Thought Leadership Interview with Dana Telsey

An Interview with Dana Telsey

Tommy Miller, President

Miller:  What is your overall view of the health of the overall economy in the U.S. and the consumer as it relates to retail sales, broken down by segment if you wish?

Telsey:  Consumer spending remains choppy.  We’re seeing that many consumers certainly have a fixed wallet.  They have more choice than they’ve ever had before because they can price compare across different channels.  I think the macro-factors, whether it’s the improving housing market, consumer confidence which is up, lower unemployment, stock markets performing, inflation and gas prices easing a bit – those are the factors that we’re currently seeing out there.  And, combined with a labor market that’s adding an average of nearly 160,000 – 200,000 jobs on a monthly basis, that’s what’s translating into more confidence in household and personal financial situations.  You have around two-thirds of the population that are in decent shape financially with a lower one-third tier that really is troubled.

But there are clearly some headwinds.  Rising interest rates have the potential to offset the momentum in housing, even though home prices continue to appreciate materially. Gas prices are rising – the cost per gallon has increased to around $3.61 on a national average basis, which is up 11.3% year-to-date.  Asia’s economic performance is mixed, but U.S. stock market valuations are high.  So the question is “what’s next?”

The higher interest rates that we’ve experienced, historical stock price performance and how different industries have performed in the consumer sector, it’s very interesting. Going back three months, there have been only four different retail sectors that outperformed the market: home improvement, general merchandise, consumer electronics, and office supplies.  The fixed-wallet mentality I mentioned earlier is leading retailers to be cautious and conservative in their guidance and how they plan their spending. Consumers now have the ability to shop where they want, whenever they want, and the multi-channel opportunity allows prices to be compared.  As a result, events are really key in order to drive traffic.  And events with promotions are even more effective.

Miller:  You had mentioned the price comparison opportunities that consumers have today online and multi-channel – what consumer trends concern you or encourage you in the near term?

Telsey:  With respect to multi-channel, what every company is trying to figure out is delivery.  A competitive attribute is speed.  Speed is manifested in having items in stock and the timetable for doing delivery to consumer’s homes.  Right now, there are many different ways you can deliver: pick up in-store, deliver from store to residence, delivery with a no cost return policy.  When you think about the world we live in with multi-channel distribution, one of the most important recent developments is that free shipping and returns are becoming a cost of doing business.

So how are companies able to manage their expenses such that free shipping doesn’t eliminate all the profit opportunities?  Because companies need to grow.  And growth allows companies to expand their assortment, to expand into new concepts and drive consumer traffic.  So figuring out what the cost of delivery is, what it means to be speedy, is really one of the next evolutions.  And my take is that the cost of speed – it is a couple points in margin – but what it does, is it helps generate more top-line sales.  Driving top-line sales and being able to increase market share, is one of the key attributes to being a successful retailer or e-tailer.

Miller:  So you’re seeing that cost of delivery hits margins but the top line may be growing.

Telsey:  Yes.  And square footage growth is not what we’ve seen in the past. There is no new mall supply being delivered.  The only form of retail real estate that’s growing is outlet malls.  We’ve certainly been seeing retailers reinvesting in their existing stores, looking to update and renovate, or sometimes moving into smaller size boxes. As you now have the full assortment of product online, the result is an edited assortment in the bricks and mortar stores.

Miller:  And on that point, which retailers do you think today have the best multi-channel strategies?  You see it in the stores now, just as you mentioned, with less merchandise, and maybe every color and size, but not every color and size together, and a hot line on the wall that you can pick up and order from the factory.

Telsey:  Williams-Sonoma is one of the most advanced companies in delivering a true multi channel experience and offering. Many retailers are very advanced in their techniques, and they’ve been working on multi-channel for a long time.  J. Crew is another company with a successful multi-channel strategy and a strong multi-channel personality and it’s really helped to grow their brand well beyond what their store base could deliver.  In addition, we’ve seen department stores become heavily invested in becoming multi-channel operators, given the assortment and selection they have.  And both Nordstrom and Macy’s are at the top of the game.  I’d say other companies are also becoming very effective in online. We are seeing some retailers for example, like Gap and Urban Outfitters, do a very good job at managing their online business.  Retailers are using online as an opportunity to build a community; that’s the opportunity for growth.

