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D EMING CENTER AUTUMN 2004 CONFERENCE TOPICS: • Value Creation in American Retailing: Are We Fighting
   

AUTUMN

2004

 

CONFERENCE

TOPICS:

Value

Creation

in

American

Retailing:

Are

We

Fighting

a

Losing

Battle?

Identifying

Sustainable

Competitive

Advantages

in

Retail

Growth

Strategies:

The

Senior

Executive

Perspective

The

Wall

Street

Analyst

Perspective

CONFERENCE

SPEAKERS:

Elizabeth

Armstrong,

GIC

Jerome

Chazen,

Chazen

Capital

Partners

Dana

Cohen,

Banc

of

America

Securities

Teresa

Donahue,

Neuberger

Berman

Joseph

Ellis,

Goldman,

Sachs

&

Co.

Bruce

Greenwald,

Columbia

Business

School

Richard

Jaffe,

UBS

Investment

Research

Mitchell

Modell,

Modell’s

Sporting

Goods

John

Mott,

Palisades

Center

Greg

Smith,

Columbia

Business

School,

MBA

‘04

Burt

Steinberg,

Dress

Barn

George

Strachan,

Goldman,

Sachs

&

Co.

Carlo

Tunioli,

Benetton

USA

QUALITY,

PRODUCTIVITY

AND

COMPETITIVENESS

Creating Value in Retail

The W. Edwards Deming Center and the Heilbrunn Center for Graham & Dodd Investing cosponsored the fifth annual Advanced Commerce Research Conference, “Creating Value in Retail.”

At the fifth annual Advanced Commerce Research Conference, “Creating Value in Retail,” on April 28, retail industry executives, Wall Street analysts, consultants and academics gathered at Columbia Business School to form

a multifaceted set of strategies for achieving

competitive advantage and strategic growth in the retail industry. Professor Nelson Fraiman opened the conference, sponsored by the W. Edwards Deming Center and the Heilbrunn Center for Graham & Dodd Investing at the School, and welcomed nearly 150 attendees who came to hear the panelists’ insights.

times per square foot of expansion space, but sales-per-labor-hour remained constant.

Can we find an alternative approach to managing growth in retail—a strategic one with which to examine future competition, consider the impact of location on price competition and attempt to anticipate future trends? What would truly sensible expansion policies look like?

The panelists also provided their perspectives, agreeing on five key points:

 

Overdevelopment doesn’t work.

Professor Bruce Greenwald outlined the

Planned regional growth must be at least a

purpose of the conference, calling attention to the problems inherent in the retail industry’s

part of successful expansion. To create value, retail managers must focus

traditional approach to choosing store locations. In the last 30 years, companies have based their decisions on local demographics, site access and transportation, and existing

on improving what they do best and resist the calls of Wall Street to grow incessantly at any cost. Using the right data is essential to making

competition—a methodology, he said, that has led to massive store overbuilding. In the same period, staff hours increased two to three

good expansion decisions, and Innovation tied to clear objectives is a key to success.

D EMING CENTER AUTUMN 2004 CONFERENCE TOPICS: • Value Creation in American Retailing: Are We Fighting

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COLUMBIA BUSINESS SCHOOL

Value Creation in American Retailing: Are We Fighting a Losing Battle?

Joseph Ellis, Goldman, Sachs & Co.

“Being the very best no longer gives you the competitive edge it used to. Today, we have aggravated competition—a tense, aggravated hammering of companies against each other, every day.”

How did American retail fall into overdevelopment? From 1950 to 1970, real estate was plentiful, people were moving into a suburban, automotive lifestyle and Wall Street was literally pushing money into the retail industry. The result was 30 years of steady development, which by the early ’90s became overdevelopment. But why were retailers constantly creating more stores than we needed? The answer lies in a society focused on equity growth and the creation of shareholder value. Three components of earnings growth create shareholder value for retailers: physical expansion, comparable store sales growth and profit margin growth. Because physical expansion is the easiest to mandate, companies built too many stores and also suffered from concept exploitation—too many players in each specialized type of retail.

Futhermore, the difference between good and poor management structures is much smaller than it used to be. In a rating of retail stores on a 1-to-10 scale before 1990, there were 10s as well as 1s and 2s. But in the period of consolidation in the early ’90s, the margin among survivors became much smaller, with 10 being the very best and 7 or 6 the worst. Quite simply, the management gap has closed considerably, and this has contributed greatly to the competitive intensity of American retailing today.

