Federated’s Risks Pay Off, but Online Bet Is Hard Sell
It was the suggestion of a race across the staid, button-down sales floor of R.H. Macy & Co.’s flagship New York store that made Sean Slackman laugh.
The 24-year-old Manhattan man sauntered up to the counter and told a dapper Macy’s worker that he wanted a pair of Michael Jordan athletic shoes. If the pounding rock music or wall of screaming sport televisions weren’t clues that this was a different kind of Macy’s, the salesman’s encouragement to try out the shoes was a giant signpost.
The race--Slackman won by forfeit, as the salesman dropped out midway--made the event seem less like a transaction and more like the two were mischief-making boys at the mall, Slackman said.
Making shopping more fun is a key goal for Macy’s and its parent, Federated Department Stores Inc., and just about every other department store in America. But no one in recent years has done it better than Cincinnati-based Federated.
The parent of such venerable retailers as Macy’s, Bloomingdale’s, Bon Marche and Burdines has been transformed during the last decade from a corporation that Canadian real-estate developer Robert Campeau saddled with debt and ran into bankruptcy to one occupying the top rung of the department-store world.
The company’s sales and profit growth at its more than 400 stores are clobbering those of its competitors, and analysts are lauding Federated’s merchandise and a management team that encourages risk-taking.
“For a department store, this company has tremendous momentum,” said George Strachan, an analyst with Goldman Sachs in New York. “But the market isn’t paying them for it.”
Indeed, despite posting the best numbers in its 71-year history, Federated shares are in the discount bin, closing Friday at $42.25 on the New York Stock Exchange, down 25% from $57.06 in July. Investors wonder whether the company can maintain its strong growth amid mounting pressure from specialty stores and discounters on one flank, and its formidable ($1.9 billion) but uncertain investment in Internet operations on the other.
“The market is very fickle and investors today are looking for maximum earnings growth,” said Jeffrey Edelman, retail analyst with PaineWebber in New York. “They figure with a slowing economy, they would prefer to just have the growth companies rather than the more mature companies.”
Traditionally, big department stores have promised convenience--virtually everything shoppers needed under one roof. But it is not clear how or whether that format will compete on the Internet, the biggest, broadest one-stop shopping opportunity in the history of buying.
Federated has made the biggest bet on the Internet of any of the major department-store operators. Last year, it paid $1.7 billion for Fingerhut Cos., not just for its kitschy catalog operations, but for its state-of-the-art mail-order fulfillment center and extensive market research on every aspect of direct selling. Those operations provided a vast consumer database and the ability to pack and ship merchandise--critical components of a successful e-tail operation.
Beginning this year, Federated plans to spend $150 million to $200 million annually to expand its online presence and to build up its three biggest e-tail sites: Fingerhut.com, Macys.com and Bloomingdales.com.
Instead of rewarding the company with the extraordinary valuations accorded to Internet-only stores, Wall Street has punished Federated for what some investors see as a mixed message and a disturbingly large capital outlay--despite management assurances that the company still will meet analysts’ earnings estimates.
Federated’s own Internet ventures have failed to flourish despite a well-developed catalog business and an Internet presence going back to 1997, with Macys.com. The company does not disclose its Web sales, saying only that the direct-to-consumer results last year were “mixed.” The unit contributed about 10% of Federated’s $18.2 billion in sales in its fiscal year ending Jan. 31.
Company officials won’t say exactly how the $200 million a year will be allocated. Executives note that when it comes to apparel, many shoppers want a name they can trust and a place, such as Federated’s department stores, where they can make returns and exchanges.
“Perhaps the biggest payback of all will not be the e-commerce business, but the connectedness with our customers that will drive them into stores,” said Terry J. Lundgren, Federated’s president and chief merchandising officer.
Eventually, the market’s short-term concerns about traditional retailers’ Internet ventures may give way to a realization of those stores’ advantages, said Goldman Sachs’ Strachan. Federated is in a relatively good position to fine-tune its long-term plans, given the company’s undervalued assets and more than $200 million in cash.
“They can say ‘to hell with the stock market,’ ” Strachan said. “The valuation is so low, Federated is not risking that much.”
A bigger roll of the dice was Federated’s decision in 1998 to change its corporate culture by encouraging key personnel to take more risks.
Led by Lundgren, the effort is designed to encourage the company’s best merchandise buyers to bet “big and bold” without penalizing them if they fail. Federated executives promised the buyers at least the same salary as the previous year, even if some of their choices or the company’s best bets didn’t pan out.
Company executives then slashed the amount of merchandise Federated’s stores offered, opting for bigger presentations and displays of fewer, but better-selling items.
