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.
Professor Bruce Greenwald outlined the
purpose of the conference, calling attention to
the problems inherent in the retail industrys
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
competitiona methodology, he said, that has
led to massive store overbuilding. In the same
period, staff hours increased two to three
times per square foot of expansion space, but
sales-per-labor-hour remained constant.
Can we find an alternative approach to
managing growth in retaila 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 doesnt work.
Planned regional growth must be at least a
part of successful expansion.
To create value, retail managers must focus
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
good expansion decisions, and
Innovation tied to clear objectives is a key
to success.
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, Modells
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
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.
EMING
C E N T E R
Q U A L I T Y, P R O D U C T I V I T Y A N D C O M P E T I T I V E N E S S
D
A U T U M N 2 0 0 4
COLUMBIA BUSINESS SCHOOL 2
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 competitiona 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 exploitationtoo 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 cant 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 dont 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 weve invested heavily in that infrastructure.
Another key to our success is our constant innovation. We began
by adding the big boxesTarget, BJs 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, weve 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!
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 dont do it profitably, you pay
the price. Proper growth is regionally focused
growth.
Whats to prevent people from copying a
successful store or mall? Lets 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-Marts prices have been
consistently lower than the competitions, 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-
Marts average purchase cost was the same as
Kmarts, and at the time Wal-Mart was also
one-third of Kmarts size. So is Wal-Marts
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-Marts supremacy. Or, does Wal-Marts
celebrated efficiency account for its higher
profit margins? Not entirely. The companys
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-Marts
operational systems definitely contributed to
profitability. But the story of Sams Club
argues against efficiency as the key to profits.
The Sams 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-Marts strategy was to go global, its
profit margins deteriorated substantially. The
price gap between Wal-Mart and its
competitors shrank dramatically.
So, whats the answer? There is another
possibility. Wal-Mart concentrated in one
region: South Central United States, where
much of the retailing costsadvertising,
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
concentratedand the most successfulof 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-Marts30 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 didnt 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 cant 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 cant 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
dominanceregional concentration is not
enough if youre 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
Joan Helpern (Columbia)
Marlene McNamee (UBS),
Krysti Keener-Thompsen (The
Gap)
COLUMBIA BUSINESS SCHOOL 4
George Strachan (Goldman,
Sachs & Co.)
and everything else. Pricing is important for
the average consumer, and indeed Wal-Marts
$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 fooda commodityenabled
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 retailersto
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-Marts 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 costscapital charges,
overhead allocations and the closing of
underperforming storesare 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 criticaland very
difficultto 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 scenariosand 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.
Wal-Mart
understands that
pricing equals cost.
You must get the
cost down to support
your pricing
structure.
W. Edwards Deming Center for Quality, Productivity and Competitiveness 5
Jerome Chazen (Chazen
Capital Partners)
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 shoppedwhere
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
storesour major businessby moving into
outlying outlet centers. Now, of course, outlet
centers are an enormous retail sales area in
their own right. Im 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, Modells
Sporting Goods
We areabsolutelya regional business. In
1987, we were primarily New Yorkbased.
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 couldnt
previouslyReebok, Russell, Champion and
New Balance.
As we grew, we realized we had to be
dominant in the Northeast marketfrom
Maryland to Connecticutwhere 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.
Were 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
employeesassociatesand then react in
the marketplace. We try to walk the talk of
corporate culture. If an associate doesnt
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 Mos cheer and a Mos 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
storesand 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.
Knowledge of
consumer
behaviorand
how to identify and
respond to itis the
key to any retail
operation from Wal-
Mart to Neiman-
Marcus.
Listen, Respect,
Respond. Thats our
mission statement.
Mitchell Modell (Modells
Sporting Goods)
COLUMBIA BUSINESS SCHOOL 6
Carlo Tunioli (Benetton USA)
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 WTOs 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,
Chinas 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
womans 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. Chinas export growth will exacerbate the
U.S. balance of trade and create a difficult
trade environment for the United States and
China.
The lesson we
learned was to stick
to what you know
how to do best,
especially in a global
market.
China stands to
dominate the apparel
and textile industries
of the world.
Burt Steinberg (Dress Barn)
Feiner: How do you as analysts
evaluate a companys 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 shouldnt 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? Whats the level of the
targeted competition? How does this
business fit into secular and cyclical
trends? How good is managements ability
to execute? Whats 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 isnt
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 coreit
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
youre far down the road, you can see the
cannibalizingbut then it is a bit late.
Jaffe: If you have a clear brand
identification, a reason to exist and a
compelling nature of your storeyour
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 itand the push is
always to growcan be dangerous.
Abercrombie & Fitch sliced the market
into segments of ages 1418 and 1822
and then had two businesses. Does this
make sense over a long period? Weve
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 timesEPS and cash
flow, for instancewhich 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 its usually people
buying at the bottom. Theyre fast, but
they often see value. If companies run
their businesses the right way, the market
will reward them. Remember, an analysts
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 hadnt 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 businesss time frame
is different from that of investors.
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
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)
COLUMBIA BUSINESS SCHOOL 8
Square foot growth for
new stores is intoxicating,
but ultimately, its not
always smart.
Richard Jaffe, UBS
Investment Research
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 Kohls 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 youre
a value-price competitor, you have to offer a
good price. If youre adding the convenience of
service, even if its 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 cant
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 Kohls.
Cohen: In the 1990s, Wal-Mart was clearly
going to win, but the scope of what they
became has dwarfed anyones imagination;
theyve managed to kill the competition. Being
in a competitive landscape doesnt 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 youeven if youre 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 theyre
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 gorgeousand there is not so
much in the boxthink 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 todays 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 cant admit it was a mistake.
Say, I was wrong, and walk away. Dont let
ego get in the way of decision making. Dont
bleed capital and management time.
Cohen: Change the strategy instead of
covering up a bad decision. Federated bought
Fingerhut, and it was a bad decisiontwo
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
managements thought process on return-on-
invested capital. Have more data available.
Monthly computations add volatility; Id
rather work on a quarterly basis.
Columbia Business School
W. Edwards Deming Center for
Quality, Productivity and
Competitiveness
Nelson Fraiman, Director
Burt Steinberg, Chairman of the
Advisory Board
Melissa Raz, Research Associate
Initiative Directors:
Advanced Commerce:
Medini Singh
Revenue Optimization:
Guillermo Gallego
Constantinos Maglaras
Garrett van Ryzin
Six Sigma:
Peter Kolesar
Newsletter Editors:
Alisa MacNeille
Cheryl Reimold
Ken Selvester
Layout/Printing:
Michael Cohick, Print Services
400 Uris Hall
3022 Broadway
New York NY 10027
E-mail Address:
deming@columbia.edu
Telephone: 212-854-9680
Fax: 212-316-9180
www.demingcenter.com
Before you expand, think
through the strategy and
trust your instinctsdoes
it makes sense? Common
sense is sometimes more
important than numbers.
Dana Cohen, Banc of
America Securities