A couple of hours ago, I was running errands. The spouse needed to pick up something at J.C. Penney before hopping on a plane so I went along and wandered around the store, looking at the newly remodeled displays, noting which products I had seen at the wholesale gift mart the last time I was in Dallas, Texas (it’s weird when you realize exactly which supplier sold those exotically colored hourglasses, and how much the blenders cost the store). As I meandered through the nearly deserted, yet much more attractive, aisles, I began thinking about the hardships J.C. Penney has encountered over the past few years.
You need to understand that I love J.C. Penney. I love its history. I love the story of the man who founded it, James Cash Penney, who happens to share my birthday. I love that he helped train subsequent giants including Sam Walton and Warren Buffett. He was an entrepreneurial force, who always tried to do right by his customers, including fighting the introduction of charge cards as he knew the working class would enslave themselves because of their lack of sophistication, which he considered evil even if it did make him money. He cared for his customers. He wanted to see them succeed, even if they weren’t as smart as he was. He wanted to make money honestly, by providing superior goods and unparalleled customer satisfaction All around, the guy got a lot of things about business and morality right. His ownership career started at 27, when he acquired a 1/3rd equity stake in a small chain of stores, later buying out the other two partners.
Whenever I pass a J.C. Penney, I think about the history; his life; what he accomplished. I know the inflation-adjusted profit figures – the guy was so good he’d launch a store and be making more than $220,000 in today’s figures on barely any inventory! He figured out ways to cut costs by reducing the wrapping ribbon used on men’s dress shirts. In fact, I don’t even see “J.C. Penney”. I read it in my mind as “James Cash Penney’s store”.
It was because of his mind that, a long time ago, J.C. Penney was one of the greatest retail companies on the planet. It used to be a place where working class and upper middle class families could buy good quality merchandise, at a fair price, with friendly sales people. It was stable, trendy, and reflected the growing affluence of the typical American consumer as the average person, in the average community, saw his wages increase. From toasters to suits, bedding to summer drinkware shown in beautiful, big glossy catalogs, it was as American as fireworks on the 4th of July, apple pie, and baseball games.
The Source of J.C. Penney’s Demographic Problems Began Roughly 23 Years Ago
In the 1990’s, the United States started the shift we’ve discussed exhaustively on the site, migrating to a nation of knowledge workers and manual workers. The middle class slowly began to hollow out until the private bankers were discussing a new model for consumer brands to reflect the growing reality called the Consumer Hourglass Theory. It posited that profits would be had on the extreme ends of the spectrum – appealing to the poor working class or the wealthy, well-educated elite. Those in the middle would be too high class for the low class and too low class for the high class, spelling economic doom.
[mainbodyad]Over the past 23 years, J.C. Penney has found itself slowly slipping down toward what its management considered the wrong part of that hourglass. It had become so irrelevant among the upper middle class and the young that a majority of its customer base had come to consist of the poor and the elderly, in dying communities focused in the South and Midwest. Gone were the days of young couples coming in, registering, then returning as they had children and made their way through life. Sure, it still happened, but it was a mere shadow of the past. Instead, the shelves were filled with merchandise appealing to a generation closer to the grave than grade school, with tastes that were out of the mainstream. The kitchen appliances, curtains, fashions, lamps, and bedding were anachronistic.
For now, this approach was very profitable even though there was an expiration date. At the height of the real estate bubble in 2007, before the economy collapsed, J.C. Penney generated pre-tax operating profit of $1.792 billion on sales of $19.903 billion. A business capable of that kind of earning power is nothing to ignore.
The executives saw what was coming on the horizon. The death of the brand was fast approaching. Every year that passed, more J.C. Penney customers were put in the ground, more stores decayed, more inventory grew obsolete, and fewer people even gave the business any thought at all. They knew something had to change because the firm was leaving most of the money on the table. They had to get young families back in the stores. They had to appeal to college graduates just starting their career. J.C. Penney was no longer a family store. It was a geriatric flea market with mass discounted, cheaply made goods and that is not what it wanted to be.
