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WWD Milestones issue 09/30/2013

José María Blanco, chief executive officer of El Palacio de Hierro, nearly fell out of his seat when Don Alberto Baillères, the company’s owner, disclosed a daring scheme.

This story first appeared in the September 30, 2013 issue of WWD. Subscribe Today.

In the middle of Mexico’s “Tequila Crisis,” the economic collapse triggered by the sudden devaluation of the peso in 1994, Baillères instructed Blanco to buy some prime real estate in Polanco, an affluent neighborhood just north of Chapultepec Park in Mexico City.

“‘Buy the Polanco space. Go get it for me,’” Blanco said in an interview, recalling Baillères’ words. “I was shocked. I said, ‘this is very, very macho.’”

The company bought 80 percent of the Polanco block from the developer/owner, in a financially risky move that ultimately proved pivotal, marking the beginning of El Palacio de Hierro’s major expansion, and reinforcing the new strategy of upscaling started in 1993 when the retailer opened in the well-to-do Santa Fe section of Mexico City.

In Polanco, El Palacio built a mall anchored by the store, which opened in 1998, and a year later, the imposing headquarters of Grupo Bal, the conglomerate owned by Baillères that includes El Palacio de Hierro, opened atop the site. It’s among Mexico City’s most recognizable structures — a towering triangular stone edifice evoking the mysterious Teotihuacán Pyramids outside Mexico City. In the years since, El Palacio de Hierro bought up the adjacent buildings to own 100 percent of the block and position the department store for a $200 million expansion and renovation, more than doubling its size to 500,000 square feet.

“This will be the flagship of all flagships,” Blanco stated, citing such introductions as Prada, Gucci and Louis Vuitton in luxury ready-to-wear and accessories. “They will all have windows and shops to the street. We started talking about this project over a year ago. Next month, we’ll see the plans for the layout.”

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As part of the overall project, Grupo Bal’s headquarters will grow, too, without losing its pyramid character and in proportion to how the store and the mall expand.

“In my 21 years at Palacio, I have never experienced a challenge like this,” said Claudia Fabela, luxury director. “With Fendi, Dior, Hermès, Bottega Veneta, we currently only have their accessories. Now we will express their whole worlds. Polanco will transform into a luxury corridor, like a shopping mall that allows the brands to express their identity in the context of a Palacio concept store.”

Creating a “harmonious” balance between brand expression and projecting the personality of the host store, Fabela stressed, is the crux of the challenge.

“Getting the Polanco property was a daring move, really at the height of the crisis,” agreed Carlos Salcido, director of marketing. “It was a great opportunity requiring great vision. It said a lot about the spirit of this company and that Mr. Baillères believes in investing in this country and taking chances.”

It also blocked Saks Fifth Avenue from taking the site. Saks was negotiating with the original property owner and having second thoughts due to the state of the Mexican economy.

“That’s when Mr. Baillères jumped in. It was the perfect opportunity,” added Françoise Lavertu, the communications director.

At 125 years old, El Palacio de Hierro — “The Iron Palace” — is far from maturity. That’s the prevailing message from the executive team, who detail various redevelopments, renovations, store openings, brand introductions and image upgrades on the agenda. Following the Polanco project, the Durango site will be reimagined with a bridge linking two sections of the store and spanning above what will become a pedestrian plaza with bistros, cafés and shops. The street for vehicular traffic will be rerouted by creating an underground passage.

El Palacio de Hierro will further increase its footprint, albeit cautiously.

“We can’t put 70 stores in Mexico,” Blanco said. “The market isn’t big enough. However, we do see opening stores in three or four more Mexican cities,” with Veracruz and Querétaro planned. In addition, “We are thinking about international expansion, to Panama, Colombia, Chile and Peru. Panama is a very big center for shopping.”

Blanco, who has served as ceo for more than two decades since his arrival at the store, dismissed any possibility of bringing El Palacio to the U.S.

“The U.S. is beautiful, but the competition is very difficult,” Blanco says. “It’s very much another level.”

El Palacio de Hierro dates back to 1888 when J. Tron & Co. started construction of a five-floor store in downtown Mexico City on the corner of Venustiano Carranza and Avenida 20 de Noviembre. The Centro store, as it is known, opened in 1891. In 1914, a fire caused by a short circuit in a window destroyed the main building and it wasn’t until 1921 that El Palacio de Hierro Centro reopened.

