Penny's Long Road to a Vacant Middle

In "The Concept of the Big Middle," Levy, Grewal, Peterson, and Connolly (2005) argue for a normative view of the retail market that treats the competitive environment as dynamic. In this view, most retailers exist in a big middle where respective retail managers attempts to maintain or improve the retailer's price advantage and/or innovative advantage. This big middle, though, shifts as the competitive environment adapts to new retailers that are more innovative or lower priced compared to the retailers in the existing big middle. Retailers that thrived in the big middle yesterday could find themselves outside the big middle today and could be forced to exit the market tomorrow. Nowhere is this shift evident than among retailers that traditionally anchor shopping malls. Many anchor stores ran into problems prior to the severe economic downturn that began in 2008. Sears' problems date to the 1980s. Pennys' issues appear much more recent but no less difficult to resolve. Enter Ron Johnson, who repositioned Target as a retailer known for cheap chic and launched Apple's foray into retailing, as Penny's savior. Most industry observers appear skeptical that Johnson can move Penny's back to a recently shifted big middle. His first decision was to reduce the number of store discount activities from roughly 350 in a year to 24. C. Britt Beemer, chairman and CEO of America’s Research Group, gives the discount money quote:

Penney’s is going to find itself in hot water when all of a sudden their [merchandise] is not going to be on sale and the consumer is not going to get it. And since Penney’s has such huge shopper overlap with Kohl’s, Kohl’s is going to love this.

His second decision was to add brand name designers; a decision he used at Target to boost that chain's financial performance. This decision becomes expensive quickly as each store is remodeled to move from an open store format to a boutique within a store format. Jason S. Baker, principal of a commercial real estate services firm, estimates that for each store Penny's needs to allocate a million dollars. Given Penny's $6.4 million margin (sales revenue - cost of revenue) per store, this decision should be considered risky.

FT Alphaville's Igor Greenwald remains skeptical that Johnson can solve Penny's problem. His money observation:

But there’s a problem... (It's) the same one that has bedeviled other middlebrow chains over the past decade. Many of those young professionals have either gotten rich enough to shop at Nordstrom or poor enough for the dollar stores and Walmart. The middle ground in American retail has been shrinking, just as it has in the broader society. And it will take more than clever marketing and celebrity spokespeople to elbow out such fierce competitors for those middle-class dollars as Macy’s and Kohl’s.

He concludes his argument that, from a stock performance perspective, Penny's has achieved superior financial performance as it stocks price makes Penny's twice as expensive as competitors Kohl's and Macy's.

Ultimately, Greenwald is correct. The big middle shifted. Penny's is scrambling to achieve cost parity with Kohl's. Johnson's team believes it will reach that point by 2015, which assumes Kohl's does not adjust for the next three years. Penny's senior executives need patience from its board of directors and time to execute their turnaround plan. Those two items could grow in short supply if Penny's operating profit and sales per square foot do not improve.

Reference Levy, M., Grewal, D., Peterson, R. A., & Connolly, B (2005). The concept of the "big middle." Journal of Retailing, 81 (2), 83-88.