Thus, J.C. Penney faced an impossible choice.
They pulled a trick from McDonald’s playbook and began a total overhaul of the interiors, bringing its brand into the modern world, shedding the now 20+ year out-of-date products, displays, and designs. It wanted to make the brand more like Apple or Target and ensure its long-term survival. Gone are the gimmicky $59.99 price tags – now, you’d just see an even $60. Gone are the huge sales with coupons that allowed you to get 50% off, swapped instead with every day low pricing. Thrown in the garbage are the overstuffed, rusting metal bracket shelving, replaced by clean displays that look like a scene out of a 1960’s Saks or Macy’s catalog; there are individual boutiques for specific areas of the store, as if you are traveling along a street filled with individual vendors.
To compare the difference, go look at the old, monstrous interiors – they were just Godawful- and compare it to the new layouts.
The changes were an exponential improvement. I first went to check them out two and half years ago, when they were liquidating some of the remaining good inventory to switch over to the new system. It seemed that once the younger generation was exposed to it, it would take some time but there was little doubt based on marketing tests and experience with comparable brand concepts that it would revitalize the business. Remember that brands are really just mental short cuts for associations about the product, service, quality, and price. J.C. Penney needed time to make consumers think of it like a shiny new penny and not an old wooden nickel.
(On a personal note, it was actually a trip to J.C. Penney more than three years ago that made me finally realize that I simply cannot tolerate the formal clothes there. I’d rather spend $400 on a single bespoke shirt than get 10 shirts for $40. I’ll never go back. The quality difference is worth it to me. In those days, I was still a bit too tightfisted with my cash. Now, I realize it’s better to buy superior goods, if you can afford them and prefer them, because the entire point of having money is to maximize the utility you get from it. In this, I unfortunately proved the private bankers right. The Consumer Hourglass Theory is real.)
How Everything Went Wrong, While Being Right
We simply cannot examine what actually happened if we aren’t honest about the cause so please forgive the fact that this is going to sound like I mean it negatively; there is no malice here whatsoever – it is a factual representation of the situation, which is important if you want to understand the forces behind the business failure. Thus, we must acknowledge the major problem: J.C. Penney had fallen so far down the social spectrum, one tiny step at a time, that the typical J.C. Penney customers were the type of people who weighed 350 pounds, wore giant plastic glasses bought during the Reagan era, had shirts made of American flag fabric, drove down country roads to sit on a porch drinking beer, thought Nancy Pelosi was the anti-Christ, still referred to blacks as the “n” words, lived off their Medicare and Social Security whilst complaining about big government, and were obsessed with institutions of authority, such as the army, the church, or the factory. They were more technologically illiterate, had far lower educational attainment, and were turned off by virtually every upgrade that was installed.
That isn’t an attack, it is simply a fact. Those are the folks who were pouring cash into the corporate coffers.
How is that relevant? People are far more predictable than most want to believe. That type of demographic behaves in very specific ways that make it different than the demographic of an Apple or a Target. The management of J.C. Penney was so out of touch with this group that it didn’t appreciate just how skewed the world view of these clients are by irrational, gut-check factors that make no sense (you’ll see what I mean in a moment). They were used to dealing with folks who wouldn’t think twice about spending $75 on an accessory that looked good and added a little functionality, and now they were trying to sell to people who thought that was three times the price of a coffee maker. There was an enormous disconnect.
The “new” J.C. Penney repulsed this now lowest-common-denominator customer base, down the advertising. Especially, it would seem, the advertising. It was so bad that – this is not a joke – there were organized boycotts because Penney’s hired the most popular television personality in the United States as its spokesperson, Ellen Degeneres, and ran father’s day ads that now reflect the world in which we live. You’d have thought they were clubbing baby seals and showing the film in the children’s section.