For example, Federated chains sold 165,000 pairs of fuzzy hot-pink and leopard-print Steve Madden slippers at $25 a pop in December simply by stacking dozens of boxes on the floor near checkout lines so customers could help themselves.
When the slippers were in the shoe department earlier in the year, sales were barely a blip on the screen. The mistake, Lundgren said, was that they should have been marketed as impulse buys. Customers paying $80 for a pair of shoes might buy them as a novelty, but didn’t consider them when they were shown alongside “real” shoes.
Successes such as this one encouraged Federated officials, who earlier had embarked on a “reinvention project” with at least one experimental idea for each of Federated’s seven department-store divisions.
The “reinvention” strategy has paid off big at Macy’s West, which built separate juniors departments at stores in Pleasanton, Calif., and San Jose that included sound systems, hip plasma screens that displayed teens as they tried out various outfits, and computers that allowed them to e-mail the images to their friends.
The departments sell jewelry and cosmetics aimed at teens--without the well-made-up but intimidating saleswoman behind the counter. The departments also sell beepers, snacks such as Mountain Dew and chocolate tacos and has vending machines that dispense compact discs.
Instead of 10% to 15% sales growth that a typical juniors department would post, the new-look departments generated 25% to 35% sales growth, Lundgren said.
Federated will begin rolling out revamped juniors departments in all of its stores.
“That’s the hallmark of what makes a department store successful,” said PaineWebber’s Edelman. “You’ve got to be flexible, you’ve got to constantly change. That’s why a lot of the department stores are gone, because they weren’t as progressive.”
At the heart of Federated’s resurgence is a course plotted two years ago by Lundgren, a 48-year-old Long Beach native, and Chief Executive James M. Zimmerman.
In January 1998, Zimmerman and Lundgren held their regular monthly meeting with the company’s three top corporate officers in an upper-floor suite at Macy’s Herald Square in New York.
“We were ready to yawn and plan our next year at the same 2.7% growth,” Lundgren said in an interview from his New York office. “Some of us said, ‘Wait a minute, is this all there is?’ ”
Lundgren led the charge for wide-ranging new ideas, getting key help from Chief Financial Officer Karen Hoguet and Vice Chairman Ronald Tysoe. In addition to their shared passion for retailing, the three have eight daughters among them.
Their girls did not grow up going to tea with their mothers at Federated stores. Knowing the new generation of girls intimately, they worried aloud about losing their daughters’ entire generation--the largest and biggest-spending population ever--for good if Federated didn’t change.
“We couldn’t help but talk about this young consumer and how kids and teens had such strong points of view at such a young age,” Lundgren recalled. “It wasn’t enough to have the product--although that was key--they also wanted a cool place to shop.
So they began tearing apart the various departments within individual stores, to examine the company’s best and worst performers.
Eager to find clues about where to improve, the leaders reconvened with the division heads and began grouping stores with similar sales levels. Why did one store’s men’s department contribute 17% of the store’s revenue, while another store got 25% from the same department?
Instead of placing new orders based on how many units of an item were sold the previous year, the executives began looking to the best-performing stores for purchasing guidance, rather than how many the store had sold in the past.
“In every case it was much, much higher,” Lundgren said. “We were doing it top-down--here’s the number I can afford instead of saying what’s my total potential.
“It was time for us to stop acting like we were still in bankruptcy. It was time to take our company to another level.”
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Federated Flourishes
Federated Department Stores, coming off its best year ever, is now looking to master the murky world of Internet retailing. Here’s a look at the company’s operations:
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Strong Finances
Federated has been one of the top-performing department-store chains in recent years. Sales and profit for fiscal years*:
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Sales have risen 21% since 1996 (in billions) ...
Sales in 2000: $18.2 billion (reflects 1999 acquisition of Fingerhut Cos.)
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... as profit soared tenfold. (in millions)
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Profit in 2000: $795 million
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Market Performance
Although it has greatly outperformed the competition, Federated’s stock is off 10.3% from its peak in the last year, as investors have fled retail stocks. Monthly closes and latest on the New York Stock Exchange:
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Friday: $42.25
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Federated Department Stores at a Glance
* Headquarters: Cincinnati
* Founded: 1929
* Operations: Nation’s largest department-store operator, with 403 stores in 33 states
* Leadership: James M. Zimmerman, chairman and chief executive; Terry J. Lundgren, president and chief merchandising officer
* Employees: 18,800
* California presence: 94 Macy’s and Bloomingdale’s stores; Macys.com
* Competition: Robinsons-May, Nordstrom, Neiman-Marcus, Dillard’s, Gottschalks
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Sources: Federated Department Stores, Bloomberg News
