JC Penney's experiments with pricing and holiday season discounting

Around a year ago, JC Penney's CEO Ron Johnson announced their 'Fair and Square ' pricing policy, to wean customers off discounts and move towards a three-tiered pricing strategy that focused on 'Everyday Low', 'Monthly' and 'Best' price levels. This was supposed to reduce the number of annual promotions from 590 to 12, thereby simplifying the shopping experience (and allowing customers to 'shop anytime on their terms'). In August, they moved completely to an Everyday Low pricing scheme.

The strategy seems to have failed...last week JCP announced that their sales have dropped 26% year on year for Q3 and have dropped 23% year on year for the first nine months. Even the online business seems to have shrunk significantly (37% year on year in Q3!). It is burning through its cash reserves and may need to raise capital soon.

In the backdrop of these bad numbers, JCP announced that they will not be using holiday season discounting this year, choosing instead to hand-out 8 Million buttons that allow customers to get freebies. Shoppers can redeem the buttons online for a chance to win one of 20 million gifts by entering a unique code located on the back of the button at jcp.com/Christmas. On Black Friday, 100 vacations to U.S. destinations will be awarded, including trips to Los Angeles to see a taping of JCPenney spokesperson Ellen DeGeneres' show. One additional trip will be awarded each day through Christmas Eve, along with gift cards, holiday certificates and merchandise.

However Ron Johnson also announced that they will offer the company's lowest prices on Black Friday and Cyber Monday.

All this begs the question: Is JCP doing the right thing on the pricing strategy front? What else can it do before it exhausts its cash reserves?

1)  While Everyday Low pricing may be a great idea in grocery and household purchases, it may not be such a great idea in apparel because customers have different price perceptions for different brands. If most customers prior to January 2011 were drawn to stores by the discount sales on the jcp brand, they are unlikely to change their behavior abruptly. JCP needs to conduct focus groups and surveys to understand the pricing preferences of their customers (since their current understanding of their customers' preferences seems to be flawed). While modeling apparel sales using price data, we always model the 'price effect' (the effect of the effective discounted price) and the 'sticker effect' (the effect of the X% off sticker). An item marked at everyday $15 price may have lower sales than if marked at 25% off from a $20 price.

2) JCP needs to aggressively continue the store-in-store concept which seems to be working well for them.

3) They need to sign up good designers to design exclusively for them (like Target does).

4) The JCP website needs a major overhaul:

• The landing page has fewer merchandize displayed than most other apparel websites. While the uncluttered look may suit Apple stores well (with its limited range of products), it does not suit an apparel website very well. 
• The quality of in-image zooming is much inferior to the out-of-image zooming in other apparel websites. 
• Finally, the checkout page does not have recommendations for 'People who bought X also bought Y" which is usually very useful while purchasing clothes

Let me know what you think

What should Best Buy do to survive?

Best Buy just announced a bad Q2 (click here). Same store sales are down in the US and significantly down internationally. Their operating income has shrunk 87% on falling margins and rising SG&A. Their services, mobile and tablets sales are the only bright spots in a fairly sad story on declining TV, gaming and computer sales. Even the shutting down of stores does not seem to have enabled them to stem the tide.

Here are excerpts from their earnings release:

FISCAL SECOND QUARTER PERFORMANCE SUMMARY
(U.S. dollars and square footage in millions, except per share and per square foot amounts)
	Three Months Ended
	Aug. 4, 2012		July 30, 2011		Change
Revenue	$10,547		$10,856		(3%)
Comparable store sales % change1	(3.2%)		(3.8%)		60bps
Gross profit as % of revenue	24.3%		25.4%		(110bps)
SG&A as % of revenue	23.1%		23.0%		10bps
Restructuring charges	$91		$0		N/A
Operating income	$33		$260		(87%)
Operating income as a % of revenue	0.3%		2.4%		(210bps)
Diluted EPS from continuing operations	$0.04		$0.39		(90%)
Adjusted (non-GAAP) Results2
Operating income	$124		$260		(52%)
Operating income as a % of revenue	1.2%		2.4%		(120bps)
Diluted EPS from continuing operations	$0.20		$0.39		(49%)
Key Metrics3
Total U.S. big box retail square feet	41.0		42.6		(4%)
Revenue per square foot (Domestic segment)	$857		$846		1%
Adjusted operating income per square foot (Domestic segment)	$41		$45		(9%)
Adjusted return on invested capital4	11.1%		10.7%		40bps