Miller:  Okay.  Let’s go into categories.  Department stores today –  we’re in the mall business, and some of the department stores are also in outdoor centers.  Give me your view of the department store business, and then maybe we can focus on a few names.  How are the department stores doing?  Are they growing?  How healthy is their financial position?

Telsey:  Department stores have basically been very focused on reinventing themselves.  The retail business is somewhat of a roller coaster.  To be successful, you need to remodel, remerchandise, and rejuvenate.  And many of these department store companies have been able to do just that.

It is interesting – most consumers today aspire to be 30 years old. If you’re 20 you want to be 30.  If you’re 40, 50, or 60, you want to feel like you are 30.  The department stores have reallocated their assortments in order to capture a wider demographic than they have in the past.

In 2012, sales generated through the department store channel accounted for only around 8.4% of total retail sales.  That’s excluding food, services, and autos.  And department stores are investing in creative partnerships with brands and vendors, and they have in-store shops.  They’re also working on using their stores as fulfillment centers.  They’re focused on controlling expenses.  And, department stores are building customer loyalty with the reward programs and private label credit cards.

So we see department stores experiencing a renaissance.  Their operating margins may vary significantly, but given the differential in margins across companies, as well as changes in the executive suite, and the shifting dynamics of the industry, we think the changes that are going on are very positive.

Off price retailers are increasingly competitive.  I think women’s apparel remains a very important category in department stores.  And between footwear, cosmetics, and accessories, these high-margin areas are becoming almost as significant as women’s apparel.  I’m seeing bricks and mortar and e-commerce or omni-channel retailing evolving, and the department stores are somewhat further ahead than other types of retailers.  The department store thesis today is, as it always has been, to provide convenience, assortment, and selection. This hasn’t changed.

Miller:  And Dana, let’s talk about JC Penney – I know your old friend Mike Ullman is back and there has been a lot of drama in the boardroom.  Give us your take on their progress and where you think the company is today.

Telsey:  I think Mike is working to stabilize the business.  It’s definitely a huge work in progress.  I think what Ron Johnson changed over the past year is the price and selection and choice was really eliminated.  And now by putting in familiar brands of private label, like Saint John’s Bay, that the JC Penney customer had known, that will help to bring back traffic.  I think the way he’s going to do that is with extensive promotions.  And I think we’ll see more of that this fall.

Miller: So you’re seeing the store-within-a-store concept, that Ron Johnson brought to JC Penney and promotions being blended back into that promotional business model.

Telsey:  Exactly.

Miller:  Is it too early to tell if that’s working?

Telsey:  Yes.  If anything, given the weakness that we’ve seen in mall traffic overall, and the choppiness that we’ve seen in the month of July, it’s certainly hard to tell at this point.  They’re putting the private brands like Saint John’s Bay back in, they’re focusing on a balance between private and national brands, as well as in store shops like Sephora.  They’re working to make a stronger part of the business, and working on enhancing the marketing in order to tell the promotional customer Mrs. Smith, who Ron Johnson pushed away, that this is her JC Penney again.

Miller:  Let’s talk about higher-end department stores, the Neimans and Nordstrom to a lesser extent – how are they performing relative to the more middle-market Macy’s, Dillard’s, etc.?

Telsey:   I think Nordstrom is performing very well.  They have multiple opportunities for growth, whether it’s from the Rack, whether it’s entering into Canada, and whether it’s the continuing enhancement of their online business.  I think Nordstrom in particular has the benefit of a little bit of improvement in California where they have a big presence.  Saks has had a more challenging 2013 than in more recent years.  They are focusing on gateway cities, but haven’t had as much strength in tourism.

Miller:  Let’s talk about the luxury segment, not necessarily luxury department stores, but Tiffany, Burberry, Louis Vuitton, etc.  For a while – and we are in the luxury business – it seems like they had put off opening domestic stores because of the huge opportunity internationally.  How is the luxury segment doing domestically?  Do you see sales and store growth domestically?  Please address the domestic and international mix of business.

Telsey:  Right now, we are seeing sales acceleration from the first quarter into the second quarter. We’re seeing, in China and Asia more broadly, a touch of improvement.  But it’s still just a touch of improvement.  I’m seeing a bit more stabilization in Europe, and that’s encouraging because we haven’t seen that for a while.  I think on the luxury goods end, the focus on creativity and more “newness” in products is really essential.  I‘m seeing big brands like the Louis Vuitton brand take 2013 and work to reinvigorate how the business has been growing.

