Should Hudson Bay Buy Neiman Marcus? The Case For And Against.

Tuesday morning the Neiman Marcus Group reported another quarter of disappointing financial results and announced that it was going to “explore strategic alternatives.”

To be sure, some of Neiman’s problems are idiosyncratic, largely owing to a botched systems implementation and a now crushing debt load taken on in a 2013 private equity buyout. Yet the brand’s continuing struggles also underscore how luxury retail has hit the wall and how it now seems increasingly likely that the storied company may need to run into the arms of yet another owner.

Recent reports have suggested that the Hudson’s Bay Company was hot on the trail of Macy’s. Yet to many, the notion that HBC would acquire a badly wounded company several times its size, seemed a bit crazy. But the rationale for HBC–the owner of Saks Fifth Avenue and Gilt–to acquire Neiman’s seems, at least at face value, more strategically sound and (perhaps) more easily financed.

When I worked for Neiman Marcus as the head of strategy and corporate marketing we took a hard look at acquiring Saks. Years later, many of the pros and cons of combining the #1 and #2 luxury department stores remain the same.

The Case For

It seems increasingly obvious that the luxury department store sector is quite mature. While e-commerce is growing (now representing 31% of Neiman’s total revenues), most of that is now merely channel shift. Moreover, there are virtually no new full-line store opportunities for either Saks or Neiman’s, and the jury remains out whether or not US brands can find a meaningful number of store openings outside their home markets. Shifting demographics also do not bode well for long-term sector growth.

Faced with this reality, consolidation makes a lot of sense. If Saks were to merge with Neiman’s there would be considerable cost savings from combining many areas of operations. Rationalization of the supply chain would yield material savings as well. Managing the two brands as a cohesive portfolio would allow for optimization of marketing spending and promotional activity. There might even be some benefits from combining buying power to extract greater margins from vendors. Less tangible, but potentially meaningful, is the ability to cascade best practices from each organization.

The more interesting benefits could come from addressing store overlaps. As the market matures and more sales move online, there will be a growing number of trade areas (and specific mall locations) where Saks and Neiman’s going head-to-head only waters down the profitability of each respective location. Selectively closing stores and redeploying that real estate could drive up the remaining locations’ profitability dramatically, while unlocking the underlying real estate value of certain locations. All of which certainly plays into Richard Baker’s (HBC’s Chairman) strengths.

The Case Against

By far the most challenging element of any buyout of Neiman’s by HBC (or by anyone for that matter) would be the price and the related financing. Neiman’s was sold in 2013 for $6 billion dollars and still carries about $5 billion in debt. Since the buyout the company’s EBITDA has gone south, with no prospect for an imminent major turnaround. Given the maturity of the sector and the company’s recent weak operating performance, it’s hard to see why anyone would pay the sort of multiple that would make the current equity and/or debt owners whole.

Unless the real estate value can be unlocked in a transformative way, the only rationale for a merger hinges on the ability to generate operational efficiencies and optimize trade area by trade area market performance. With regard to the former, this isn’t trivial. The Saks and Neiman’s cultures are very different. To say one is very New York and the other is very Texas merely hints at the challenges. It’s easy to sketch out the synergies on paper. Making them actually happen is another thing entirely.

With regard to the latter, the fact is that Saks and Neiman’s are very similar concepts (though Neiman’s historically has been operated far better). When I was at Neiman’s we struggled with how we would operate two virtually identical brands often operating in the same mall–or in places like San Francisco, Beverly Hills, Boston and Chicago–just down the street. Even if we could get out of a lease (or sell the store), would closing a shared location actually be accretive to earnings? If we continued to go head-to-head could we shift the positioning of each brand enough to actually grow market share and profits. Ultimately, other issues trumped this particular concern, but this issue isn’t trivial either and the degree to which it is important mostly comes back to the ultimate price to get a deal done.

Without access to proprietary data it’s impossible to completely assess the likelihood of an HBC/Neiman’s deal. But it seems increasingly likely that something dramatic needs to happen with Neiman’s capital structure and it’s difficult to imagine how another leveraged buyout gets done with private equity sponsors. And it’s hard to see another strategic buyer that makes much sense. More and more, HBC looks like the only game in town.

A version of this story appeared at Forbes, where I am a retail contributor. You can check out more of my posts here.

Luxury retail hits the wall

For a long time, the conventional wisdom has been that the luxury market was largely impervious to the ups and down of the economy. Yet recent results suggest otherwise and even with an improving macro-economic picture and booming stock market, most U.S.-based luxury retail brands continue to struggle.

