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I’m writing this as a follow-up to the webinar I presented to SAP Mentors on April 17.  A lot of people wanted to understand “what happened” to JC Penney.  How did something that seemed so right go so wrong?  Here’s my analysis (as published on www.rsrresearch.com).

As we bid a last farewell to Ron Johnson at JCP (or Penney, or whatever new name comes along) it’s worthy to take a look back at his sixteen month tenure.  Most industry observers were excited to see him come on board.  In my own case, it wasn’t because he’d ‘rocked it’ at the Apple stores.  That phenomenon is a singularity, and I’m not sure it’s a replicable model – especially in the moderate-priced department store space.  I was most excited about getting a fresh set of eyes looking at a model that has struck me as dated, tired and generally very hard to shop. 

I don’t think of Kohl’s as a department store.  That company seems more like a hybrid between a mass merchant and a category killer than a traditional full-line department store.   I do include Sears in the category, and we know how well that chain is doing. In fact, let’s give Terry Lundgren his props here – he has found a way to keep Macy’s growing and relevant.  I’m not his core customer anymore – I think he’s far more interested in Millennials than me – but the results do speak for themselves.

In any case I, like many of my peers, anticipated something new.  Something different.  Something interesting.  And to be fair, I know several women who have shopped at the “new” JCP.  They found great products at reasonable prices.  I will say that the small sampling of men I’ve spoken to were not nearly as enthused, but I’m also not sure how much influence Mr. Johnson really had over the product in the store.  After all, overall time-to-volume tends to be between 12-18 months in our industry. And the Martha Stewart home product, while ready, still sits in distribution centers awaiting judicial dispensation.

I think we’ve heard the obvious: Shifting a customer base is a delicate exercise.  You don’t want to scare all the existing customers away before you’ve had time to attract the new ones.  Last year’s precipitous revenue drop was far beyond anyone’s expectations. That’s an area where Lundgren’s leadership at Macy’s has been superb.  He gradually alienates shoppers like me as he gradually attracts a new customer.  Changing a pricing strategy is another delicate dance.  The new strategy has to be very carefully spelled out.  On this score, JCP gets an #Epicfail. I love Ellen Degeneres, but the scripts in her ads were funny, but otherwise completely unclear.  Redesigning more than 1100 stores without closing them and keeping the store looking fresh at the same time is no easy feat.  That never got too far, but in fact, it was underway before Mr. Johnson’s tenure began (the Sephora store-within-a-store and Mango).

So we had three delicate things going on, all handled somewhat…indelicately.  As things started going downhill and mass layoffs and firings continued I started scratching my head.  Whenever he made public statements about all his ongoing initiatives (including a decision to replace most of the company’s systems) he always talked about freeing up capital. The decision to replace the systems was not a bad one – certainly a better solution that what has been described to me as JCP’s current “hodge-podge of customized products and home-grown solutions.” The timing just seemed…off.  A company can only manage so many initiatives at a time.  This was getting whacky.

And so I started following the money and digging into the company’s 2011 financial statements. It turns out that the company wasn’t exactly cash-rich going in. It had $1.5 billion of cash in hand, but had only thrown off $23 million in 2011 to add to that number. Money had been used to buy the full rights to the Liz Claiborne line and also for share re-purchases.  Inventory was valued at $2.9 billion to support sales of roughly $17 billion. In that context, the $1.5 billion in cash seems a bit tight.  More alarming is this statement from the company’s 10K:  “On January 27, 2012, we converted our existing credit facility into an asset-based revolving credit facility and to further enhance our liquidity, on February 10, 2012, we increased the size of our revolving credit facility to $1,500 million.”


Asset-based credit lines are a double-edged sword.  Used properly, they help even out cash flows for companies that have to pay for product before it sells (like holiday goods, for example). A full explanation of these lines are both beyond the scope of this document and beyond my ability to articulate, in any case.  In short strokes, you can borrow up to a given percent of your current inventory value.  However, the lender creates all kinds of “carve-outs” that eliminate certain categories of inventory from the available borrowing pool and those carve-outs can be increased if the lender perceives that inventory is going to age as a result of diminished sales.  Remember Circuit City?  That’s how it was thrown into bankruptcy.  Its lender decided its holiday sales were going to be less than anticipated and so it increased the anticipated aged inventory carve-out. Overnight, the company became insolvent and was thrown into Chapter 11. And who is going to buy durable goods from a company that’s in Chapter 11?  Not too many. Goodbye Circuit City.

