The Business of Fashion
Agenda-setting intelligence, analysis and advice for the global fashion community.
Agenda-setting intelligence, analysis and advice for the global fashion community.
NEW YORK, United States — The decline of the American Department Store has been well documented, but the start of 2017 seemed to edge some of America's biggest players one step closer to a final reckoning.
On January 6, the Neiman Marcus Group, currently owned by asset management firm Ares and the Canada Pension Plan Investment Board, withdrew its initial public offering a year and a half after filing with regulators.
The company had filed an IPO in August 2015 with the intention of raising money to pay off its long-term debts, which, at the end of its 2016 fiscal year, stood at nearly $4.6 billion, with total long-term liabilities amounting to $6.5 billion. But as revenues decreased and earnings continued to shrink — with a total comprehensive loss of $470 million in 2016 and just $62 million at the bottom of its cash-flow balance sheet — these hopes were quashed.
Rumours that Hudson's Bay Company — the department store group owned by real estate developer Richard Baker — might acquire the chain continue to swirl, although sources close to Baker say the company is no longer entertaining the idea. (A spokesperson for HBC declined to comment.)
Around the same time Neiman Marcus' plans were publicly unravelling, Macy's announced plans to close 68 of its 730 stores, eliminating more than 10,000 jobs along the way, many of them management positions. The troubled chain saw comparable store sales fall 2.1 percent during November and December 2016 after seven straight quarters of decline.
There's just a lot more competition for what is at best a flat pie or, you could argue, a shrinking pie.
Meanwhile, at the privately-held Barneys New York, which is 75 percent owned by Perry Capital — the troubled, $4.1 billion hedge fund that began liquidating its assets in September 2016 — there are concerns over the leases on its two highest volume stores. If the rent on the Barneys Madison Avenue and Beverly Hills flagships triple in 2019, as widely expected, it has been speculated that the retailer could exit these locations.
Barneys did not respond to a general request for comment. However, a source close to the company said that the speculation is unsubstantiated, and while it has yet to begin formal discussions on lease negotiations, it is financially secure enough to exercise options to remain at both locations for multiple decades if it does indeed choose to do so. (Other macro factors, such as declining foot traffic, migration to e-commerce and decreasing retail rents in New York City — which could mean favourable deals at alternative locations — will be considered.)
To be sure, apparel retailers across the board are struggling to succeed in an increasingly fragmented market where the customer makes the rules and Amazon makes the best offers. But department stores face unique challenges.
For one, the convenience of e-commerce has unbundled retail, removing the friction that provided much of the raison d'être for one-stop-shops, where a wide range of products can be found under one roof. At the same time, American department stores have failed to evolve their business models for a direct-to-consumer world and have been slow to keep pace on consumer experience.
Some will likely face bankruptcy. “There’s just a lot more competition for what is at best a flat pie or, you could argue, a shrinking pie,” explained Steven P. Dennis, a retail consultant and former Neiman Marcus executive.
“But there is time to pivot,” said Brendan Witcher, an analyst at Forrester Research. BoF outlines the key challenges facing the US department stores in 2017 and the potential turnaround opportunities they can tap.
Growth stems from low-margin revenue streams. In order to compete with category leaders like Net-a-Porter and Amazon, traditional department stores have invested heavily in e-commerce, funding back-end system improvements or acquisitions of online retailers. For instance, Neiman Marcus bought German luxury retailer MyTheresa in 2014, while HBC acquired flash-sale site Gilt Groupe in 2016. Nordstrom bought flash-sale site HauteLook in 2011 and personal styling service Trunk Club in 2014.
At the same time, many department stores also began investing in off-price — expected to outpace the growth of the overall apparel market through 2020 — by opening new stores at a rapid clip. By the end of 2016’s third fiscal quarter, Nordstrom was operating 215 Rack stores, up from 194 the year previous. HBC has also bet big on off-price, with 118 Saks Off 5th stores open in the third quarter of fiscal year 2016, up from 91 the year before.
While both of these strategies have worked to drive revenue and growth, they don’t always drive profits. Unlike the full-line retail business, margins on off-price goods are significantly lower — typically just over 20 percent, and sometimes lower with further price reductions. Margins on full-price items, by contrast, are 40 to 50 percent. Retailers make up for lower margins by increasing inventory — hence the addition of more physical stores — but this requires further investment.
High-growth online businesses also operate on lower margins often weighed down by the cost of acquiring customers. Nordstrom, for instance, recently took a $197 million write-down on Trunk Club in light of its inability to turn a profit. “While this business continues to deliver outsized top-line growth, current expectations for future growth and profitability are lower than initial estimates,” Nordstrom said in a November statement. “To further improve the customer experience and better position Trunk Club's business for profitable growth, the company is making a number of operational changes.”