How are the remaining major players doing? Not as Wall Street expected. In 1994, when Goldman Sachs studied the 10 previous years, we found that half of the companies already had single- digit to negative growth rates. Yet analysts were giving virtually all of them double-digit earnings forecasts and kept looking for those companies to expand. Our studies of large retail companies from 1993 to 2003 showed that two-thirds had single-digit or

negative growth rates. Has the analyst community learned anything? Some analysts are showing more caution, predicting growth rates of 10 percent or less, but analytic bias can’t seem to allow analysts to imagine a negative number, even though companies’ behavior suggests growth rates of 5 percent or less going forward. Can we still create value in retailing? Absolutely. Although large-scale retailing suffers from too many stores and is, frankly, boring, I still see great opportunities for fresh new concepts.

John Mott, Palisades Center

“If you don’t experiment, you will never be first.”

Location is a big part of the success of Palisades Center in Rockland County, New York. We are near four of the wealthiest communities in North America. Six months after opening in 1998, we had a market area of 3.2 million people, which expanded to 9.2 million people in 2003 (12 percent are weekend guests from New York City). The center is easily accessible by major roadways, and we’ve invested heavily in that infrastructure.

Another key to our success is our constant innovation. We began by adding the big boxes—Target, BJ’s and Home Depot. We also have category stores interspersed throughout the space. Our biggest innovation is our entertainment and dining destination on the fourth floor. We have continued this mix in other store locations in New York and Massachusetts, and it works. It is critical to bring people to the shopping center for both their daily and weekly needs. To achieve this, we’ve added a New York Sports Club. Even with another gym facility nearby, the one in the mall does very well. Our sales, which have grown to over $700 million annually, show a high degree of cross-shopping, as mall customers purchase in different categories of retail. People stay in Palisades an average of 136 minutes versus 69 minutes in other malls. They stay longer and spend more, because it is more fun to be there!

2 COLUMBIA BUSINESS SCHOOL Value Creation in American Retailing: Are We Fighting a Losing Battle? Joseph

Nelson Fraiman (Columbia), Joseph Ellis (Goldman, Sachs & Co.), John Mott (Palisades Center), Bruce Greenwald (Columbia)

W. Edwards Deming Center for Quality, Productivity and Competitiveness

3

Identifying Sustainable Competitive Advantages in Retail

Bruce Greenwald, Columbia Business School

“If you grow and don’t do it profitably, you pay the price. Proper growth is regionally focused growth.”

What’s to prevent people from copying a successful store or mall? Let’s take some lessons from Wal-Mart. In 1985, Wal-Mart was enormously profitable. It had a return on equity of more than 30 percent and created $7 billion in market value on a $1.7 billion investment. Wal-Mart’s prices have been consistently lower than the competition’s, both in competitive markets and in monopoly markets. In general, its prices are lower than those of Kmart and others, yet its profit margins are consistently much higher. Why is this, and how sustainable can it be over time?

It is not just purchasing power. In 1985, Wal- Mart’s average purchase cost was the same as Kmart’s, and at the time Wal-Mart was also one-third of Kmart’s size. So is Wal-Mart’s success related to its location in one-store towns? No, because monopoly locations account for only 20 percent of Wal-Mart stores. Nor does the mix of goods account for Wal-Mart’s supremacy. Or, does Wal-Mart’s celebrated efficiency account for its higher profit margins? Not entirely. The company’s labor costs are 8 percent lower, their store costs are 14 percent lower and their overhead costs are 30 percent lower than those of competitors, and in the early days Wal-Mart’s operational systems definitely contributed to profitability. But the story of Sam’s Club argues against efficiency as the key to profits. The Sam’s Club diversification and extended merchandising mix has, for the most part, failed. Furthermore, if operating superiority were the answer, then as the company grew, its margins should have increased. After 1985, when Wal-Mart’s strategy was to go global, its profit margins deteriorated substantially. The price gap between Wal-Mart and its competitors shrank dramatically.

So, what’s the answer? There is another possibility. Wal-Mart concentrated in one region: South Central United States, where much of the retailing costs—advertising, distribution, supervision, inbound logistics—

are fixed. Competitive advantage seems to be rooted in regional concentration. It is uniformly the case that profitability and regional market share go together, not just for Wal-Mart, but for all of retail. For example, Walgreens is the most geographically concentrated—and the most successful—of all drug store chains. Grocery-store data reveal similar results.