Fiscal Second Quarter 2013 Highlights

• Domestic comp store sales decline of 1.6 percent improved compared to fiscal first quarter decline of 3.7 percent 
• Domestic estimated market share maintained year-over-year 
• U.S. big box square footage reduced by 4 percent year-over-year; Domestic revenue per square foot up 1 percent year-over-year 
• Similar to the first quarter of fiscal 2013, International segment year-over-year operating income decline driven primarily by lower revenue in China, Canada and increased competitive conditions in Europe 
• Domestic segment total Services category revenue increased approximately 6 percent 
• Momentum grows in Domestic services with key partnerships announced recently: AARP, Verizon and Target  
• Domestic segment online revenue growth of 14 percent 
• Domestic segment connections growth of 11 percent 
• Domestic segment mobile phones comparable store sales growth of 35 percent 
• Domestic segment comparable store sales growth in tablets, mobile phones, appliances and eReaders more than offset by declines in gaming, digital imaging, televisions and notebooks 
• Adjusted (non-GAAP) Domestic segment year-over-year operating income decline driven primarily by lower gross margins in computing, mobile phones and televisions 

Best Buy today announced GAAP net earnings from continuing operations were $12 million, or $0.04 per diluted share, for the three months ended August 4, 2012 compared to net earnings from continuing operations of $150 million, or $0.39 per diluted share for the prior-year period. 

Revenue

	Three Months ended Aug. 4, 2012						Prior-Year Period
($millions)	Revenue		Change YOY		Comp. Store Sales		Comp. Store Sales
Domestic	$7,803		(2.2%)		(1.6%)		(4.1%)
International	2,744		(4.7%)		(8.2%)		(2.8%)
Total	$10,547		(2.8%)		(3.2%)		(3.8%)

The Domestic segment comparable store sales decline of 1.6 percent was driven by declines in gaming within the Entertainment revenue category, digital imaging and televisions within the Consumer Electronics revenue category and notebooks within the Computing and Mobile Phones revenue category. These declines were partially offset by comparable store sales growth in tablets and mobile phones within the Computing & Mobile Phones revenue category, the Appliances revenue category, and eReaders within the Consumer Electronics revenue category. The Domestic segment online channel revenue grew 14 percent compared to the prior-year period.

The International segment comparable store sales decline of 8.2 percent was driven by the lower growth in consumer spending in China and the continued impact from the expiration of government sponsored programs, which negatively impacted sales in Five Star. Market softness in notebooks, digital imaging and home theater in Canada also contributed to the International comparable store sales decline.

Gross Profit

	Three Months ended Aug. 4, 2012
($millions)	Gross Profit		Change YOY		% of Revenue
Domestic	$1,896		(6%)		24.3%
International	668		(9%)		24.3%
Total	$2,564		(7%)		24.3%

Domestic segment gross profit decreased 6 percent, reflecting a rate decline of 110 basis points compared to the prior-year period. The Domestic segment rate decline was primarily due to three factors. In mobile phones, connection growth and a mix into higher price point smart phones resulted in strong comp sales and gross profit dollar growth, although at a lower overall rate. Second, industry softness in computing resulted in increased promotional activity in the quarter to stimulate consumer demand ahead of the second half of fiscal 2013, which will include the Windows 8 launch. Finally, there was less favorable product mix within the television category.

International segment gross profit declined 9 percent, reflecting a rate decline of 130 basis points compared to the prior-year period. This rate decline was driven by Best Buy Europe and due primarily to increased mix of lower margin wholesale sales and promotional activity within a price competitive environment for mobile phones.

Operating Income

	Three Months ended Aug. 4, 2012
($millions)	Operating Income		Change YOY		% of Revenue
Domestic	$83		(65%)		1.1%
International	(50)		n/a		(1.8%)
Total	$33		(87%)		0.3%

What should they do to survive the onslaught of online retail (and the show-rooming effect) and of discount retailers?

I think the following measures would make sense:

• Continue to aggressively expand the services business by extending tie-ups to a wider range of partners (much like their VZ, TGT and AARP alliances). Become the preferred service partner for as many telecom and cable companies, and computer/ TV manufacturers as possible so that customers look to Geek Squad irrespective of the brand of device or service being consumed.
• Improve online buying experience. Bestbuy.com does not have a good recommendation engine ("People who bought this product also bought Y", "People who viewed this product bought X"), unlike Amazon.  Also BestBuy.com should clearly state its free shipping policy and clearly highlight the value of the store pick-up option.
• Continue to close down unprofitable stores
• Focus more on small kiosks at airports (mp3 players, DVDs, headsets) and on smaller store formats -- these locations have lower SG&A

Let me know what you think!