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A tough turnaround road gets even tougher

The halfway mark is looming in the five-year turnaround marathon that JCPenney embarked upon in 2001.

The 101-year-old retailer has jumped some prodigious hurdles since then — centralizing a buying process that had been conducted on an antiquated store-by-store basis, streamlining its distribution system, overhauling its merchandising operation to focus on category dominance and key items, and upgrading its back-end operating systems to improve trend forecasting and speed to market.

So much for the hard part. Here comes the harder part: making it pay.

Having cleaned up the worst of the mess, the executive team overseeing JCPenney's department stores, catalog and Internet needs to prove in 2003 that the strategy it has put in place is the right one. The needle must begin to move decisively on the key metrics of top-line sales, margin improvement and a competitive ROI.

But just as Penney should be gaining traction, it finds the road under its feet pitted with sinkholes — rising unemployment, soft consumer confidence and consecutive months of unseasonable weather patterns across major pockets of the country — not to mention the effects of the now-concluded war in Iraq.

And, like many retailers, Penney stumbled over the lot during the first quarter of 2003. Profits at J.C. Penney Co. Inc. dropped by nearly 30 percent to $61 million, a setback in what had been a steady earnings recovery during most of 2002. Sales in department stores and catalog fell by 7.1 percent to $3.7 billion, and comps eroded by 4.9 percent.

Regardless, Penney last month stuck by its earlier guidance for the second quarter and back half of the year: a zero payout in this quarter, in the low 30-cents per share range in Q3 and in the mid-90 cents area during the last quarter. During the company's annual analysts' conference in April, chairman and ceo Allen Questrom batted aside the opportunity to excuse sub-par performance.

"At the end of the day, nobody can blame all those issues," he said. "Business is about making incremental changes and being committed to the strategy."

Facing the road ahead

Penney's roster of what remains to be accomplished is by no means a short list. And the department store operation's chief executive acknowledged in April that the road ahead runs uphill.

"We face tough comparisons against last year. We have a mature marketing calendar. And, we're more and more on our competitors' radar screens," said Vanessa Castagna, executive vp, chairman and ceo of JCPenney stores, catalog and Internet.

In sum, Penney is working toward three goals: to become the dominant retailer in the mall for the moderate customer; to use fashion, quality and value to differentiate itself from competitors; and to wrest greater cost savings from its new centralized business model.

In detail, the plan has a sweeping array of components. Among them:

In-store space allocation: Concentrate on areas in which JCPenney can dominate, including home, fashion jewelry, and special sizes. Expand growth businesses such as housewares, fine jewelry and contemporary sportswear. Build out services businesses, including custom decorating and beauty salons.

Brands: Leverage the strength of six "megabrand" private labels. Six megabrands account for approximately 70 percent of that private label business: JCPenney Home Collection (over $2.3 billion in soft home alone), the Arizona teen apparel collection, St. John's Bay casual and outdoor apparel, Worthington women's apparel, Stafford men's dress shirts and Delicates intimate apparel. Look for opportunities to add on-trend brands such as Bisou-Bisou in apparel.

Catalogs: Diversify the media and sales base for the catalog division by rebuilding the depleted customer file, make the Big Book more productive and launch a series of special interest catalogs that can hit target consumers with more frequency. In home, the Cooks specialty catalog launched in fall 2002 was a clear winner. However, the Living Spaces book of high-fashion home textiles that debuted this past spring did not hit the mark as distinctly — possibly because it skewed too upscale with its offerings — and is likely to be retooled.

Multi-channel retailing: Reinforce category dominance across the store base, Internet and catalog assortment in key product categories, including window coverings, intimate apparel and special sizes. Emphasize broader assortment offerings available in catalogs and on-line in those key categories. Offers "solution selling" in catalogs and on line in window, bed and bath, rugs, tableware, storage, children's furniture, travel and intimate apparel.

Real estate: Roll out the Box 1 high-performance prototype strategy to high-potential mall stores. Open three freestanding stores in 2003 to test improved productivity models for off-the-mall locations.

Supply chain: Leverage the recently completed network of 13 store support centers to pare 50 to 100 basis points off expenses by year-end 2005.

Store operations: Eliminate non-value added costs, improve store staffing models for greater efficiency and clip an additional 60 basis points off SG&A expenses over the next two to three years.

Signs of strength

Although it is halfway home, Penney is still 30 months from the finish line. And despite the slack retail environment during the first five months of 2003, Penney execs say they have seen some signs that suggest they are beginning to make financial progress.

In the face of a first quarter sales shortfall, department stores and catalog managed to improve gross margin by 140 basis points to 39.2 percent from 37.8 percent. The Big Book's sales productivity per page is showing some slight improvement. And, although sales in bed and bath — superstars in 2001 and 2002 — dropped behind during the first quarter of 2003, they appear to be picking up the pace again.

At the end of the road that leads to 2005, Questrom told analysts, he sees an operation that brings even more intensification to trends and speaks to customers with more clarity in terms of value.

"We have a clear vision of what we can be when we grow up."

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