Overall size is not the key, but in the regional markets, size does seem to be related to profitability. Before 1962, Kmart was dominant in the upper Midwest. Its return on equity was close to Wal-Mart’s—30 to 35 percent. From 1960 to 1968, Kmart responded to Wall Street and opened nationally but went bankrupt once it abandoned the protection of regional dominance. A&P traveled along the same route and it, too, is history.

Look at growth without concentration with the big box retailers: in the 1980s, these stores were new concepts that didn’t seem able to be copied, but their stocks dropped sharply from their peaks. Petsmart, Toys “R” Us, Barnes & Noble, Borders, Home Depot and Circuit City were all down 50 percent or more. Evidence shows that if you grow, profit margins will probably shrink, as not all areas will be as profitable as before. Yet publicly traded companies are constantly pushed to grow. Consider three “good to great” companies:

Kroger, Walgreens and Circuit City. Where were their friends on Wall Street when growth let them down? If you can’t resist the temptation to make a growth record, go private! If you can develop a regional franchise, you may be able to avoid “aggravated competition” by doing something that can’t be copied. It requires discipline to do focused growth. Of course, regional growth is not sufficient for success. There must be excellent merchandising: mix and presentation of goods are critical, as well as cost controls. But merchandising expertise and cost control can be copied. To differentiate, regional dominance is the key. Notice I say regional dominance—regional concentration is not enough if you’re second. You have to be the No. 1 player in the region.

George Strachan, Goldman, Sachs & Co.

Recent studies have shown that one-half of U.S. households make $35,000 or less per year after taxes. The median annual household cost of basic necessities is $21,275. That leaves $13,725 for clothing, entertainment, tuition

W. Edwards Deming Center for Quality, Productivity and Competitiveness 3 Identifying Sustainable Competitive Advantages in Retail

Marlene McNamee (UBS), Krysti Keener-Thompsen (The Gap)

W. Edwards Deming Center for Quality, Productivity and Competitiveness 3 Identifying Sustainable Competitive Advantages in Retail

Joan Helpern (Columbia)

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COLUMBIA BUSINESS SCHOOL

4 COLUMBIA BUSINESS SCHOOL George Strachan (Goldman, Sachs & Co.) “Wal-Mart understands that pricing equals cost.

George Strachan (Goldman, Sachs & Co.)

“Wal-Mart understands that pricing equals cost. You must get the cost down to support your pricing structure.”

and everything else. Pricing is important for the average consumer, and indeed Wal-Mart’s $290 million business was built on the theory that price is critical. The company has been building its U.S. business at a rate of 13 percent annually. Its return on investment had been declining but is now stabilized at 13 to 14 percent. Operating efficiently generates volume, which allows Wal-Mart to leverage its costs. Adding food—a commodity—enabled Wal-Mart to continue its success as the concept of supercenters matured. Part of the Wal-Mart strategy is to hollow out the profit opportunity available to other retailers—to turn other companies’ profit drivers into traffic drivers (for example, toys at Toys “R” Us). The question is not, How can they charge so little? but How can they lower costs to charge even less?

Wal-Mart’s cost structure is different. Their cost per square foot is $7.30, versus $18 for supermarkets. Their expenses are $89 per square foot, versus the supermarkets’ $137. Sales productivity is the name of game, and supermarkets and other competitors have not been focused on keeping costs low in order to lower prices and drive sales. Sales productivity topped out in the 1990s for supermarkets, and they have had to raise prices to keep their margins. Wal-Mart currently has 10 percent of the $1 trillion market for supermarkets, with plans to open 240 supercenters in 2004.

Greg Smith, Columbia Business School, MBA ’04

As with any capital-allocation project, when looking at retail-store expansion strategies, value is created only when returns exceed the cost of capital. Some costs—capital charges, overhead allocations and the closing of underperforming stores—are frequently ignored or calculated with incomplete data, often resulting in faulty decisions. By correctly incorporating all costs into the calculation, we can determine the earnings power of a successful mature store and compare it to the cost of reproducing that store. If the earnings power exceeds the cost, the store should be opened.

Over time, those store chains that are successful and those that underperform tend to even out, or “revert to the mean.” For the outperformers, increased competition gradually lowers the excess returns. Conversely, underperformers tend to improve as a result of capacity reductions and consolidation. Therefore, it becomes critical—and very

difficult—to find ways to sustain competitive advantage over the long haul.

