WINNERS AT LOW COST
WAL-MART SETS THE STANDARD IN MASS MARKET RETAILING, BUT IT’S THE DYNAMIC DUO OF TARGET AND KOHL’S THAT HAS RAISED THE FASHION BAR AMONG POPULAR-PRICE STORES.

Byline: Evan Clark

Runners in the foot race of mass-market fashion need a flair for apparel and a upside surprise for Wall Street if they’re going to catch up to Kohl’s and Target’s commanding lead.
Wal-Mart Stores may be the undisputed retail behemoth in basics while department and specialty stores offer up snazzier threads, but Target Corp. and Kohl’s Corp. populate the very profitable realm between the two, where speed and efficiency take the day.
If nature abhors a vacuum and only two prominent players currently populate this very lucrative space, free-market economics dictate that competitors will eventually crawl out of the woodwork while there’s still money to be had.
Right now, though, it’s Target and Kohl’s that are “providing most of the competition,” said Fitch Ratings retail debt analyst Philip Zahn.
“Penney’s and Sears are trying to revive their businesses, so if they’re successful, they could provide more competition down the road,” he said, adding that, with proper fine-tuning, Gap Inc.’s Old Navy and Gap concepts could assemble similar merchandising armadas.
Last week, J.C. Penney Co. and Sears, Roebuck & Co., both of which are undergoing major restructurings, updated investors on their transformations including their tandem moves to centralized check-out — a feature lifted from the Kohl’s and Target playbook. While Penney’s will have centralized checkout stations completely rolled out by the end of October, Sears will have the job mostly done this month.
Centralized check-out signals one way both firms are striving to be less like the traditional department store, a concept which has been losing market share to low-cost providers hand over fist for years. According to Commerce Department statistics, discount department stores grew their dollar share of total department store sales to 60.7 percent last year from 51.9 percent in 1992. Total sales for discount department stores for this period leapt 56.5 percent to $143.87 billion, while conventional and national chain department stores saw their total sales rise only 9.2 to $92.96 billion.
Becoming less department-store-like means evolving into something more like Kohl’s and Target, or at least something that could compete with them, but facing this low-cost duo is easier said than done.
Both run tight ships, a habit born of more than just financial savvy and Wall Street demand. Efficiency and speed are an essential part of both cultures, ways of business that largely eliminate the whims of the fashion cycle.
Rather than gambling, these two firms identify a new fashion trend once it’s already made a splash and reproduce it — or one might say knock it off — ASAP to catch as much of its peak as possible.
While these trends are hardly haute couture, picking up on and selling them cheaply helps keep traffic brisk in stores far away from the style capitals of New York and Los Angeles.
Steven Skinner, a partner in the retail industry group at Accenture, a management consulting firm, noted these companies “figure out how to best replicate a trend and leverage their short-cycle supply chain to get new products into their stores as quickly as possible.”
Once a new trend’s been identified elsewhere and tested with the store’s target consumer, the supply chain is ironed out before the product is developed and then shipped to stores. The goods may be slightly late to the fashion gala, missing both the risk and potential rewards of being on a trend’s ascension, but heavy marketing once fashions hit the store help offset the delayed arrival.
As Skinner described it, “They integrate their market intelligence with their in-store merchandising.” When this is done effectively, “consumers are unable to differentiate between the first product that comes out at the Gap and the second or third product — reasonably close in style and quality — from the discounter.”
Apparently, in terms of style, the low-cost, quick-turn retailer’s hand is indeed quicker than the consumer’s eye. That hand doesn’t need to be too quick, though, since the mass merchant customer isn’t all that interested in being on the cutting edge of fashion. They are likely to be swayed more by the difference in the nearly chic apparel’s price tag.
Still, turning around the fashions speedily requires “responsive merchandising, a corresponding supply chain and a store that is flexible enough to adapt to new products coming in relatively quickly,” said Skinner.
While turnaround times vary, apparel usually goes from the drawing board to the stores in six to nine months. That’s a general time frame and certain hot trends can be turned around more quickly.
Target and Kohl’s may both play catch-up with the fashion curve, but they have different takes on apparel and generally don’t compete head-on despite the close proximity of many of their stores.
A.G. Edwards equity analyst Robert Buchanan noted, “They’re both destination stores” which have “complementary assortments. The Kohl’s customer, by and large, is a meat-and-potato customer, while the Target customer is hip and aware of fashion, if not a slave to fashion.”
While there is some overlap in young men’s apparel, he said, Kohl’s is more traditional on women’s and men’s and is older in outlook, in sync with the firm’s family focus.
The common denominator for both chains, he said, “is that all of their customers are seeking value.”
Philip Emma, fixed income analyst for Moody’s Investors Service, agreed: “The perception is that people feel like they’re getting a better value.”