There were even people complaining that J.C. Penney’s new fancy tea kettles looked like Hitler. I wish I were kidding. I really do. They were angry about the Hitler-kettle. How can a rational, intelligent person possibly deal with clients who think you are secretly showing support for a long-dead German dictator when designing mundane kitchenware? These are not the brightest crayons in the box.
Dealing with this customer base was a demographic disaster; a ticking time bomb. Such a group is only appropriate if you are a niche retailer specializing in items $10 or less. Yet, Penney’s had found itself in the position where only 13 out of every 100 of its customers made $100,000 or more in a year. It was no longer the store that America’s secret millionaires-next-door shopped in and thought of as a good value. Penney had lost the so-called “aspirationals” who wanted, and appreciated, the nicer things and were willing to pay more, even though they couldn’t afford the truly expensive brands. They had lost the trend setters. They had lost the community leaders. They had lost the folks who owned the local car dealerships and movie theaters, whom people wanted to emulate as a result of social proof.
Before those people, the marketing “desirables” for lack of a better term, could be enticed back into the stores, the now-alienated, elderly, poor, undereducated customers began to leave, first in a trickle, then in droves. Offended by the shiny lights, wireless checkout registers, lack of coupons, homosexuals, and Nazi teapots, they threw in the towel on the brand as not reflecting their values, creating a black hole on the income statement.
The Black Hole That Opened on the J.C. Penney Income Statement
To understand that black hole, you need to understand operating leverage. Like most retailers, J.C. Penney has a high degree of operating leverage. For the non-accountants among you, it means that there is a certain level of fixed expenses that once you dip below, you experience losses, but when you exceed, nearly everything falls to the bottom line. It takes a lot of lease payments, light bulbs, hangers, and computers to run a Penney location. Whether you sell anything or not, those expenses must be paid. Once you exceed them, there isn’t a lot of incremental cost, so revenue over a particular threshold has far higher operating margins. Now, multiply that by thousands of stores.
J.C. Penney saw sales fall from $19.903 billion in 2007 to $12.985 billion in 2013. This caused the firm to go from a pre-tax profit of $1.792 billion to pre-tax losses of $1.536 billion, a staggering swing of $3.328 billion. Dividends were slashed, book value destroyed. There were rumors the company was surviving by pushing payable bills and hoarding cash.
The CEO was fired.
[mainbodyad]What makes this situation so upsetting is that, long-term, he was right. The changes he made were good, just poorly executed. They had to happen. Where he failed was he alienated the old customers before the new customers had come on board. It was all done at once, unilaterally. Stores were under renovation for more than a year, customers fighting their way around drywall and walking on cement floors. New, younger, richer customers had not yet seen the Abercrombie & Fitch-like denim departments or the Gimbels-like kitchen section where shiny copper-embellished toasters lined the illuminated walls. The banker or executive who is probably shopping at a St. John’s boutique hadn’t yet realized she could now pick up the same great kitchen accessories she found at Williams-Sonoma.
The coupon policy was especially troublesome. When you’re dealing with undereducated customers, you must account for their irrationality and stupidity with numbers. This was a painful lesson that the bluest of blue chips, Procter & Gamble, learned decades ago when its marketing psychologists discovered that customers revolted if coupons were taken away, even if the price of the laundry detergent was higher with the coupon! It’s absurd. Completely, totally absurd. People would rather pay more but feel like they were saving money than actually save money. It’s almost impossible to get your mind around that if you have even modest dexterity with figures.
Final Thoughts on J.C. Penney
Had J.C. Penney been part of a larger conglomerate, like Berkshire Hathaway, or had a private controlling family, like the Walton’s at Wal-Mart, it could have stayed in it for the long-haul. It could have made the shift and weathered the storm, sailing through the darkest days, despite having misstepped. But it’s accountable to Wall Street. Investors there think three years is a long-term commitment! Yes, there was mismanagement. The fact remains that the brand equity was dying and something had to be done.
Can J.C. Penney be saved? I haven’t a clue. I wish I did. If it fails, I will consider it a great tragedy. If they survive, at least their stores now look like something out of the 21st century.