For retailers, the best and perhaps only sustainable source of competitive advantage lies in regional economies of scale. Wal-Mart is the prime example of this strategy. To leverage fixed costs (such as advertising, distribution and middle management) on a regional or global basis, the company must also be dominant in its region. Contrary to popular belief, overhead is not a truly fixed expense. Data from 12 public retailers show that overhead grows as stores grow.

Furthermore, some overhead expenses should be allocated, not as a percentage of sales, but directly or by region. Failing to do this can lead to inaccurate measures of store-level profitability. For example, if you were to build 10 stores in a single state, you might need 1 warehouse, 10 local advertisements and 1 regional manager. If you built the same 10 stores across the nation, you would need 10 warehouses, 100 local advertisements and at least 5 regional managers. Calculating the overhead in this way, by region, is not only more accurate, but results in a much higher profit margin for the single-state stores than for those built nationwide. In contrast, using the traditional formula of calculating overhead as a percentage of sales would show the same profit margin for both scenarios—and lead to faulty store-opening and -closing decisions. Retail managers and analysts should calculate the earnings power value and the reproduction value for a mature store to determine whether store growth is intelligent (that is, where earnings-power value exceeds reproduction value). Growth is not value-added in and of itself; to grow at any cost is usually to grow into bankruptcy.

4 COLUMBIA BUSINESS SCHOOL George Strachan (Goldman, Sachs & Co.) “Wal-Mart understands that pricing equals cost.

W. Edwards Deming Center for Quality, Productivity and Competitiveness

5

Growth Strategies:

The Senior Executive Perspective

Moderator: Nelson Fraiman, Columbia Business School

Jerome Chazen, Chazen Capital Partners

Retail is the largest industry in the world, and it is constantly changing. Consumers were once stratified by where they shopped—where you shopped showed the kind of person you were. Not any more! Cross-channel shopping is the rule today. How does a retailer grow?

Expand beyond the home regional area.

Add merchandise categories.

Tweak categories, as The Limited did.

Change categories slightly and open new

stores, as T.J. Maxx did. Acquire properties and names.

Increase channels of distribution, for example, from store sales to catalog and Web site sales.

What is the best way to grow? Strength of management and infrastructure is key. You need a great deal of knowledge, background, expertise and discipline to expand from a successful base. Liz Claiborne was a pioneer in outlet stores. We recognized that this could be a potential for expanding our business and a channel for our “mistakes.” Working with a developer in that business, we tried to be careful not to upset department stores—our major business—by moving into outlying outlet centers. Now, of course, outlet centers are an enormous retail sales area in their own right. I’m a globalist. I do believe that the world is getting smaller. Business opportunities and ideas must become important globally or they will cease to exist. Companies that understand global positioning for their needs will be the most successful.

Mitchell Modell, Modell’s Sporting Goods

We are—absolutely—a regional business. In 1987, we were primarily New York–based. Then Polly Brothers, a chain of 18 stores, went bankrupt. We acquired this company in bankruptcy strictly to procure the opportunity to buy certain retail lines we couldn’t previously—Reebok, Russell, Champion and New Balance.

As we grew, we realized we had to be dominant in the Northeast market—from Maryland to Connecticut—where we compete. Being a regional player gives us an advantage in that we can understand local buyers and nuances in the market. We have a different merchandise mix in different regions, with 15 to 20 percent customized for each local store. We understand that what sells in Brooklyn may not sell in the Bronx.

We’re a privately held, debt-free company, so we can open a store when we feel there is a good opportunity. There is no single strategy for our new-store decisions. We look at household income, population in a 3- to 10- mile radius and location of the competition.

Our goal is always to listen to customers and employees—“associates”—and then react in the marketplace. We try to walk the talk of corporate culture. If an associate doesn’t receive a response to a problem in 48 hours, that employee can go above the superior, and up and up until he or she gets satisfaction. We do a “Mo’s cheer” and a “Mo’s huddle” every day; if we make associates feel appreciated, they make customers feel appreciated.

Carlo Tunioli, Benetton USA

Benetton is located worldwide but is dominant in Europe, its home region. We have learned from our mistakes. We followed the market and went to a larger format with bigger stores, but that was not our forte, and we stumbled. It was not profitable. In retailing, you open stores—and sometimes you have to close them! The trick is to learn that lesson and reposition quickly.