HNWIs prefer experiences to stuff. While Neiman Marcus and Saks Fifth Avenue were once positioned as trade-up stores catering primarily to the middle and upper-middle class, the mid-2000s luxury boom spurred them to more closely target high-net-worth individuals, whose deep pockets could handle the notable spike in prices. One luxury retail executive said that price increases could be equated almost exactly year-on-year to comparable store sales increases. "Back then, if you raised prices 9 percent, your comps were 9 percent," the person said. "We didn't really attract a lot of new customers and we absolutely didn't grow transactions. You started to lose the more aspirational customer."
But these days, those who can afford to buy increasingly expensive luxury goods are often choosing to spend their money elsewhere. “You don’t have that generational wealth,” Dennis said. “Silicon Valley entrepreneurs aren’t big spenders at stores like Neiman Marcus and Saks.” [V1] Indeed, 78 percent of Millennials posit that they would prefer to spend their money “on a desirable experience or event over buying something desirable,” according to an Eventbrite survey.
You don't have that generational wealth. Silicon Valley entrepreneurs aren't big spenders at stores like Neiman Marcus and Saks.
What’s more, while 51 percent of Neiman Marcus’ customers are 50 years or younger and 40 percent have a household net worth greater than $1 million, the average customer age is still 51. “Peak spending on luxury is typically in the early-to-mid 50s. In the upper 50s and 60s, you start spending less on products in general,” Dennis added. “If you’re customers are aging out, you’ve got to replace them. But there doesn’t seem to be the evidence that the customers in their 40s are spending the same way to prior generations.” Over the next 50 years, $59 trillion in wealth is set to be transferred from US Baby Boomers to their heirs, according to a 2014 study released by the Center on Wealth and Philanthropy at Boston College.
Tourist spending is down. The strong dollar has made it nearly impossible for retailers to woo foreign shoppers. In 2015, international visitors to the US spent $216.8 billion in the country, almost $4 billion less than the year before, according to the US National Travel and Tourism office. While numbers for 2016 have yet to be published, they are projected to tell a similar story, which could be exacerbated by the immigration policies enacted by the Trump administration, potentially blocking certain foreign tourists from entering the US.
There are (still) too many stores. While Macy's — which is being trounced by both Amazon and fast-fashion competitors on both price and style — is closing 68 of its stores, that still leaves the company with well over 600 locations. Retailers may be better off investing more in fewer locations in order to generate concentrated foot traffic that is not beholden to promotions. "There is just too much square footage in offline retailing," Witcher said.
The product mix is commoditised. With thousands of choices available from hundreds of retailers, selling the same product as a competitor makes it more difficult to win the customer. While exclusives can help to distinguish the product mix, not every exclusive turns into an "it" item. "They still think that the product they carry matters," Witcher says. "I know that I can find the same blue sweater at 25 different stores." If the product is the same, then the lowest price will win, fueling margin-eating promotions.
More consolidation is coming. Department stores must consolidate in order to decrease their operating costs, increase shareholder value and better service the customer. Expect retailers to close more stores and sell off more property in the coming months. Mergers are surely also in the works with HBC amongst the likely acquirers. "HBC owns a real estate portfolio that allows us to have low-cost financing and resources that other retailers don't have," HBC's Baker told BoF in 2016. "It gives us tremendous access to capital. We can make commitments that our competitors can't because we have financial strength and flexibility."
Stores are turning to the concession model. Outside of the US, most department stores operate a concession business model, effectively acting as landlords to brands that rent and operate their own spaces. In return, the retailer takes a commission on sales. This mitigates retailer risk but also incentivises brands, which benefit from wider margins. This is increasingly important as more and more brands open their own direct-sales channels.
A point of view is critical. "They're trying to be good at everything," Witcher said of American department stores. "It's about creating unique customer experiences." Many department stores aim to be everything to everybody instead of crafting a personality in the vein the world's great specialty boutiques. One way to do this is through experiential elements like food. (The restaurants at Barneys New York and Bergdorf Goodman are performing well even as retail sales lag.) But it's also about improving customer service. Nordstrom, for instance, has spent the last 10 years investing in its back-end to ensure a smooth experience from desktop to register. "There needs to be a value proposition," added Witcher.
A shift towards digital culture. When it comes down to it, most retail executives — especially those at the senior level — were not trained to run businesses where half of the revenue is coming from digital. "Most of it is culture and organisation," argued Witcher. "They made their way up the chain and have a very hard time thinking outside of the box. Startups don't have to deal with that because they started by digitising the strategy."
But hiring new talent is only one piece of the puzzle. The other is executing on new ideas, which requires cash, something many of these retailers simply do not have. While consolidation and layoffs can be a very successful temporary fix, “a retailer cannot save its way to growth,” Witcher said. “It takes investment, understanding the customer journey, as well as the pain points.”
UPDATE: This article has been updated to reflect pertinent information from a source close to Barneys New York that arrived after article was first published.