The history of El Palacio — Mexico’s first department store — is filled with pioneering maneuvers, from being among the earlier retailers to see real value in owning its real estate, to introducing a store credit card in 1958, before the Mexican banking system did.

In 1963, the Baillères family bought El Palacio de Hierro, and not long after, the store opened its Salón Internacional shop for designers and couturiers such as Bill Blass, Manuel Pertegaz, Lanvin, Oscar de la Renta, Hubert de Givenchy and Carolina Herrera, most of whom regarded El Palacio as their entry to the Latin American market.

Expansion began in 1980 with an opening in Perisur, Mexico City, which has become the company’s biggest volume store, generating 2.5 billion pesos annually, or $190 million. Nine years later, the Centro Coyoacán shopping mall owned by Baillères opened. In 1993, the Santa Fe store in Mexico City opened, and a store in Puebla, the company’s first outside Mexico City, opened in 2002. Casa Palacio, the upscale home format, made its debut in 2006 in Antara, Mexico City. And in 2007, the retailer adopted yellow as its signature color.

El Palacio de Hierro remains a small but increasingly complex company that’s growing. Currently, there are 12 department stores, two freestanding high-end home stores, three Palacio boutiques, a restaurant operation, outlets, a travel agency, two owned and operated malls and three other malls owned in partnerships, and more than 100 brand boutiques that El Palacio is licensed to operate in Mexico. Many luxury brands sold inside El Palacio department stores don’t have the infrastructure or market knowledge to establish freestanding shops in Mexico. That’s where El Palacio steps in, by operating Burberry, Bebe, Mango, Kiehl’s, Aldo, Cartier and Hugo Boss boutiques, among others, in Mexico.

“Even though it’s an upscale store, it’s becoming more and more accessible to anyone. There’s a Mexican philosophy and kind of a cultural link to the society,” observed Javier Sordo Madaleno, one of Mexico’s most prominent architects, who has created 10 facades for El Palacio department stores.

Inside the stores, the ambiance is elevated compared to Liverpool, the much larger Mexican department store chain that reads like a standard Macy’s. El Palacio is sometimes regarded as the Saks of Mexico but once past the main floor luxury accessories, fine jewelry and cosmetics, the tone is a rung below.

The luxury accessories, cosmetics, kids and high-end home businesses are among the retailer’s strongest categories. On the other hand, contemporary sportswear, lacking such labels as Vince and Rebecca Taylor, designer rtw and e-commerce remain underdeveloped areas, and are regarded as opportunities. Across the rtw floors, American, Spanish and Mexican brands are in greater evidence than European lines; bridge, casual, children and active assortments appear fulsome.

In dissecting the El Palacio DNA, executives cited the company’s accelerating luxury appeal — predominantly, its leased designer accessory shops. Luxury accessories and fine jewelry combined represent about 20 percent of the company’s volume, and is mostly sold at the Santa Fe, Monterrey, Guadalajara, Perisur, Interlomas and Polanco locations. There’s a smattering of designer rtw, though going forward, the buy will grow. Trunk shows, such as with Bottega Veneta, are being stepped up.

They also cite a strong brand focus and that the company has identified 50 strategic brands for building up the partnerships, among them Apple, Louis Vuitton and Tiffany.

“Store takeovers” lasting a few days entail a 360-degree tactical approach involving intensified marketing, merchandising, visuals and special events. Store takeovers have been orchestrated with Tory Burch, Nautica and Apple, among other brands, and this week, Ferragamo gets spotlighted.

El Palacio is known for its innovative advertising and getting a lot of bang for the buck, spending no more than other department stores — 3 to 4 percent of annual revenues. The advertising projects an aspirational, upscale appeal, is image-oriented rather the price or promotionally driven and it strives to differentiate the business. The retailer’s enduring tag line, “Soy Totalmente Palacio,” a Baillères brainstorm, was introduced in 1996 and has become part of the Mexican vernacular, the way Nike’s “Just Do It” slogan has stuck.