He added, though, that some of that value is just perception. While Kohl’s customers, he said, “feel like they’re getting better value, Kohl’s has better clarity in its pricing message,” relative to its department store competition, that sends its customers on coupon-hunts in the Sunday circulars.
“You know at Kohl’s what you’re paying. It’s easy for the consumer to figure out what the value is,” said Emma. “The department stores, in some categories, probably provide the same value,” but may not get credit for it with the consumer.
While perceived value — real or otherwise — and speed are important to both Kohl’s and Target, retail is a long-term proposition and a lean muscular physique best serves a retail marathon runner.
Zahn noted, “The fact that they’re coming through with stuff that looks fashionable but is less expensive certainly means that they need to be more efficient.”
And the proof is in the numbers. Retailers tabulate sales-per-square-foot in slightly different ways, but it’s considered one of the best yardsticks of their efficiency.
Last year Kohl’s realized $283 in sales for every square foot of selling space in its stores opened a least a year. Likewise, Target discount stores’ broadline assortment pulled in revenues of $274 last year, taking a 13-month average for retail square feet.
By contrast, May Co., often heralded as an efficient department store operator, took in $193 in sales per square foot. Despite losing money for the year, Gap Inc. racked in $394 in sales per square foot in 2001, based on weighted-average gross square footage.
Last year, Target’s discount stores racked up $32.59 billion in sales, an 11.3 percent increase, while Kohl’s top line swelled 21.7 percent to $7.49 billion. May Co. last year had sales of $14.18 billion, but Wal-Mart, with revenues of $219.81 billion, was about four times larger than the other three combined.
A.G. Edwards’ Buchanan added that both Kohl’s and Target “are working on an expense-to-sales ratio in the low 20s and the conventional department stores, as a group, are working at expense ratios around 30 percent.”
Keeping expenses down helps create what he termed a “productivity loop” in which a low expense ratio leads to lower prices for the consumer which lead to greater sales and market share. These, in turn, support a lower expense ratio.
Squeezing every penny out of their suppliers, by leveraging their volume, also helps these retailers keep expenses down and the productivity loop well oiled.
And they save by sourcing some of their own apparel. Fitch’s Zahn noted, “They’re doing a lot of importing and different things with private label that they can source directly from the manufacturer and sell for less, but generate a good profit.”
J.P. Morgan Securities equity analyst Shari Schwartzman Eberts said of Target, “On the apparel side they have a very efficient overseas sourcing situation so they are really are able to chase fashion very quickly.”
While private label accounts for almost 100 percent of Target’s apparel and 20 percent of Kohl’s, it’s unclear exactly how much they source exclusively on their own. However deeply involved they are in sourcing and manufacturing their own goods, savings in that area can be sweet while risks are also increased. Neither company would provide specifics about their sourcing operations.
Eberts noted, “Target does a very good job on its markdown systems and Kohl’s does a very good job with inventory management and product flow and part of that is their systems.” She added, though, that sourcing “is more about relationships and partnerships than it is about systems.”
Retailers who source themselves, though, face greater risks. Moody’s Emma pointed out that when firms don’t make their expected margin or they accumulate excess inventory, “There’s nobody to go back to for markdown money and the order’s yours.”
Whether it’s an effect of being relatively current on fashion, or cutting costs on the back end, Target and Kohl’s are making a lot of money — for themselves and their investors — doing it. Shares of Kohl’s and Target as of Friday jumped 52.9 and 31.9 percent, respectively, to $75.61 and $44.60 over the past two years.
This success, and a straight line to future growth which Wall Street can recognize, makes their niche between the low and high end even juicier to would-be competitors.
“In order for these discounters to be caught up to, somebody’s going to have to not only reproduce the ability to replicate trends, they’re going to have to make a new business model. Kmart is the poster child of what happens when you miss the mark,” said Accenture’s Skinner, referring to the now bankrupt discounter’s attempts to first take on Target’s upscale discount model and then low-ball Wal-Mart.
“Will there be new entrants? Absolutely,” said Skinner. “But whether they are successful clearly depends on execution.”
A.G. Edwards’ Buchanan said Kohl’s and Target are also driven by a low-cost philosophy: “To some extent it’s a cause for the consumers. A lot of the merchandise you can buy in Target today, both in apparel and home decor, was prohibitively expensive in the past. So they’ve brought fashion to the masses. Kohl’s brought the same thing people were getting elsewhere, but at a lower price.”
With nearly 1,100 Target discount stores dotting most of the American landscape and 420 Kohl’s units in 29 states, the low-cost duo still have significant growth opportunities, especially with Kmart closing hundreds of stores.
Both firms seem to grow their store counts daily. (Target is set to grow by about 8 to 10 percent annually, while Kohl’s smaller store base should increase by 18 to 20 percent a year.) They have also ingratiated themselves into the minds and hearts of consumers. And that’s trouble for the competition, said Buchanan.
“The most powerful force in global retailing is momentum,” he added, “so good luck catching someone who’s got a head start.”

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