A little over a week ago, reports surfaced that Neiman Marcus was looking to restructure its debt after a series of disappointing quarters. While Neiman Marcus faces unique challenges owing to high leverage from its 2013 buyout and a botched systems implementation, they are also being hit by a general malaise affecting the sector. HBC’s Saks Fifth Avenue division revenues have stalled during the past year. Nordstrom, which was once a shining star in the retail pantheon, has seen five straight quarters of declines in its full-line stores. Tiffany and Kors are among other brands facing similar declines. So what’s going on here?

The most common explanations for faltering performance have been the strong dollar’s impact on foreign tourism and a weak oil market. To be sure, these factors have not been helpful. But the problems in the luxury market go deeper, particularly among the department store players. Even an improvement in foreign tourism or the oil market are unlikely to return the sector to its former glory. Here’s why:

  • Little new customer growth. Other than through e-commerce, luxury retailers have had a tough time with customer acquisition for many years. With e-commerce maturing–and most recent reported gains merely channel shift–unfavorable demographics (see below) and very few new store openings, luxury brands are struggling to replace the customers they are losing.
  • Little or no transaction growth. While not widely appreciated, most of the comparable store growth in luxury retail has come through prices increases, not growth in transactions. To change this dynamic companies need to appeal to a wider range of customers and that’s proven difficult to execute in an intensely competitive environment. Brands must be also be careful not to dilute their brand relevance and differentiation in an attempt to cast a wider net.
  • Unfavorable demographics. Affluent baby boomers have propped up the sector for more than a decade. But as customers get older they tend to spend less overall, and quite a bit less on luxury in particular. Baby boomers are slowly but surely aging out of the segment. Gen X is a smaller cohort and there is little evidence they will spend as much as the boomers. Over the longer term, millennials will need to make up for the boomers who, to put it bluntly, will be dying off. Most studies suggest millennials will be more price-sensitive and less status conscious then then the cohorts ahead of them. This is a major long-term headwind.
  • Growing competition. Strict control over distribution largely insulates the luxury market from intense price competition and having to go head-to-head with Amazon. Nevertheless, full-price luxury is increasingly being cannibalized by retailers’ own growing off-price divisions. Luxury brand manufacturers are also aggressively investing in their own direct-to-consumer efforts by improving their e-commerce operations and continuing to open their own stores. Luxury websites like Net-a-Porter are gaining share of a no longer expanding pie.
  • Shifts in spending. Affluent consumers continue to value experiences and services over things–and are allocating their spending accordingly. Perhaps this multi-year trend will start to reverse itself. Perhaps.
  • The omni-channel migration dilemma. Luxury retailers are spending mightily on all things omni-channel, as they must to remain competitive. But it’s incredibly expensive to create a more integrated customer experience. The better a retailer becomes at this, the more business shifts from physical stores to digital. Most often this is not accretive to earnings as brick & mortar economics get deleveraged and online shopping is plagued by high returns and expensive logistics.
  • Looming over-capacity. While the luxury sector does not face the pressure to close stores that the broader market does, stagnant sales and a continued shift to digital channels will start to put more and more pressure on full-line store economics. Moreover, there is growing evidence that the high-end off-price sector is approaching saturation. The rationale for a Saks and Neiman merger may start to make more sense and some pruning of locations seems inevitable.

Notwithstanding the capital structure issues Neiman Marcus must deal with, the luxury market does not face nearly the same immediate challenges that many parts of retail must address. Nevertheless, there is mounting evidence that the sector’s struggles go beyond foreign currency woes and the vagaries of the oil market.

Profound change is coming to luxury as well and most of the headwinds simply aren’t going away.

A version of this story appeared at Forbes, where I am a retail contributor. You can check out more of my posts here.

What if retail traffic declines last forever?

The results keep pouring in and they don’t bode well for brick & mortar retail. Across just about every sector and virtually every time period, traffic to physical stores continues to decline.

Of course, for the most part, we aren’t buying less, we are shopping differently. The obvious dominant trend is the explosion of e-commerce, and the one player accounting for the most growth is Amazon. Yet the real news for everyone else is how shoppers are diversifying the channels in which they research purchases and ultimately transact. This so-called “omni-channel” world is wreaking havoc with traditional retailers’ underlying economics and, like most things, the future will not be evenly distributed.

The vast majority of retailers have now likely entered a period where comparable store traffic will never increase again for any sustained period of time.