Europe has stabilized a bit and that’s encouraging for the whole luxury business.  The Chinese are continuing to spend oversees particularly in Europe.  The price increases in Japan are driving sales growth there, but global sales is a little bit more steady-state now than it had been a year or so ago.

Miller:  Domestically, how’s the luxury segment doing?  Do you think there’s a prospect for opening new stores domestically?

Telsey:  I think there is.  But it has to be in “A” malls and prime city street locations.  I think there’s a greater focus on enhancing existing stores. The luxury goods company that’s the most advanced in multi-channel is Burberry.  The speed at which they bring the runway to your living room is exceptional.

Miller:  A growing segment, which sometimes can get mixed up with luxury, is “bridge” or “aspirational luxury” tenants such as Michael Kors, Kate Spade, Tory Burch, Lululemon, etc.—  Have you thought about the aspirational or bridge segment, and how important it is to the retail industry today?

Telsey:  I think the bridge segment is very important.  Many of those bridge companies are young.  There’s still a lot of room to open stores and gain greater brand awareness.  Michael Kors has done an exceptional job at building his brand and really showcasing his assortment, both wholesale and retail.  There is a long way to go.  The way luxury brands expand is via new product, great channel distribution, and entering into new geographies.  And for Michael Kors, that opportunity is great.

Coach has done it in Japan.  It’s done it with different channels both wholesale and retail, and now it’s about geographies as they set out to China, along with updating and enhancing their core product assortment.  So I think the newness and the youth of accessible luxury is what makes that area exciting.

Miller:  Yeah.  A lot of it is very youth oriented.

Telsey:  Definitely.

Miller:  It is interesting, the last few months I’ve noticed that Diane Von Furstenberg has shown up again in terms of opening stores.  Do you have an early read on that concept?

Telsey:  I’ve heard about that too.  I’ve heard that there’s been acceleration in new store openings.  I hear it’s doing very well.

Miller:  And the Restoration Hardware story is awfully compelling right now, these large “mansion” stores are really cutting edge.  How bullish are you on the company?

Telsey:  I think the whole housing tailwind is certainly helping Restoration Hardware.  The personality, the brand, the fact that it’s expanding into different price point categories, the differentiated point of view of Gary Friedman, the real creative visionary at the company, makes it exciting.  With the size of the stores, you certainly can’t have them everywhere, but that’s why online can bring the store to you.

Miller:  Talk about the big box, or promotional tenant retailer side of the business.  Tell me what you think about – I’ll throw a few names at you:  Target, Best Buy, Barnes & Noble, etc.  How do you think about the promotional, or more budget-oriented big box segment in the industry?

Telsey:  There has been more of a bifurcation with the low end versus the high end.  I think that the low end consumer is struggling overall, whether it’s because of expenses, or other factors.  I think the fact that the dollar stores and the restaurants have been a bit more challenged lately; it definitely shows that that low-end consumer is feeling the pinch a bit more.  I mean, the 2% payroll tax increase – you say “it’s only 2%”, but 2% means a lot to a low income household.

Miller:  One big topic in our industry today is the grocery business.  Walmart’s entrance into it, maybe Target’s retreat from the grocery business, and the proliferation of small, specialty stores led by Whole Foods. A whole new crop of concepts like Fresh Market and Sprouts and Trader Joe’s has emerged in a big way.  And how are the traditional chains like Kroger and Safeway doing?  Could you give us your perspective on the grocery business?

Telsey:   It’s almost as if Lifestyle is permeating everything – a healthier lifestyle – whether it’s in what’s happening with lululemon and yoga, and all aspects of a healthier lifestyle.  We’ve definitely been noticing that the specialty food category is attracting investor interest.  New concepts with unique strategies are expanding.  And the demographic profile that this category hits is vast.  I only see it expanding, I don’t see it shrinking.  With consumables being around 50% of the discounter’s assortments right now, specialized consumables is what is very interesting to us today.  And whether it’s Sprouts, Fresh Market or Fairway, I think there’s more opportunity to gain a repeat customer base.

Miller:  How are the more traditional, inline grocer such as Kroger or Safeway faring relative to these new smaller specialty grocers encroaching into their market?

Telsey:  I think they’re adjusting their assortments to adapt to this new reality, and to capture this new trend.  This trend is a high margin trend.  And so everyone wants to get into that sector now.

Miller:  Online and catalogue as a percent of retail sales is at 7-8%, still pretty low.  What is your forecast, or how high can that number go, and what impact might that have on bricks and mortar retail?