The other point of note here is that most companies use asset-based lines to buy product.  That’s the sure ROI – you know it’s likely to sell.  But early in 2013 Mr. Johnson announced that despite the precipitous drop in sales last year (I think the number is roughly -28%) the remodels would go forward funded by the asset-based line.  Now THAT’s scary. It’s also a bad idea.  It’s sort of like using your credit card to buy a car.  The net?  We know capital was an issue from the get-go, and only made worse by the far worse than expected sales drop in 2012.

No analysis of failure is complete without also following the egos. Mr. Johnson’s biggest backer was William Ackman of Pershing Capital, a large shareholder in JCP stock and a board member.  Vanity Fair produced a pretty stunning article on Mr. Ackman at the end of February.  Witness this quote from the article, attributed to Chapman Capital’s Robert Chapman: “If he jumped off a building in pursuit of super-human powered flight but then slammed to the ground, I’m pretty sure he’d blame the unanticipated and unfair force of gravity.”  And Ron Johnson was Mr. Ackman’s guy.  He may have given him far too much latitude for far too long. (A late note:  When Mr. Ackman finally threw Mr. Johnson under the bus, he revealed that Mr. Johnson and his newly minted trusted advisors never moved to Dallas.  They ran the company from Palo Alto, CA.  Can you imagine laying off a third of the workforce, eliminating commissions, and changing almost everything about a business and not hanging around to re-shape the culture?  I can’t.)

And so Mr. Johnson exits and Mr. Myron (Mike) Ullman returns. When asked why I thought the company had picked him I replied (somewhat in jest), “Dinosaur riders are hard to find.”  In other words, not too many people could really run a department store the size of JCP, and frankly, given its current situation, not too many who could, would. The cash position remains problematic. The customer remains confused.  As one friend said to me “I expect they’ll be putting lovely house coats back in the women’s department now.”  Mr. Ullman will have to act decisively and fast.  He also has the luxury of being able to say “I told you so” – as from the beginning he counseled that this was Mr. Johnson’s first stint as CEO, and that’s a pretty tough job.  He was right. I was wrong.  #epicfail.  There are those who don’t blame Mr. Johnson, or say that he just didn’t have enough time. Me, I think there was too much ego, not enough cash, and really, really bad execution.

And that’s my requiem for retail’s most recent heavyweight.

Postscript:  On the evening of April 11, 2013 the Wall Street Journal announced that JCP was seeking a cash infusion of $1 billion. It is reaching out to Private Equity Firms.  I suspect those carve-outs on that asset based line just got a LOT bigger. Requiem indeed.

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4 Comments

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  1. Graham Robinson

    Hi Paula,

    thanks for following up the great call this morning with this post. All very interesting. There is no doubt the retail industry is going through major change – I guess they are trying to figure out what their new business models will be.

    Cheers

    Graham Robbo

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  2. Mohamed Amer

    Paula,

    Thanks for sharing your great insights into JCP and Ron Johnson’s tenure at the company. 

    I once received some valuable advice from a seasoned executive in the office products industry (where I cut my teeth after B-school):  never do more than one major change in the business at the same time.  In those days changing your catalog (12-18K SKUs), replacing existing systems, and adjusting pricing on your contracts were the big bugaboos…

    Looks like JCP simultaneously took on similar major structural projects and more!  .It was a high risk strategy (and poorly executed as you rightly noted) and makes me wonder if the alternative viewed at the time was limited to slowly dying from a thousand cuts?

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  3. Lori Mitchell-Keller

    Paula,

    You bring out a very good point on the financial condition of the company’s cash flow even before Ron Johnson joined the company. Add to that all the moving parts they chose to go after and the impact in the stores and you have greatly reduced the chances of success. JCP will have to refine the art of walking a tightrope to raise internal morale, appease vendors and creditors, and attracting new (and old) customers. I do wish JCP and Ron Johnson all the best in the months ahead.

    Lori

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  4. Stephen Johannes

    Interesting observations and personally the problem I saw as consumer with JCP is that Kohl’s essentially was eating their lunch in terms of middle america.  Best evidence was that in a traditional nearby mall with Sears, JCP, Macy’s and Dillards the parking situation became strange.  It used to be that Sears was the only anchor due to low sales volume where you could park “up-front” year round(minus holiday shopping season).  Then JCP made their changes and all of sudden after going to the same mall for 15+ years, I could score upfront parking next to JCP.  This was in area where the nearest Kohls are at least a 20 minute drive.  The rest of the mall parking was normal.  All the surrounding Kohl’s would have full parking lots no matter what time of day or season.  I think a ton of former JCP shoppers ended up there.

    However the sudden departure and issue with JCP is not new.  In fact someone told me(who worked in retail) ten+ years ago that JCP was already doomed due to squeeze from the higher-end and lower-end.  I wasn’t 100% convinced of it then, but he was right.

    Take care,

    Stephen

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