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As activist investors raise the heat, Dillard’s Inc. says its turnaround strategy is sound but concedes that reinventing a department store takes time.

Dillard’s wants to position itself above Macy’s and Belk, and below Nordstrom and Bloomingdale’s, with the goal of offering “affordable luxury and less promotion,” said Julie Bull, director of investor relations.

The chain, with 330 stores in 29 states concentrated mostly in midsize markets of the Southeast and Southwest, is staying the course set a few years ago. It is trying to evolve from moderate to better prices and update from traditional, basic product to more enticing fashion assortments, said William T. Dillard 3rd, vice president of accessories, intimate apparel and shoes and the grandson of William T. Dillard, who started the company in 1938 in Little Rock, Ark.

The direction is inspired by specialty stores, with edited product in sharper, snappier presentations. Dillard’s has moved from the old “sea of racks” formula to showcasing key lines in in-store boutique settings. BCBG Max Azria, Peter Nygård, Lucky Brand Jeans and other labels have dedicated space, with distinctive color, unique lighting, signage or video of runway footage on plasma-screen TVs.

New stores are smaller, averaging 170,000 square feet in open-air lifestyle centers, compared with 200,000 square feet for older units in enclosed malls.

“If you haven’t been in a Dillard’s lately, you wouldn’t recognize it,” Dillard said.

The change to a more updated product is crystallized in “The Style of Your Life,” a multipage print advertising campaign launched in 2006. A first for Dillard’s, the campaign appeared in Vogue and other fashion magazines, and the slogan became the cornerstone of Dillard’s attempt to change consumers’ perception of its image.

“We are working day by day, category by category, to get where we want to be,” Dillard said.

The changes were under way before the push by unhappy shareholders.

“Nothing good ever came easy,” Dillard said. “It’s been a tough year for everyone.”

Investors, led by the New York-based hedge funds Barington Capital Group and Clinton Group Inc., which own more than 5.3 percent of Dillard’s shares, are not satisfied. The stock closed at $15.93 on Tuesday, down 8.66 percent. The 52-week low was $14.46. The high was $40.56.

This story first appeared in the February 20, 2008 issue of WWD. Subscribe Today.

In a letter to the retailer’s board in January, the investment firms complained that their recommendations to improve shareholder value had been ignored. “Unfortunately, it appears to us that you have…also done little to improve the company on your own initiative, as Dillard’s financial results have gone from bad to worse since our initial communication in June 2007,” the letter said.

Barington Capital and Clinton Group, seeking to bolster their case, pointed to Dillard’s operating losses of $24.5 million and $6.5 million for the second and third quarters ended Aug. 4 and Nov. 3, respectively, and said the retailer had not reported a boost in annual same-store sales since 1999. A 12 percent decline in same-store sales during January, after a 5 percent drop in December, is almost certain to add fuel to the fire.

There are limits on the level of change that an activist investor can generate. The Dillard family has about a 13 percent ownership in the company and controls substantial voting power.

The move by the hedge funds comes as retailers such as Saks Inc., Target Corp. and Sears Holdings Corp. also find themselves under increasing pressure from stakeholders.

Dillard’s insists that the message has not been ignored. “Our goal to improve comes from within,” said Bull, who declined to comment on the critique from Barington Capital and Clinton Group.

Among the long-term initiatives is reversing the ratio of moderate to better product. Moderate-price goods once accounted for an estimated 65 percent or more of what was for sale. That figure is now less than 45 percent, depending on the category.

“We knew moderate, promotional product was not working, and we changed the old philosophy of ‘stack it high and let it fly,’ of my grandfather’s day to more edited, fashionable product,” Dillard said.

He pointed to intimates, shoes, accessories and contemporary apparel as success stories where sales improved more than in other areas, such as juniors and misses’ apparel, though he did not provide figures.

Wall Street analysts, however, echoed the criticisms of Barington Capital and Clinton Group. “Dillard’s has shown years of underperformance; we’re not seeing improvement,” Adrianne Shapira, managing director of Goldman Sachs & Co., said in an interview.

As a slowing economy squeezes consumers, Shapira isn’t expecting much positive change for Dillard’s any time soon, despite attempts to bring more updated products to the stores.

“Fashion is always a better strategy than dull,” she said. “But their plan is one established by their competitors years ago. Customers vote with dollars, and Dillard’s numbers aren’t reflecting change.”

Department store consolidation has eliminated all but a few major players and more specialty and online merchants have emerged, making it imperative that each define its position.

Rather than coupons and one-day sales, Dillard’s relies on two clearance sales a year. “We want to create distance between us and Macy’s, with less noise and chaos,” Bull said. “We are often the only store in our smaller markets where customers can get upscale, contemporary assortments.”

Some experts said Dillard’s has not clearly differentiated itself. “It sounds like Belk to me,” said Mark Vitner, senior economist at Wachovia. “Belk dresses up well in these middle markets. Dillard’s has been hot and cold.”

But Jim Stockman, Dillard’s general merchandise manager of product development, said the key difference is that Dillard’s brings fashion into more stores than its competitors. “Other retailers may have spectacular top-tier stores,” he said. “But it doesn’t always drive down to many stores.”

Starting at zero in 1997, contemporary product is now in 150 doors and expanding to 200 this year, with lines like Cynthia Steffe, Amanda Uprichard and Parameter. For a slightly older fashion customer, Dillard’s is expanding on lines such as Kenneth Cole. Bridge labels, including Ellen Tracy and Dana Buchman, are in 150 doors and expanding.

“Department store floor space used to be controlled by the big manufacturers, the Tommy Hilfigers, Laurens, etc., but now we’re open to more suppliers and smaller lines,” Stockman said.

Private label, now at around 20 percent, depending on the category, is as important as new brands in supporting the revamped fashion image.

“Private label was another dirty word,” Dillard said. “It’s no longer just basics product, but brands that we have to nurture. The customer can’t perceive it as cheap house merchandise.”

Dillard’s push to develop and market its private brands began in 2002 when Vince Camuto designed the chain’s Gianni Bini contemporary brand, which now includes shoes, apparel and handbags.

Dillard’s will open nine new stores this year, most in the first half, all in open-air lifestyle centers in smaller markets, such as Ocala, Fla., which opens this month.

Dillard said improved sales training, replenishment and distribution will help the retailer execute its product strategy more efficiently.

“We can’t blame the weather or the economy or anything else. We just have to play our game and focus on being great,” he said.

“There’s a wide country between New York and Los Angeles,” Stockman said. “We will continue to push fashion, bring it to the heartland, and our challenge is to get that message out.”

Store Photos by MARK PETKO; Dillard by ZACK SECKLER

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