The retailer is also known for unique store design marked by dramatic facades, and has been modernizing stores with curvilinear cosmetic floors for greater visibility and brand presentation. Big bright atria, fixtures with flair and cash-wraps installed in transition areas between categories so they’re obvious and don’t intrude on selling space, are signatures. For store design and merchandising, the company has drawn inspiration from the old grande dame department stores in Europe, such as Galeries Lafayette in Paris and Selfridges in the U.K.

Among El Palacio’s most distinctive features is what isn’t seen much at all in the department store industry anymore — an eclectic, old-style emporiumlike assortment covering everything from apparel, beauty and footwear to food, toys, electronics, furniture, tabletop and appliances. The broad approach works because Mexicans are prone to shop as families.

Volume at El Palacio de Hierro reached 20 billion pesos last year, or about $1.5 billion. Net profit was 7 percent of sales. “The target is 9 to 10 percent by 2018, as we continue to heavily invest in the company,” said Daniel Elguea, chief financial officer. Capital spending is at 2 billion pesos a year, and the debt level is twice earnings before interest, taxes, depreciation and amortization, said Elguea, who conveyed that the company is growing significantly and is in good shape.

On the revenue side, he forecasted 25 billion pesos, or more than $1.9 billion, by 2015. For the 2010 to 2015 period, the company will have doubled revenues, and from 2008 to 2012, tripled profitability, he added.

“Managing growth — that’s our biggest challenge,” Elguea said. “We have the money, the financial discipline and the results to do it. And we already have a successful business model. We have been able to consume a substantial amount of complex projects.”

Along with mall and store projects, the company has been installing an SAP enterprise-wide system for the finance, financial planning, human resources, payroll, real estate and merchandising functions.

Not too long ago, the executive ranks did have concerns that El Palacio had too much on its plate, and that the company should walk before running, particularly with many American and European retailers expanding to Mexico. Saks, which opened in 2007 in Santa Fe and in 2010 in Polanco, added to the anxiety. The Saks stores are in partnership with Carlos Slim Helú, Mexico’s richest man.

“That was a threat, a huge competitive threat,” Elguea acknowledged. “But the single fact that 80 percent of our brands opted to stay with us and only 20 percent left or chose to be in both stores validated our strong positioning in the high-end market in Mexico. Five years after, those that left us are back knocking on our doors. Now we set conditions of how we want them back — and we do want them back. When the big names stick with us, that is a validation that what Palacio is doing is right. It’s not us saying that. It’s a bunch of brands saying it.”

It’s helped that Saks has not been the perceived threat, with reports that the stores lack traffic and are priced too high.

This year, sales at El Palacio are seen running flat, due to cutbacks on exports amid the world economic malaise and government pulling the reins back on spending and infrastructure projects, impacting consumer spending. However, El Palacio’s team thinks long term, so its game plan for upscaling is undeterred and supported by Mexico’s rising middle class, relaxed import restrictions over the years and import prices approaching parity with prices in the U.S.

There’s also the population’s love of brands. “Our customers know all about fashion,” said Blanco. “They’re just like consumers in the States. They know Prada very well.”

How well Prada knows Mexico and El Palacio de Hierro is another story. Last May, Blanco met for the first time with Patrizio Bertelli, ceo of Prada SpA.

“He spoke a little Spanish. I spoke a little Italian — very little,” Blanco said. “He never expected Palacio would be the kind of store it is, with the brands it has, the design and the visual merchandising.

“The most difficult have been the Italians. Some think Mexico is Central America. They think Mexico is like Colombia or Peru. When they finally come here, they quickly see that we are a sophisticated and educated society. When they come here, they see the city and say ‘Wow. This is the new world.’”

That said, numerous Italian brands are carried in the store, and are among the key vendors, particularly in men’s wear.

Along with the luxury buildup, cultivating an image of Mexico’s most aspirational store, where consumers learn to trade up, is critical to keeping the customer from shopping abroad. It’s also key to differentiating from the retail pack that’s crowding up with overseas retailers. Among the recent entrants into Mexico: Crate & Barrel, American Eagle Outfitters, Aéropostale, H&M, Express and Zara, while Wal-Mart, which considers Mexico its second-largest market next to the U.S., would not be a direct competitor.

In the office of Ernesto Izquierdo Desoche, chief operating officer and commercial director, there’s an old photo of a bullfighting ring that closed, though bullfighting still exists in Mexico.

