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Miracle off 34th St

Papers around the country are leading, or at least leading their business sections, with the story of how Federated is changing venerable old stores like Marshall Fields, Kaufmann's, and Foley's into Macy's.

All of the stories, though locally written and not from the wire services, have the same basic structure. They note the historic (centuries old!) roots of the store, and then use the occasion of the change-over to Macys to quote "retail consultants" saying things like

department stores have become dinosaurs ... [t]he department store model is eroding. Business models don't last forever

and (these are different people)

The whole department store base is questionable today

and

the power of such plans to inject new life into traditional department stores will prove out only over time, just as the segment took many years to decline

Color me just a little sceptical of the near-uniform pessimism about the prospects for department stores from "retail consultants." Now, it's not as if every business takeover story is revealed to be far-sighted prescience, but if the prospects for department stores were that bad, why would Federated be doubing down its investment in the sector?

A little historical perspective on this goes a long way.

Been here before
This is also a newspaper story I've seen before. If the department store is dying it is taking a mighty long time. You can read similar predictions from 1930s retail consultants when Woolworths was growing rapidly. When did you last shop at an American Woolworths? Quite a while ago. That's right.

Department store consolidation began in the 1920s, in the sense of consolidated ownership. But operations, from the name of the store to purchasing, were not really co-ordinated across these groups until computerized point-of-sale systems became both common and reliable. So, there is something different to what is going on today with greater centralization of purchasing and management by Federated.

As to whether department stores will survive, it's a basic point, but easily forgotten by some business journalists that just because you aren't growing doesn't mean you can't be consistently profitable. Now, department stores have had trouble being consistently profitable, but it's still worth remembering down the road. Department stores might not be the newest thing on the block, but they can rake in a steady cash flow which is no small advantage in any business.

What do department stores do, anyway?
Nearly all of the press coverage pits department stores against Target and Walmart, because they're all large and sell a variety of goods. Well, so does Home Depot if you think about it like that.

Let's start on the demand side. The demand for stores which sell a wide variety of apparently, and often genuinely, unrelated products is fundamentally a demand to save time. That's why the "big box" retailers have grown rapidly recently--people can and do buy 96 rolls of toilet paper at a time because the fixed time involved in buying 12 is about the same. Same goes for department stores, whose early business model was all about encouraging the idea you could get everything you wanted there. This had a lot of appeal before World War II when work hours were significantly longer than they are now.

On the other side of the market, the shopping mall has eroded some of the advantages of the department store. It is possible to visit multiple stores, and get all the goods you might have previously purchased at one department store.

One of the advantages department stores had over competitors (and some still do) is that situated downtown they were at the hub of public and private transport networks in their city. Not so much anymore (though there are exceptions in Chicago and New York, at least) in the United States. The real story here is the slow decline of downtown shopping in the United States, a decline aided and abetted by politicians and private business over a long time. Perhaps, perhaps, if gas prices stay high and American cities develop public transport that people feel comfortable using for shopping this will reverse. Downtowns have not died everywhere, and still have enough physical and locational capital invested in them, that they may revive.

To put it more simply, one shouldn't confuse the decline of the downtown department store with the decline of the department store itself.

On the other side of the market, department stores are fundamentally about aggregating a range of functions that have some scale economies when combined over a diverse selection of products. The most obvious are real estate management, labor relations, financial control, and advertising. Consolidation of stores into larger chains merely continues that search for scale economies further up the management hierarchy.

The Federated/Macy's expansion has better prospects of succeeding than previous attempts, if for no other reason than the previously cited change in technology. Historically department stores did rely on the local intelligence of department managers and salespeople to determine what to buy and sell because accounting systems were paper-based and communicating information across a large number of people, or across the country, was relatively slow and expensive.

Federated claims that one of their changes will be to target discounts and sales to customers who have an account with them, and reward them for shopping with the store. While this was possible back-in-the-day, it's cheaper to do on a large scale now, and makes sense. What department stores offer is not exclusive, you can get it elsewhere, and "loyalty" schemes are a rational attempt to bind customers to particular stores.

The key, as it probably ever was, for department stores is the merchandising side. If they can compete with the specialty clothing and housewares stores on the merchandise side, and offer the benefits of saving time, and accumulating loyalty rewards across combined purchases, department stores will probably survive. There is still a place for the salespeople, however, and I don't say that just out of misguided affection from having studied them.

While it's true that Sears and Montgomery Wards started in mail order, and that some department stores did well at mail order (the internet shopping of 1913), department stores' competitive advantage right now is going to be in selling goods people like to try on, touch, and experiment with before buying. It's just more difficult to try on pants online, right? In the end what department stores will be selling, over and above the goods, is what they always claimed to be in the business of providing: good service. If your pants don't fit quite right, you can come back and get them exchanged by an actual human being who is paid to pretend to care in a more convincing way than the person on "live chat" at the internet store.

Department stores are not the hot new business innovation of tomorrow, but they'll be around in some form for decades to come.

Posted by eroberts at September 3, 2006 3:03 PM