How Department Stores Came Back into Fashion

With Lady Gaga blaring overhead, Felicia Terry and Susanna Chung check out a display of dressy, short-sleeve tops in a Manhattan store. A few feet away, a black chandelier hangs over rows of skinny jeans and aviator sunglasses. A pair of chic peep-toe sandals selling for more than a C-note floats nearby on its own shelf. The twentysomethings aren't trolling for new styles at some hip Soho boutique but at one of America's most venerable merchants, J.C. Penney (JCP). "If this was the old J.C. Penney," Chung says, "we would have just walked by."

U.S. department stores, widely regarded as endangered 10 years ago, are staging an unlikely revival. Along with high-end icons like Saks (SKS) and Bloomingdale's, middle-market players such as Penney, Macy's (M), Dillard's (DDS), and Kohl's lately have been luring shoppers with exclusive, trendy items that appeal to Gen Y. Once-stodgy department stores are a "credible destination for fashion," says Brian Sozzi, an analyst at Wall Street Strategies. Financial results at department stores also are outpacing those at many specialty retailers such as Gap (GPS) and American Eagle Outfitters (AEO). In February, sales at department stores open at least a year rose 5.7 percent, versus a 3.2 percent gain for apparel stores, according to the International Council of Shopping Centers. That trend has prevailed for three quarters.

In their dark days last decade, department stores were much harder to tell apart; they sold similar apparel made by the same vendors. Consumers defected and sales slowed, setting off a rush of consolidations that peaked with the $17 billion combination of Federated Department Stores, later renamed Macy's, and May Department Stores in 2005. The trauma of the Great Recession prompted department stores to cut costs, shutter ailing stores, and get bloated inventories under control.

With their balance sheets on the mend, chains set out to reposition themselves. After watching premium denim lure younger shoppers to its West Coast stores, Macy's decided to focus nationwide on 18-to-30 year-olds, a cohort that spends 50 percent more on average than the rest of the population, according to Jeffrey Gennette, the chain's chief merchandising officer. The retailer's Impulse apparel lines are aimed at those millennials, whom Macy's considers "a huge opportunity," Gennette says. Kohl's appeals to a similar demographic with its Simply Vera Vera Wang clothing. And Dillard's is wooing younger buyers by rolling out handbags and accessories designed by Korto Momolu, a popular runner-up on reality TV show Project Runway.

Borrowing from fast-fashion pioneers like Sweden's Hennes & Mauritz, whose H&M chain can get versions of runway fashions into its shops in as little as two weeks, department stores are turning over their clothing collections faster. Rather than refreshing styles only when seasons change, new items are continuously added to Material Girl, the teen-oriented line Macy's developed in 2010 with singer Madonna. Penney also has a fast-fashion contender called MNG, made by Mango, the European urban fashion brand.

Large merchants are aggressively locking up the rights to sell lines exclusively in an effort to make their stores destinations. In 2007, the percentage of Macy's sales in exclusive or limited distribution brands, including its private label lines, was 35 percent. By 2010, it was 43 percent. At Kohl's it's 48 percent. Kohl's this fall will launch clothing lines by singers Jennifer Lopez and Marc Anthony in what it says will be its largest brand initiative ever.

Such changes help the bottom line. Macy's profit more than doubled last year to $847 million. Dillard's, long an industry laggard, in 2010 earned $180 million after losing money as recently as 2008. And while rising cotton prices could hurt margins this year, department stores are less vulnerable than apparel chains because they sell things besides apparel. Their scale also means they can squeeze suppliers for better deals than smaller merchants.

The bottom line: Department stores' resurgence is driving unusual pairings, such as Sephora shops at J.C. Penney and Karl Lagerfeld goods at Macy's.

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