Campeau Redux? Commentary by Peter J. Solomon

  • June 6, 2017

What's the big surprise? Commentators can't stop bemoaning the fate of department stores. But as a concept, department stores have been losing market share since the 1950s when their share of retail sales was over 60%.

Their dominance grew from a number of factors, only one of which related to marketing or merchandise. Their initial hold on consumers' wallets was rooted in the ability to extend credit to customers and to the manufacturers which supplied merchandise. Credit played another role, namely, shopping center developers used the financial stability of department stores to finance construction.

Introduction of Diners Club credit card in 1950 followed rapidly by competitive cards empowered consumers. Soon shoe stores proliferated; apparel stores multiplied; they became pilot fish of retail commerce - staying close to the department stores, feeding off their customer traffic. Developers charged these upstarts much higher rents and sandwiched them between the anchors.

I start with department stores but they are a proxy for much of retailing. The explosion of retail selling square footage compared to the increase in disposable income over the last thirty years is now widely acknowledged. But not enough is written about the implications and what propelled a pell-mell expansion.

Four observations:

First, the proliferation of stores meant that after an initial expansion virtually every location that every retailer opened in the last decades has opened at a lower sales volume than a comparable store opened a year earlier; has ramped up more slowly and has cost more. The result was successive declines in returns on investment.

Second, few retailers are able to predict the opening volume of any single store. In the aggregate, management usually gets within 5 to 10 percent but not as accurate on any single store. This phenomenon is a variant of the "fallacy of composition."

Third, despite retail managements' knowledge of the above, they continued to open more stores because it is the surest way to achieve sales growth. And though they should know better, retail security analysts base much of their valuations on “comp” sales and give shorter shrift to return on invested capital.

Fourth, when faced with the above facts and the inability to create value, many retailers have gone private, recapitalizing with leverage. It has always been imprudent for retailers to incur high financial leverage since a retailer with its leases and high fixed costs has operating leverage. Despite the risks, a number of earlier retail recaps were successful but many more recent ones are not.

E-commerce and Amazon exacerbated the challenges in the domestic retail environment but it did not create these facts.

If past is prologue, looking at the destruction of major department store chains is instructive. In the mid-1980s the managements of department store chains such as Allied, Associated Dry Goods, the May Company and, in their own way, Macy's, Saks, Marshall Field, Dayton Hudson, Carter Hawley Hale and Neiman Marcus realized that their worlds were changing and merged or went private. Three subsequently filed for bankruptcy because of the debt incurred from their recapitalizations.

In 1986 Robert Campeau, a residential real estate developer emerged from Canada, sensed the vulnerability of the aging department store chains and launched hostile tender offers for Allied Stores and eventually Federated Department Stores, the dominant chain. Campeau won the initial battles. He succeeded in buying both and then merging them. He had visions of undervalued real estate and its profitable reuse but alas, he lost the war. Soon those two well financed giants were bankrupt, adding to the list of humbled giants.

Three decades later department stores’ market share has collapsed and stands at less than 3%. Of the major public chains only Dillard's and Nordstrom have kept their same ownership. May Company had to merge with its arch rival Federated which had merged with Macy's. Penney is struggling. Sears is a relic. Even Belk's is without a Belk family member.

A new Canadian-based but American real estate investor is stalking US department stores and owns the historic names Hudson Bay in Canada and Saks and Lord & Taylor. He is rumored to be interested in bailing out Neiman. He is consolidating entities. His challenge is more formidable. There are no extraordinary savings from consolidated buying. Department stores don’t seem to be able to emulate the newer fast fashion retailing European competitors.

Stores are not going out of style. Store square footage and disposable income will eventually find equilibrium. In the interim, innovation through technology and the new media, making the customer experience more exciting and seamless will be the hallmark of winners.

On the other hand, no amount of financial engineering will rescue the remaining department stores which still have more excess square footage than they did 30 years ago. Unless Hudson Bay or any other acquirer can imagine the reuse of acres of excess space in suburban locations and change the supply chain, more buying with debt will result in Campeau redux.