That’s profound. And more than a bit scary.

Drops in store traffic almost always dictate sales declines. Given that physical stores have relatively high fixed costs (rent, inventory, staffing, etc.) a material drop in revenue deleverages operating costs and profits fall disproportionately. This long-term (and increasingly widespread) trend is causing a great deleveraging across many retail segments and is the primary reason so many stores are being closed. It’s also causing brands to rethink the size and operating nature of the stores that remain or they plan to open. These shifts will prove seismic.

While there is a belief that e-commerce’s economics are superior to brick & mortar stores, that frequently is not the case, primarily owing to challenging supply chain costs, high product returns and compressed margins. As traditional retailers invest heavily in building their digital operations–and creating the much vaunted seamlessly integrated shopping experience–many are merely spending a lot of money to move sales from one channel to the other, often at lower profitability. Even brands such as Nordstrom, Neiman Marcus and, to a lesser degree, Macy’s, that are often touted as omni-channel pioneers and have industry leading online penetration, have seen profit growth stall despite massive investments.

Roughly 90% of all retail is still done in physical stores. Yet the growth of e-commerce will continue unabated and the resulting drop in store traffic is an undeniable and unrelenting force. With rare exception, there is little any retailer can do to stem this tide. One key focus must therefore be on right-sizing store counts and the remaining stores’ footprints and operating costs. But the far more important strategy is to create a remarkable customer experience across all channels that reflects how consumers shop today and the intersectionality of digital and physical channels. Ultimately the key is to maximize customer growth, loyalty and profitability irrespective of where the customer decides to transact.

The pain of store traffic declines is inevitable.

The degree of suffering from it remains optional.

 

This post originally appeared on Forbes where I recently became a contributor. You can check out more of my writing by going here.

Kors is the latest retail highflier to get its wings clipped

Add once soaring–and seemingly invincible–Michael Kors to the list of retail brands to disappoint the market.

Last week Kors, the “accessible luxury” fashion brand that has grown from a niche player to a multi-billion dollar global juggernaut in under a decade, reported earnings that actually slightly beat expectations. Yet a miss on sales and lowered guidance sent the stock cratering.

At first blush, the overall sales weakness should not have surprised anyone. Kors has pulled back significantly on its wholesale distribution while simultaneously reducing promotional activity. An increase in that sector would have taken a miracle. But what was shocking was a rather precipitous 6.4% drop in comparable stores sales and a nearly 23% decline in licensing revenue.

It’s tempting to see the problems at Kors as brand specific, self inflicted and temporary as the brand realigns its pricing and distribution strategy. But I believe they underscore several broader and more vexing industry issues.

For several quarters now we’ve witnessed a panoply of once mighty high-end brands falter. The luxury department store industry’s big stall is now well into its second year. Saks has reported several quarters of disappointing comps. Neiman Marcus, saddled with high debt and weakening sales, had its debt rating downgraded last week. Nordstrom’s industry leading full-line store performance has become tepid at best. And all of this comes amidst a surging stock market and improving consumer confidence.

To be sure, the strong dollar and weak oil market has a material dampening effect. But even if that were to reverse–which seems rather unlikely anytime soon–the industry is still plagued by increasingly unfavorable demographics, lack of innovation, over capacity and growing consumer willingness to “trade down” to less expensive substitutes. Until these companies find ways to drive traffic increases, attract meaningful numbers of new customers and drive revenues through transaction growth instead of merely raising prices, we can expect a continued string of disappointments from most, if not all, of these brands.

And it just might take a major shakeout to restore the industry to its glory days.

A version of this post originally appeared @Forbes where I recently become a contributor. You can check out my latest work here.

Stop blaming Amazon for department store woes

Given Amazon’s staggering growth and willingness to lose money to grab market share it’s easy to blame them for everything that is ailing “traditional” retail overall–and the  department store sector in particular.

In fact, with announcements last week from Macy’s to Kohl’s and Sears to JC Penney that could only charitably be called “disappointing” many folks that get paid to understand this stuff reflexively jumped on the “it’s all Amazon’s fault” bandwagon. Too bad they are mostly wrong.

The fact is the department store sector has been losing consumer relevance and share for a long, long time–and certainly well before Amazon had even a detectable amount of competing product in core department store categories.

dept_store_sales_grwth_large

The fact is it’s just as logical to blame off-price and warehouse club retailer growth–which is almost entirely done in physical locations, by the way–for department stores’ problems.

dillards-2

The fact is that, despite other challenges along the way, Nordstrom, Saks and Neiman Marcus have maintained share by transitioning a huge amount of their brick & mortar business to their online channels and have closed only a handful of stores in the last few years. Nordstrom and Neiman Marcus now both derive some 25% of their total sales from e-commerce.