We have presented a strategic plan to Wall Street for a very conservative expansion over the next five years. In the next few years, our other efforts and investments will be focused on the supply chain and shortening time-to- market of goods. At present, we are unique in keeping all of our sourcing in the Mediterranean and Eastern Europe. The other critical component of our growth is merchandising expansion. In the past few years, we have augmented our product mix to make it more appealing regionally. Continually revamping our merchandise is critical for success in the marketplace.

We are also developing marketing focused on the point-of-sale rather than on our prior marketing tactic, which was to focus on social awareness.

W. Edwards Deming Center for Quality, Productivity and Competitiveness 5 Growth Strategies: The Senior Executive Perspective

Jerome Chazen (Chazen Capital Partners)

“Knowledge of consumer behavior–and how to identify and respond to it–is the key to any retail operation from Wal- Mart to Neiman- Marcus.”

W. Edwards Deming Center for Quality, Productivity and Competitiveness 5 Growth Strategies: The Senior Executive Perspective

Mitchell Modell (Modell’s Sporting Goods)

“Listen, Respect, Respond. That’s our mission statement.”

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COLUMBIA BUSINESS SCHOOL

6 COLUMBIA BUSINESS SCHOOL Carlo Tunioli (Benetton USA) “The lesson we learned was to stick to

Carlo Tunioli (Benetton USA)

“The lesson we learned was to stick to what you know how to do best, especially in a global market.”

6 COLUMBIA BUSINESS SCHOOL Carlo Tunioli (Benetton USA) “The lesson we learned was to stick to

Burt Steinberg (Dress Barn)

“China stands to dominate the apparel and textile industries of the world.”

How Will the Apparel World Look Starting in 2005?

Burt Steinberg, Dress Barn

On January 1, 2005, member countries of the World Trade Organization (WTO) will eliminate textile and apparel quotas. The removal of these quotas will affect $375 billion of international trade.

First, some background: when it formed in 1995, the WTO agreed that barriers to trade should be eliminated, including those in textiles and apparel. The object was to enable all countries in the WTO to compete on the same level, eliminating the advantages of countries with large quotas.

As a result of these changes, China, now a WTO member, will emerge the winner. Other countries may simply become noncompetitive, and the losers face huge economic and social problems. Look at Mauritius, a small country that once had a robust textile and apparel trade. It lost over 80 percent of its textile industry when the African Growth and Opportunity Act (AGOA) changed the duty and quota system for Africa.

Among the WTO’s 147 member countries, a huge shift in market share is already occurring. In 2002, Mexico was the No. 1 supplier of textiles and apparel to the United States. In 2003, it fell to No. 2. In the same period, China’s exports to the United States rose 30 percent, and China is now our No. 1 supplier of textiles and apparel. From February 2003 to February 2004, imports from Hong Kong, Thailand, Turkey and the Philippines fell dramatically as market share skewed toward China and India.

Even with the elimination of quotas, textiles and apparel remain the most protected of industries in the United States, with duties reaching up to 32 percent. These industries will become more competitive without quotas. The current quota charge in China for a woman’s cotton pair of pants is approximately U.S.$2.50–$3.00. Without the cost of a quota, prices could fall as much as 15 to 20 percent FOB.

There is an excess of worldwide capacity in textiles and apparel; and yet last year, 3,700 new plants were under construction in China,

adding even more to the overcapacity situation, which will put more pressure on prices. The dominant force will be China, thanks to its low wages, access to raw materials, speed to market and competitive business environment.

A major problem is that countries that are unable to compete may have social and economic unrest. A massive shift could take place in the exporting countries. Of these, Mexico, the Philippines, Cambodia and the AGOA countries could lose 25 to 50 percent of their textile jobs. General Agreement on Tariffs and Trade (GATT) and WTO agreements never took into account the potential of these political and social developments.

What will be the impact on domestic production in the United States? As competition increases, textile companies will have a hard time; U.S. factories are inefficient compared with new Chinese factories. We have to become more competitive. For example, there is still a high duty rate on synthetic apparel. If made in a quick-to-market fashion in smaller factories in the United States, there may still be a competitive advantage.

The quota system is a thing of the past. China could have some restrictions placed on it until 2008 if it is determined that China is causing market disruptions. By 2008, however, China will be free of all restrictions, and its exports of apparel and textiles to the United States could grow to a market share of over 60 percent. For example, China currently controls 80 percent of toy and shoe imports to the United States because these items are quota free. China’s export growth will exacerbate the U.S. balance of trade and create a difficult trade environment for the United States and China.

