Rafi Mohammed

Will J.C. Penney Survive?

Posted on February 28th, 2013 (0 Comments)

Reprinted from the Harvard Business Review website. 

This week J.C. Penney released its fourth quarter earnings results and they were dismal. Comparable store sales nosedived by 31.7% in the fourth quarter of 2012 versus the prior year. Internet revenue sank by 34.4%, and gross margin dropped from 30.2% to 23.8%.

What's causing this financial Armageddon? The sole culprit is J.C. Penney's new "Fair and Square Every Day" low pricing strategy. In January 2012, Ron Johnson, Penney's CEO, announced that instead of offering weekly sales, the retailer was reducing prices across the board. Johnson's pitch to consumers was in essence, "Why wait for a sale? We have low prices all of the time." To be clear, Johnson was not claiming that Penney's everyday prices are the lowest, simply "fair."

The problem with this strategy is that when a retailer sells fairly commoditized products in a generic selling environment — as Penney currently does — it needs sales to motivate consumers to visit a store. Penney's financial results have clearly demonstrated that without deals, few people are waking up on Sunday morning thinking, "I have to go to J.C. Penney today to hang out and shop." Fair and Square pricing has been in place for a year, and comparable store sales have progressively worsened, declining from -18.9% to -21.7% to -26.1% to -31.7% over the last four quarters.

While Mr. Johnson sought to shy away from deep discounts, Penney's 6.4% drop in gross margin reveals that it acted otherwise. Since merchandise was not selling, it had to offer bargain basement clearance prices to move inventory, thus reducing gross margin. So ironically, over the last year the best deals in retail have likely been at J.C. Penney's clearance rack.

In fairness to Johnson, he has ambitious plans to revitalize the venerable retail chain by offering differentiated products (80 - 100 branded boutiques) as well as a unique shopping experience. In essence, he is striving to make Penney the Apple Store of general merchandise retail. It's an outstanding idea that could be the model of success for retail in general — provide unique value that insulates brick and mortar stores from intense web retailer price competition. Early on, I suggested that Penney ditch this new pricing strategy — and return to weekly sales — until it achieves the retail differentiation that on its own might draws customers into stores.

In this week's earnings call, Johnson seemingly retreated on his Fair and Square pricing strategy. Early in the call, he stated, "We'll offer sales each and every week as we move forward." But Johnson's mea culpa has been limited by his lack of clarity and wishy washy stance on pricing, both to consumers and Wall Street. In October, for instance, he sent an email to customers reinforcing his pitch of not having to wait for a sale or coupon to get a good deal — and then paradoxically included a $10 off coupon in the same email. Just on Monday, the Wall Street Journal reported that Johnson is reticent to use the word "sale" and while Penney has announced sales will be timed to "events and holidays," he would not confirm how frequently they will occur.

The latest ambiguity comes in how consumers and Wall Street are to interpret the word "sale." Late in this week's earnings call, Johnson indicated that sales will primarily be held on J.C. Penney's brand products, but typically not on national brands. So sure, in a technical sense Penney will be holding sales. But with rival retailers heavily discounting national brands every week, the key question is whether discounting Penney's own brands will be enough to achieve the ultimate goal of a sale: drawing in customers to its stores and website.

While there may be some positive effects, I don't think J.C. Penney's "sales" will be enough to remedy its financial meltdown. To entice masses of consumers, you have to discount products that they really want — that means well-known national brands. Discounting lesser-known, private-label brands simply won't achieve the financial upside that J.C. Penney desperately needs.

So what's next for J.C. Penney? Either it further revises its pricing strategy to include sales on national brands or it heads to bankruptcy court.

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