rate of two or three a month. “We are open to the world. We want to take the best global brands and bring them to Penney’s. We want to bring in the best designers like we did with Nanette Lepore and Martha Stewart,” Johnson said, referring to the first two designer partnerships that he has unveiled since taking over as ceo last November.

Responding to reports that vendor orders were down 10 to 15 percent for 2012, Johnson replied: “We have reduced commitments to vendors for the early part of the year….We are going to clean up the stores to reduce clutter, reduce inventory. If the orders are down, it means we want to turn our inventory faster. You make the most money when you chase the business.” Even with orders down, “it doesn’t mean anything about revenue.”

Johnson also addressed relationships with vendors, stating, “We shouldn’t comingle our profit formula. We shouldn’t have all these games. We are going to radically simplify our vendor process [so that] all the interaction is on merchandise, with product and not managing the profit formula.”

Regarding markdown allowances, which department stores are heavily dependent on to meet profit goals, eliminating them is part of the plan, at least to some degree. “Personally that’s where I would like to go,” Johnson said. “I don’t want to be absolute, but on the highest level we want to simplify.”

Other changes cited by Johnson:

• Using more technology to prevent shrinkage, rather than personnel, who can deployed to provide better service. “RFID is ready for prime time,” Johnson said, referencing a technology that has had a checkered history with major retailers, including Wal-Mart. He also cited electronic monitors to protect merchandise theft.

• On adding new categories to stores: “I really don’t know [which ones] yet. I spend a lot of time walking through stores. Each time I see something new I ask, will that make sense to the J.C. Penney customer?” Johnson said. “We want to curate shops that are of great interest to the customer. We are exploring any or all alternatives, but new shops will primarily be in the categories we do today; but over time we will experiment with new things.” Greeting cards, currently not sold at Penney’s, will be offered in the Martha Stewart shops.

• On reducing private label and exclusives, which represent about 50 percent of Penney’s volume: “We do think there is an opportunity to slightly reduce private brand and replace that with more global brand,” Johnson said. “Directionally, there will be more global brands — there’s not a specific number we have targeted in any manner or form.”

• Converting the center core into a town square “may bring services and activities not in our store but in neighboring locations. Town square will be very integrated with our credit card and loyalty program. We want to earn loyalty. We don’t want to buy loyalty.”

According to Francis, Penney’s has dispatched people all over the world in the last 90 days to create “a compelling list of ideas and options,” to enhance the assortment and the town square.

Johnson was also questioned about localizing the merchandising. While content will be edited on a store-by-store basis, “localization will not be a primary strategy. I think that is something exaggerated in its importance….What people love in Chicago is what people love in Birmingham. It takes away from your ability to do great merchandise everywhere. The things we do well will more than offset the opportunity with localization,” he said.

While some analysts have expected Penney’s to close smaller stores soon, Johnson said he has visited many and that they look “tired” but generate good returns. “Job one is to raise productivity of all stores,” he said. “We eventually decide to rationalize or improve,” the fleet. “I don’t think there is any need to go out and close those small stores.”

 

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