Don’t get me wrong, I’m not saying that Amazon isn’t stealing business from the major department store players. Clearly they are. And as Amazon continues to grow its apparel business they will grab more and more share.

But the underlying reason for department stores decades long struggle is the sector’s consistent inability to transform their customer experience, product assortments, marketing strategies and real estate to meet consumers’ evolving needs.

More recently, those brands that have been slow to embrace digital first retail are scrambling to play catch up. Those that still haven’t broken down the silos that create barriers to a frictionless shopping experience will continue to hemorrhage customers and cash.

Most importantly those that think they can out Amazon Amazon are engaged in a race to the bottom. And as Seth reminds us, the problem with a race to the bottom is that you might win.

seth-godin-quote-1-800x397

Slow motion crises

In the world of retail it’s pretty rare that brands get into trouble over night–much less over a matter of months or even years.

What will turn out to be the deathblow for Sears started with Walmart in the 1980’s, and was followed by Home Depot, Lowes and Best Buy chipping away at Sears core tools and appliance business as these insurgents opened new stores and improved their offerings over many, many years.

The ability to deliver books, music and other forms of entertainment digitally (or shipped directly to the consumer) just didn’t pop up one day. Blockbuster, Borders and Barnes & Noble had years to respond. They just didn’t in any especially powerful way.

Starbucks initiated its rapid store growth more than 20 years ago. And the broader reinvention of the retail coffee business by local independents, along with forays by Keurig, Nespresso and others, is hardly a recent phenomenon. Yet it’s hard to point to anything particularly innovative that industry leaders Folger’s and Maxwell House have done during this extended period, despite their brands continuing to lose sales and relevance.

As Macy’s, JC Penney, Dillards and other traditional department store players garner lots of negative press about their current struggles, we should remember that the department store sector has lost relative market share for more than two decades. Their problems are not simply a function of the growth of e-commerce. And even if they were, the best in class players were investing heavily in e-commerce–think Neiman Marcus and Nordstrom–more than 15 years ago.

Crises created by unforeseen events are one thing. Slow motion crises only reveal that we took our eyes off the ball, were too afraid to act or both.

The way to avoid a retail slow motion crisis is as follows:

  • Understand where customer value is being created on a go forward basis
  • Dissect your most valuable customer segments to understand where your brand is vulnerable and where you have potential leverage
  • Figure out where you can compete by modifying your core business and where you need to innovate outside of your core
  • Don’t be afraid to compete with yourself
  • Consider acquistions as way to build new capabilities quickly
  • Embrace a culture of experimentation
  • Spend more time doing, than studying.

 

 

 

 

Retail’s big reset

It’s been happening for a few years now, but the pace is accelerating.

Retailers waking up to the reality of a slow or no growth world.

Retailers beginning to understand that if you don’t garner share of attention, you have little or no shot at share of wallet.

Retailers starting to comprehend that it’s not about the silos of e-commerce, catalogs, social, mobile and physical stores. It’s about one brand, many channels.

Retailers seeing that it’s not only a digital first world, increasingly it’s a mobile first world.

Retailers coming to terms with having too many stores, and being confronted with the cold hard facts that the ones that should remain are often too large and, more importantly, too boring.

Retailers recognizing that continuing to offer up average products for average people is a recipe for either long-term mediocrity or inevitable bankruptcy.

Retailers realizing that most of their e-commerce growth is now coming from channel shift and that much of their “omni-channel” investments are proving unprofitable.

When historically strong brands like Nordstrom and Neiman Marcus start taking a big whack at their corporate staffs and pulling back on capital investments, it’s hard to argue that this is just about low oil prices and weak foreign tourist traffic.

The big reset is upon us.

Some get it. But too many clearly don’t.

Change is happening faster and faster. Disruption is now just part of the ecosystem.

If you believe, as I do, that we are in for an extended period of muted consumer spending, that we are way over-stored in most major markets and that the power has shifted irretrievably to the consumer, then business as usual–and relentless, but vague promises to become “omni-channel”–will not cut it.

The discipline of the market will be harsh. Good enough no longer is.

If you aren’t worried, chances are you should be.

And if you aren’t in a hurry, you might want to pick up the pace.