W. Edwards Deming Center for Quality, Productivity and Competitiveness

7

The Wall Street Analyst Perspective

Moderator: Jeffrey Feiner, Columbia Business School

Panelists: Elizabeth Armstrong, GIC; Dana Cohen, Banc of America Securities; Teresa Donahue, Neuberger Berman and Richard Jaffe, UBS Investment Research

Feiner: How do you as analysts evaluate a company’s business strategy?

Jaffe: Ideally, the company should have a right-brained merchant offset by a disciplined but creative operational thinker.

Cohen: My main criterion is this: Does the company have a differentiated reason to be? It shouldn’t be just another store out there. Is the brand or the box differentiated enough to bring consumers into that store? For specialty stores, you definitely need a vision for the brand.

Armstrong: What is the size of the targeted niche? What’s the level of the targeted competition? How does this business fit into secular and cyclical trends? How good is management’s ability to execute? What’s the scalability of the business model? And, what is a reasonable return in that business?

Donahue: I start with my own assessment of the demand for their concept. Next, I consider whether management has the vision and the flair to differentiate itself. Finally, I want to know if the operational structure and support are in place to execute strategy or anticipate future needs.

Feiner: How do you evaluate new store openings?

Donahue: I use my sense of the size of the market, the competitive set and the penetration of a given concept or subsegment by region. On a company level, I consider the return on a new store, the sales productivity and the trailing sales per square foot. It is also important to keep an eye on inflection points. Wal- Mart is an example. They know where the competition is, not just physically, but

also in the minds of consumers. I think you have to base your strategy on that.

Armstrong: I look at the level of competition and the growth of other companies in the industry. Just believing you have a competitive advantage isn’t enough. To be objective, you have to study the metrics on saturation and productivity, for instance. Management can do this better than analysts, as they have more numbers, in more detail, and they can get them quickly. They should look at these numbers carefully, because it is easy to be deceived about your own stores.

Cohen: In apparel, companies have often gone into outlets and then decided that doing so has destroyed their core—it becomes cannibalizing. It is important to ask in the beginning: does this make sense? Is it right for our strategy long term, despite near-term attractions? When you’re far down the road, you can see the cannibalizing—but then it is a bit late.

Jaffe: If you have a clear brand identification, a reason to exist and a compelling nature of your store—your growth prospects will be greater. But you must make sure your identification resonates with the consumer.

Feiner: What about growth strategies? Are there negatives to consider?

Jaffe: Definitely there are negatives. You can grow beyond franchise limits through cannibalization, low-dollar return or in other damaging ways. You have to see where you need to grow or if there are better ways to invest your capital.

Cohen: There is tremendous pressure from Wall Street to grow. Most of my companies are sitting on too much cash.

What they do with it—and the push is always to grow—can be dangerous. Abercrombie & Fitch sliced the market into segments of ages 14–18 and 18–22 and then had two businesses. Does this make sense over a long period? We’ve found kids say it is confusing. More Hollister growth may have a negative impact on Abercrombie & Fitch.

Armstrong: The market has different themes at different times—EPS and cash flow, for instance—which can be damaging to businesses. A company should ignore the theme of the market and instead run its business the way it should be run. When I hear a company is investigating new concepts, I wonder what that says about its existing concept. The best return on business is usually in the original concept; all other businesses tend to have a lower return. Management of a public company needs to have a three- to five-year time frame, but it must be aware of the longer term.

Cohen: We see more and more money in hedge funds, and it’s usually people buying at the bottom. They’re fast, but they often see value. If companies run their businesses the right way, the market will reward them. Remember, an analyst’s upgrade or downgrade can affect the market for a day!

Donahue: Each side has to take responsibility. Management must consider what is best for the business and shareholder value in the long term. Wal- Mart would never be the size it is today if it hadn’t accepted that dilution to returns in the mid-’90s when it expanded into food. Conversely, too often investors blame management when they get into a company at the wrong time in its life cycle. Sometimes a business’s time frame is different from that of investors.

W. Edwards Deming Center for Quality, Productivity and Competitiveness 7 The Wall Street Analyst Perspective Moderator:

From left to right: Jeffrey Feiner (Columbia), Richard Jaffe (UBS Investment Research), Dana Cohen (Banc of America Securities), Elizabeth Armstrong (GIC), Teresa Donahue (Neuberger Berman)

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COLUMBIA BUSINESS SCHOOL

“Square foot growth for new stores is intoxicating, but ultimately, it’s not always smart.”