“The ghost of the bullfighter visits us,” he explained, to warm up his guest before getting into what the future holds for El Palacio de Hierro and a frank discussion about the business climate.

“El Palacio is an exciting place to work because in Mexico there is not much space for other luxury retailers,” he says. “We are the most significant luxury player in Mexico. In Mexico City you have Masaryk, which is like our Rodeo Drive, but that street has a lot of problems in terms of traffic and parking. We have much better parking and better security,” said Desoche, who has the purchasing directors [like general merchandise managers at U.S. stores] and senior operations and marketing executives reporting to him.

He said the Polanco store will grow from 200,000 to 500,000 square feet of selling space, reopen in 2017, and contain a 140,000-square-foot area for designer rtw, as well as shops for Louis Vuitton, Gucci, Prada, Hermès, Dior, Chanel, Bottega Veneta, Fendi and Burberry. Some will be two levels or more. “We think the market is ready. We feel comfortable. Our partners are comfortable. We need to create the right environment.”

“Mexico is still a good place to do business and attractive to retailing,” Desoche said. NAFTA, the North American Free Trade Agreement, he pointed out, reduced imports, making the pricing on brands more reasonable and consistent with other countries. Also, Mexico’s Minister of Finance and the Bank of Mexico have kept inflation in line, while the GNP has been consistently growing at 3 to 4 percent annually, and the middle class is growing. Still, he characterized Mexico as a nation of “parallel worlds,” explaining, “For the main part of Mexico, the society lives well, but like any city you have to be aware.”

Though business this year is running flat, “The bright side is that our economy is so pegged to the U.S.,” Desoche observed. “What is good for the U.S. is good for Mexico and the best news that trumps all the other issues is that most of our exports go to the U.S. and that millions of Mexicans live in the U.S. and send money back to Mexico.”

Amid Mexico’s mixed economic signals, “We are moving from being a department store to being a conceptual store, that there’s this balance between letting the personality of the brand project, and projecting the personality of the store. If you look at Bergdorf Goodman — practically all of the focus is on the image of Bergdorf. Very few brands there have a strong image. Galeries Lafayette takes it to the other extreme. You need to keep that balance so the consumer says, ‘I know I am in Palacio.’ And believe me, we put in some rules, like how large the lettering on their logos can be. And there are visibility requirements. They can’t have closed spaces,” with entrances that feel like the customer is entering a separate freestanding store. “We try to keep it open.”

Lease agreements, for concession shops, are welcomed and on the rise, provided the brands meet certain criteria. “When there are capable salespeople, if they invest in image and take care of their inventory, it generally makes sense,” Desoche said. “When the brand has these capabilities, we are very willing to make a lease agreement.”

To some extent, El Palacio de Hierro takes its cue from the European retail model. “We like Selfridges very much,” he said, “but you have to develop your own personality.”

Besides luxury, “Contemporary, is an area where we are really focusing, building up business with Michael Kors, Tory Burch, Marc Jacobs, Juicy Couture, and our private Wild & Alive and Epsilon labels. Two French brands are being bought for next year, Sandro and Maje, and Diane von Furstenberg, Alice + Olivia and Vince are being pursued. Bridge is already “well established,” he added.

“Our biggest project now is e-commerce,” Desoche continued. “It’s relatively dormant in Mexico. People here are worried about security and delivery.”

E-commerce, he said, is about 1 percent of total revenues. “Our first objective is that it amounts to one of our medium-sized stores, like $80 million [in sales] in two or three years.” The Web site will be relaunched in October. Currently, the company leverages the store buying team, though there is a small supporting team totally devoted to e-commerce. “With the new design, our Web site will be very representative of what you see in the store.”

On average, those shopping El Palacio de Hierro earn $50,000 a year. Those earning $100,000 or more represent a very small percentage of the clientele. “So even though our strategy is luxury, we also have to cater to the rest of the population. We have to be sensible about leading consumers in trading up,” essentially educating them about why luxury products are priced so high, and what their value is.

“Many consumers don’t understand it. For that, the most significant thing is staging events, like a breakfast at Tiffany’s, or a fashion show for Zegna, or a wine tasting,” Desoche noted. “When we do a wine tasting, 110 percent of the people we invite come. People with invitations bring other people,” and not just for free drinks. “It’s fun and they learn about the brands.”