Analysis: New pricing strategy could be Penney wise, but risky

The man who imbued Target Corp (TGT.N) with its "cheap chic" appeal and helped build Apple Inc's (AAPL.O) chain of avant-garde stores is about to unveil his latest trick: How to breathe new life into J.C. Penney Co Inc (JCP.N) and turn it into America's favorite store.

Ron Johnson, plucked from Apple last year to become Penney's new CEO, has so far said only that the department store chain will change its pricing strategy in time for the spring 2012 season.

That has fueled speculation ahead of a splashy media event in New York on Wednesday that the 110-year-old retailer will do away with much of the deep discounting that practically defines it and move to consistent pricing on many items, making "everyday low prices", as the model is known, a central plank of its reinvention.

Former retail executives and experts warn that the strategy, while full of up-sides, could alienate Penney's core clientele of price-conscious shoppers who seek out mark-downs.

"If Penney moves to an everyday low price concept, they'll lose a portion of those customers who only respond to price," said Roger Goddu, the former Target executive who hired Johnson at the discount chain in the early 1990s.

A Penney spokeswoman declined comment for this article.

Everyday low price is an approach that promises consumers they will get a low price without having to wait for sales or shop around. It helps retailers cut costs by reducing the need to pay vendors incentives, protects margins and - if successful - can lead to steadier, more predictable demand for products.

That pricing model is used notably by Wal-Mart Stores Inc (WMT.N) and Target, and more recently by home improvement chain Lowe's Cos (LOW.N). Lowe's senior vice president of merchandising, Troy Dally, told Reuters the strategy does "eliminate the peaks and valleys of a promotional model."

Penney, as well as its close rivals Kohl's Corp (KSS.N) and Macy's Inc (M.N), primarily uses "high-low pricing," where a store charges a high price for an item, then cuts the price around special sales events.

Everyday low pricing can succeed only if Penney simultaneously ramps up its exclusive merchandise and makes its stores more exciting -- steps that would make it harder for rivals to undercut it on price, retail experts said.

Penney already outdoes its rivals on private and exclusive brands, which account for about 55 percent of sales, compared with about 51 percent at Kohl's and 45 percent at Macy's.

But experts say Penney's needs even more exclusive brands of the kind Johnson brought to Target, as well as new, exciting ones. Otherwise, price wars on widely available items are inevitable.

"As soon as you say, 'my price is the best', someone comes in lower and they make you look illegitimate" said Mark Cohen, a former CEO of Sears Canada and now a professor of marketing at Columbia University.

In a research note in early January, J.P. Morgan analyst Matthew Boss said he saw everyday low prices being tested at a Penney store. He said "retraining the customers will not be an easy task," though he called the shift "right" in the long term.

TOUGHER SELL THAN APPLE

Johnson, who launched the Apple retail chain in 2001, has a lot of work ahead.

Analysts estimate Penney's 2011 sales will come to $17.3 billion, down 2.5 percent from last year, in part because of the closing of its catalog business, and well below pre-recession levels, even as revenues at Macy's and Kohl's have risen.

Penney's same-store sales have weakened in recent months after rising in the first half of 2011.

The toll discounting has taken was clear over the holiday season: mediocre sales and price slashing led Penney to cut its quarterly profit forecast.

Driving customers to Penney is much more complex than attracting them to Apple stores, where Johnson was helped by market-dominating products like iPads, iPhones and iPods.

Penney sells thousands of products and brands, many of which are also available at other department stores, so it does not have the brand cachet of Apple.

The challenge is clear: Apple's stores generated sales of $4,710 per square foot in its last fiscal year, compared with $210 at Penney and $222 at Kohl's. And sales per square foot at both department store chains were down significantly compared with 2006.

Given the weak economy and subdued U.S. consumer spending, it is also a risky time for Penney to experiment with pricing, especially since the last holiday season was marked by heavy promotions.

"It is as bad a time as ever to try this. Business is lousy," said veteran industry analyst Walter Loeb, who earlier in his career was a senior merchant at Macy's and analyst at Morgan Stanley.

Macy's, Penney's closet rival, does offer some popular items for an everyday low price but does not plan to implement that model across the board, spokesman Jim Sluzewski told Reuters. "Customers love sales. They love coupons," he said.

And the fight for sales can get rough.

Wal-Mart went back to stressing everyday low prices in 2010, after an unsuccessful two-year experiment with intermittent promotions. In 2011, it said it had a $2 billion war chest to subsidize sales and make sure its prices are lower than those of rivals, as it found itself facing stiff price competition from dollar stores.

Penney doesn't have that kind of firepower. Its adjusted operating income in the first nine months of the fiscal year was $433 million, compared with $18.2 billion at Wal-Mart.

So its best protection will be more exclusive merchandise.

MORE EXCLUSIVES

Johnson made his name at Target by launching the Design Initiative there, starting with the Michael Graves Design Collection comprising kitchen, storage and home decor products by the celebrated architect.

He offered the first glimpse of his merchandising strategy at Penney last month by announcing a deal to build boutiques for home goods doyenne Martha Stewart. It was also a clear signal to Macy's that Johnson would have no qualms about muscling in on its lines.

But experts said solid brands like Martha Stewart, Liz Claiborne and St. John's Bay are unlikely to create major new excitement or draw many new shoppers, and that Penney needs to build on the success of exclusives like its in-store Sephora cosmetics boutiques.

"I'm not saying deep-six the brand (Claiborne), but don't make that the showcase of the new J.C. Penney," said Craig Johnson, president of Customer Growth Partners, a retail consulting firm.

Experts also expect Johnson to re-think the layout of Penney's stores, making them less cluttered. Rivals are not remaining idle: Target last week said it will soon have exclusive shops selling items from candy to clothing, while Macy's is spending hundreds of millions of dollars to update its stores.

Johnson's high-profile hires since taking the helm include former Target marketing chief Michael Francis and ex-Apple and PepsiCo technology executive Kristen Blum, making it clear the new Penney will use many of the tricks he learned at his alma maters.

Goddu, now a partner at private equity firm Brentwood Associates, said Johnson had impressed him in the 1990s with how he re-thought the display of children's clothing at Target stores and made that chain a leader in that category and praised Johnson's retail acumen.

Re-doing Penney's 1,100 stores would take years and be very expensive, so one theory has Johnson, a perfectionist, turning some stores into flagships first.

"You need to be very, very patient - there will be some pain in the transition along the way," said Goddu.

(Reporting By Phil Wahba, additional reporting by Dhanya Skariachan, Jessica Wohl and Brad Dorfman. Editing by Gunna Dickson)

© Thomson Reuters 2014 All rights reserved.