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Will Macy’s third act be a game changer?

INSIGHT ARTICLE  | 

The following article explores Macy’s intense ride through the volatile retail landscape and how their journey has rivaled the climatic drama in a three-act play. What’s in store for this premier U.S. retailer? Jeffrey Edelman, director in RSM’s retail and consumer products industry practice, provides his insights.

Act I: How easily can Macy’s’ profitability be restored?

Macy’s’ growth was successfully orchestrated by retail visionaries that acquired and transformed a loosely knit federation of regional department stores into the strong powerhouse it became.

The retailer reached its long-term EBITDA target of 14 percent in 2014, a level that could be difficult to achieve again. Its profitability dropped to 12.4 percent in 2015 and is estimated to fall further this year, in the area of 11.5 percent. Terry Lungren, chairman and CEO since 2004, will be turning over the CEO reins to President Jeff Gennette, a longtime executive who will hopefully reverse the course of the company’s direction. Gennette recently stated, “There is no doubt that Macy’s Inc. will need to be a significantly different retailer in the future in the way we operate and approach the marketplace.”

An evolving operating environment

The business has changed significantly over the past several years suggesting past levels of profitability will be difficult, if not impossible, to achieve. Macy’s target customer is different today. The competitive landscape has changed. E-commerce has increased the company’s investment spending. Value and fashion, rather than brands, are millennials’ focus. Merchants, more than ever, need to create the want to purchase rather than cater to the consumer that needs to purchase a replacement item. It would appear that the long time Macy’s operating model is obsolete. Today, we see revenues of TJX Companies, Inc., adjusting for comparable merchandise categories, already exceeding Macy’s before store closings, and it is still growing.

Act II: E-commerce helped drive sales, but at a cost

Macy’s has the ability and opportunity to maintain, or even increase market share. E-commerce provides its customers with a seamless shopping experience and the potentially added benefit of incremental purchases if and when the merchandise is returned to the store. The unanswered variable in the equation is profitability, which to date, has been disappointing. Handling costs are higher and quite often, a returned product might not be carried in that particular store, raising the prospect of increased markdowns. Furthermore, logistics and free shipping are cutting into margins.

There is a more important issue: the transference of sales to online versus the store. Comparable store sales appear to be declining at a faster rate than expenses can be managed down, further pressuring profitability. Store-level service suffers because of the time-consuming return process and reduced sales associates on the floor. Price matching has become a common practice in today’s transparent environment, eroding with the resultant margin insufficiency to offset higher transaction costs.

Act III: Closing unprofitable or marginal stores will help

Closings may help, but will likely not move the needle substantially. The recent announcement to close 100 stores, about 15 percent of the total, will allow management to redirect resources to those stores that show a faster and higher rate of return. Expense reduction and increased efficiencies, after the impact of one-time charges, will hopefully provide an overhead structure than can be more easily leveraged. This, however, might prove illusive in light of the ongoing decline in mall shopper traffic.

Shifting mix of brands

Fashion and price have consistently become critical to survival, but it is the relationship of both that determines value for the target customer. Management has stated Macy’s (more so than Bloomingdales) is a promotional store and research has indicated that its customers prefer lower prices at the expense of service. Its buyers have consistently pushed back on its vendors for lower prices and increased promotional allowances; more often than not, resulting in some degradation in brand image and oversaturation.

Recent moves by Polo, Coach and Michael Kors to reduce department store emphasis and participation in promotional programs will likely set the stage for other brands to follow. Macy’s’ plans to shift its merchandise mix more to its own brands and exclusive brands, which it can hopefully promote and enjoy a better margin rate. But, it will have to plan further in advance, absorb development costs, as well as liquidation. There will be no markdown or promotional allowances, which at times were believed to have been a sizable contributor to profitability.

Competing retailers who have attempted to reduce promotional activity experienced a fall-off in store traffic. So will the pricing spread with value retailers widen? Or, will  Macy’s’ strategy of creative merchandising, differentiated product, an enhanced store environment, speed to market and a heightened online experience, be enough to sufficiently transform the retailer’s next act? During Act I, Macy’s was a federation of local department store brands that catered to its customers with specific merchandise and programs, perhaps only lacking in an efficient expense structure. Act III promises to be the most interesting and potential game changer for Macy’s. 

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