One More Face Lift For J.C. Penney

It's cutting costs and getting fashion into stores faster

Until recently, J.C. Penney Co. practiced what seemed like a formula for fashion disaster. Weeks after the latest dress design from Leslie Fay or a blazer from Alfred Dunner had hit the racks at Federated Department Stores or Dayton Hudson Corp., they would show up at Penney. That's because buyers for most of Penney's rivals are free to order immediately upon spotting goods they judge to be hits, while Penney's buyers had to follow a ponderous system of first showing potential new product to store managers. Only after taking orders from those managers could they place them with fashion houses.

The resulting delays help explain why the nation's largest department-store chain has suffered three years of weak sales and earnings. Now, CEO James E. Oesterreicher is vowing to get merchandise into stores faster and more efficiently with a new buying strategy Penney began implementing in February. And he's not stopping there. The Plano (Tex.) chain has embarked on a plan that includes sharp cost-cutting and improved inventory management--all designed to squeeze the most out of a department-store franchise with few growth prospects.

Last month, Penney reported a paltry 0.2% gain for fiscal 1997 net income, to $566 million. Revenues rose 30%, to $30.5 billion, but most of the gain came from Penney's drugstores, which have emerged as the engine that will drive the company's growth into the next century. Steve Kernkraut, an analyst at Bear, Stearns & Co., expects department-store sales to rise a mere 2% on a same-store basis this year.

Penney's department-store unit, which includes 1,200 outlets and the nation's largest catalog operation, has been slow to cut costs, move inventory, and attract top designer labels. It also doesn't help that Penney's stores are caught in a kind of retail no-man's land. More and more, shoppers are gravitating to discounters such as Wal-Mart Stores and Kmart or high-end retailers such as Neiman Marcus and Saks Fifth Avenue, abandoning retailers that cater to middle-income consumers.

LOOSE THREADS. But even if its sales growth is constrained, Penney has lots of room to improve its bottom line. Its department-store operating margins, 6.7% last year, are the lowest among major rivals, such as Dillard's Inc., 12.1%, and May Department Stores, 12.2%.

Oesterreicher, 56, is aiming to close that gap. Last fall, he offered voluntary early retirement to department-store managers. Some 1,250 of those asked to take the package, or about 80%, did so. The program should result in annual savings of $85 million. In January, Oesterreicher laid out plans to close 75 "underperforming" stores and slash 4,900 jobs, or 2% of Penney's workforce. That's expected to save an additional $105 million a year.

Penney is also attempting to get a better grip on purchasing and shipping. The new buying policy will consolidate purchasing functions at its headquarters for 50% to 60% of its stores' merchandise. John T. Cody Jr., president and chief operating officer for Penney's stores, merchandising, marketing, and catalog, says store managers will still buy the other 40% to serve local demographics.

The centralized buying strategy, Cody says, will typically save about four to five weeks. Penney also has substantially improved its fashion offerings by adding private and national brands in recent years. But it still lacks top labels such as Liz Claiborne, Ralph Lauren, and Tommy Hilfiger, some of which appear in rival Dillard's, May, and Federated. This summer, for instance, Penney will roll out Crazy Horse, a private line of misses' sportswear designed for it by Liz Claiborne Inc. But Liz Claiborne CEO Paul R. Charron balks at giving Penney its signature line for fear of diluting the brand.

SALE CITY. By making earlier commitments, Penney's buyers should be able to negotiate lower prices. And Penney is working to cut its high inventory levels, which have forced it to take aggressive markdowns to clear merchandise. Penney already is doing a better job of predicting sales levels: Inventory at the end of the fourth quarter was down 4% from a year earlier. That helped push department-store operating income up 42% for the quarter, to $663 million. "They're not giving away the store anymore," says Donald E. Brown, an analyst for Public Employees' Retirement System of Ohio, a big Penney shareholder. The moves won't put Penney's margins on a par with Dillard's or May's but should lift them over 8% this year, says Bear Stearns's Kernkraut.

This is familiar territory for Oesterreicher, a 34-year Penney veteran who started as a management trainee in 1964. In the early '90s, while he was head of stores and catalog sales, the company hit the skids after a push into higher-priced goods coincided with the 1990-91 recession. Net income plummeted from $577 million in 1990 to $80 million in 1991. It recovered to $1.1 billion in 1994 on a winning lower-price, higher-quality "value" strategy. The fix didn't stick, though, and Penney sought sales growth through diversification. It bought drugstore chain Eckerd Corp. for $3.3 billion in February, 1997. Says Oesterreicher: "We believe J.C. Penney is now well-positioned for profitable growth."

He has won some converts on Wall Street, where Penney's stock has shot to 75 from around 50 last June, where it had been stuck for 3 1/2 years. The boost came mostly from Penny's job cuts and store closings. But others wonder why it has taken so long. "I think Penney sat around on the success they achieved in the early '90s, while the world changed around them," says Tony Kreisel, chief investment officer at Putnam Investment's Basic Equity Fund, a shareholder. "They were slow to make changes, and now they are having to spend a lot of time playing catch-up." For Oesterreicher, the trick is to make sure that this time, Penney stays fixed.