–Richard Jaffe, UBS Investment Research

“Before you expand, think through the strategy and trust your instincts—does it makes sense? Common sense is sometimes more important than numbers.”

–Dana Cohen, Banc of America Securities

8 COLUMBIA BUSINESS SCHOOL “Square foot growth for new stores is intoxicating, but ultimately, it’s not
Columbia Business School W. Edwards Deming Center for Quality, Productivity and Competitiveness Nelson Fraiman, Director Burt
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Feiner: What about pricing strategy?

Jaffe: Being disciplined about taking markdowns on a timely basis is key. You must institute a regime of change.

Cohen: Pricing has to fit who you are and who your customers are. A customer in a high-end department store is looking for a certain product; a customer in Kohl’s is looking for something else. The price has to fit the business. People get into trouble when they

deviate from what they are.

Armstrong: Know your product and your customer, and be honest about them. If you’re a value-price competitor, you have to offer a good price. If you’re adding the convenience of service, even if it’s a commodity product, people will pay more for it. If it is something that really creates demand, like a Vuitton bag, the elasticity of price becomes almost nonexistent. It is vital to your business that you understand both the product and the customer.

Donahue: I hate it when companies try to play games and dance around Wal-Mart. When gross margins go up because of this, it is a red flag for me. The fact is that you can’t ultimately not compete against Wal-Mart on

certain products. In the luxury markets,

Neiman Marcus deserves credit for

maintaining a realistic view of square-foot growth. The company has kept it to 2 to 3 percent, so there is not a lot of dead real estate.

Armstrong: Where is a company in its growth cycle? Is there open-ended growth, is it a turnaround like JCPenney or is it starting to mature? Every business will mature. If it slows its growth rate on a rational basis and the P/E ratio comes down smoothly, the multiple will come back up. That is much better than hitting the wall and risking credibility, as may be happening with Kohl’s.

Cohen: In the 1990s, Wal-Mart was clearly going to win, but the scope of what they became has dwarfed anyone’s imagination; they’ve managed to kill the competition. Being in a competitive landscape doesn’t define the future. In the luxury market, some excellent strategies seem to have been executed well. They are more rational on growth and returns.

Jaffe: It is not just about competition. If you can do it better and differently, people will come to you—even if you’re reinventing the mousetrap.

Feiner: Are retail managers using the right metrics in talking about capital for new stores?

Jaffe: The return on sales is not a key metric any more. Retailers are looking at operations

much more realistically. It is also smart to manage inventory to improve dollar profitability.

Cohen: Retail still focuses too much on four- wall return on investment, though they’re getting better. Numbers can be deceiving. Management should walk away from what looks good today but is ultimately wrong for their business.

Armstrong: Fill-in or adjacent markets may be the best approach. Then you can roll out the concept geographically. Also, consider the size of the box. When people are successful in small boxes, they tend to grow to larger boxes. This is not always profitable. And when stores are absolutely gorgeous—and there is not so much in the box—think about how much they must charge to pay for that gorgeous empty space.

Donahue: Retail managers have become more sophisticated in evaluating new space. I wish they would have a broader view of the economic and competitive set, rather than just looking at their own in companies’ boundaries. Another problem is our use of the cycles in capital investment and allocation. We tend to base today’s decisions on what happened yesterday, when in fact things have changed.

Feiner: What would you tell retail management to change?

Donahue: Broaden your focus and evaluation of the competitive set. Tune out analysts when making decisions on time frame and think of the business instead. And consider carefully the remodeling part of capital-allocation decisions. Spend less time on mathematics and more on quality.

Armstrong: Value objectivity and honesty. Acknowledge what your business is, and make changes if it is not working. Many retail managers keep putting capital into a concept just because they can’t admit it was a mistake. Say, “I was wrong,” and walk away. Don’t let ego get in the way of decision making. Don’t bleed capital and management time.

Cohen: Change the strategy instead of covering up a bad decision. Federated bought Fingerhut, and it was a bad decision—two years later they recognized the error and shut it down. They deserve credit for seeing their own mistake and taking action.

Jaffe: Give analysts more disclosure to show us management’s thought process on return-on- invested capital. Have more data available. Monthly computations add volatility; I’d rather work on a quarterly basis.