Telsey:  I hear exactly what you hear, that it’s under 10%.  I mean, it wouldn’t surprise me if it doubles over time, given the investment that companies are making in online channel distribution.

Miller:  Give me your perspective on – this is more of a shopping center industry versus a retailer question– various shopping center types.  Which types are working, and which ones need to evolve?  Regional malls, lifestyle, outdoor fashion centers are easily definable but, we’re seeing more and more hybrid centers that mix everything together in one place – a “why go anywhere else” type of concept. I don’t know how much you think about the real estate format, but I’d love to hear your perspective.

Telsey:  Overall on the real estate format, I think just like retailers need to reinvest in their store base in order to capture appeal, the willingness of landlords to reinvest in their centers makes a big difference too.  I’ve seen an improvement in the “B” malls, given the fact that the “A” malls are fully occupied and you’re getting tenants like a Kors, and tenants like Ann Taylor going to “B” malls as a way to grow their brand.  I think what’s most impactful is certainly the “A” malls.  It’s the most exciting, it has the most exciting mix of tenants, and that’s where everyone wants to be.  I think location matters.  And outlet malls today, are getting closer to traditional retail concentrations. There is less fear of having an outlet mall near a regular mall. I think that’s exciting.  I am for whatever can drive traffic – I am all for it.  Off-price retailers like TJ Maxx or Ross bring traffic in hybrid formats.  The mix of stores is just as important as the type of real estate location.

Miller:  Creating a great shopping experience is a big part of our business whether it’s a community center or regional mall.  How important is the experiential value of the center to driving traffic and customer loyalty, and do you think the retailers understand this?

Telsey:  Retailers do understand that the experiential factor is very important.  I think it’s the partnership between the landlord and the retailer that makes shopping environments more appealing to everyone.  For example, when you have a fashion show in your mall, the apparel retailers that send clothes down the runway can see in excess of a 30-40% increase in sales for that week.  Awareness matters.  And I think that the investment in the mall and the store together – a true win-win partnership – drives more sales and traffic.

Miller:  So a partnership between the retailer and the real estate owner is important?

Telsey:  Yes! Think about how do you market the center to capture awareness?  They don’t just want to buy goods online, consumers want to be engaged to spend time at the mall.  Order online, pick up in-store, and that hopefully helps to drive even more traffic and sales.

Miller:  My last question is about the general supply of retail space in the U.S. as some believe there is too much, and that, for example, in the mall business, you’re going to see some malls close, maybe a couple of hundred due to obsolescence.  Overall, how oversupplied is the U.S. in terms of retail space?

Telsey:  I think overall, it’s not a matter of over supply, you have to have the right supply.  I think the right supply is dictated by what kind of sales growth is seen out of the center.  Positive sales growth is essential to show that you are necessary and you are essential, and that continuing reinvestment with exciting concepts makes a difference.

Miller:  The follow up on that, briefly, is that for years, the upper-market retailers very much tended to favor gateway cities and traditional larger markets to smaller markets.  We’re now seeing the best retailers go into secondary and tertiary markets.  For example, Apple is considering one of our secondary market malls.  What do you hear from retailers in terms of moving into more secondary and tertiary markets?

Telsey:  They will move into more secondary and tertiary markets, and sometimes they adjust the size of the store depending on sales potential.  I think it’s all a matter of return on investment and expansion of the brand in appropriate markets and real estate settings.

 Miller:  By the way, what is happening with apparel sales – the trends seem dismal, particularly in the youth category (for example, Abercrombie).  What is driving this?  Is it the cost of electronics and mobile crowding out apparel sales or just an economic issue?

Telsey:  In apparel, the success of new product offerings in 2012 is impacting sales results in 2013. Last year’s successful color denim trend is not being repeated in 2013. Therefore, the sales growth of accessories appears to be outpacing that of apparel. In addition, there is more choice on where to buy apparel, not just specialty stores, but department stores are doing a better job and now fast fashion – for example Forever 21, H & M, Zara, Uniqlo – retailers allow consumers of all ages to buy the trend for now in an affordable manner, and then come back and buy the next trend.

Perhaps, the macro factor that is impacting apparel sales is that the consumer’s wallet is being allocated more to housing and auto than apparel; that is another key reason why apparel sales growth has lagged.

Miller:  I really appreciate your time, and look forward to continuing to read your materials.

Telsey:  Thank you.

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