The Fight For the Middle

By Dody Tsiantar

The JCPenney at Queens Center mall in Elmhurst, N.Y., is decked out for the holidays. Nothing surprising there. But visit the second floor, and you'll find something quite unexpected sandwiched between women's coats and fine jewelry: a 3,100-sq.-ft. Sephora, the European retailer known for its hip beauty products. The boutique is a miniversion of a typical Sephora store, replete with fanciful makeup and pricey skin-care lines presented on accessible, self-service shelves.

The lighting and signage are exactly the same as in a Sephora store, as is the black-and-white color scheme. Step out of the space, though, and the techno-pop sound track gives way to the drone of holiday background music, and you're back where you started--the second floor of a department store.

The new store within a store--one of five Sephoras opened in a Penney in October--is part of the new face of a century-old retailer and the $18.8 billion company's strategy to attract younger, more affluent female customers. Come March, 10 more Sephoras will open, followed by nine more in June. "It's a brilliant move," says Citigroup analyst Deborah Weinswig. "It has a halo effect on the whole store."

Across the Hudson River at the Newport Centre mall in Jersey City, N.J., Kohl's, the $13.4 billion chain based in Menomonee Falls, Wis., is in the middle of its own makeover. The store, opened just in time for the prime shopping season, is the antithesis of the formula that has worked for Kohl's since it was founded in 1962. Unlike its hallmark one-floor, off-mall format, loved by suburban working moms, this two-story unit lies smack-dab in the center of--drumroll, please--a mall, directly across from none other than Macy's. Even Kohl's off-mall stores are changing, taking on a more department-store-like look. At a new Kohl's in Brandon, Fla., for example, big glass windows, slick white benches and piped-in music welcome shoppers. "We're all about responding to our customers, focusing on what we sell and putting it in an exciting environment for them," says Kevin Mansell, president of Kohl's. "We want to broaden our reach."

Penney and Kohl's aren't just hanging holiday tinsel to get customers to fill up their Christmas stockings. By adding exclusive-to-them designer labels and partnering with upscale sellers, they are redeveloping the middle market, a segment once thought lost forever in the crush between the high and low end. "Both JCPenney and Kohl's have come to understand what their shoppers expect: great prices every day, ease of shopping and an exciting store," says Wendy Liebmann, founder of WSL Strategic Retail, a consultancy that publishes quarterly surveys on how Americans shop. "They're working hard to address the needs of the core, Middle America shopper."

Retailers are heading for a decent if not solid Christmas, but the industry is still sorting itself out after a series of big deals and big changes. Last year Federated, which owns Macy's, swallowed up the more moderate May Department Stores. Macy's, having replaced with its own marquee some famous regional department-store names--Marshall Field's, Famous-Barr, Kaufmann's, Filene's--experienced a strong 8.5% increase in same-store sales for November. Sears, which combined with Kmart in 2004, is still struggling. And Wal-Mart, in the throes of a mammoth, disruptive restructuring, reported a dismal 0.1% drop in sales.

Penney and Kohl's, even with all their fine-tuning, stand to have a relatively merry Christmas. Indeed, sales at Kohl's stores that have been open at least a year--a key industry measurement--rose 3.7%. JCPenney reported a somewhat disappointing 1.4% increase (Wall Street was hoping for 3.7%), but its online sales rose 17.5% in November. And the portent for more good things to come is evident. Consider the results for the third quarter: Penney, which only a few years ago was in deep trouble, reported a 22.6% increase in net income, while Kohl's racked up a 45% gain. "It's the sweet spot in the market," says Marshal Cohen, a retail-industry analyst for the NPD Group. "The lower end is reaching upward."

Penney and Kohl's are taking advantage of the middle opportunity. "They're cannibalizing the market from beneath them, and they're benefiting from the trickle down from traditional department stores who are trading out of Middle America," says David Wolfe, a fashion-retail consultant for the Doneger Group in New York City. "They're getting it coming and going."

And they're expecting more. For starters, both companies are aggressively expanding and experimenting with new formats. Kohl's opened 65 stores in October on a single day, the biggest one-day opening in the company's history. Penney, based in Plano, Texas, opened 20 stores that same month, most in off-mall locales. Both companies have plans for a lot more: Penney, which operates 1,037 stores, has announced that it will open 50 stores annually through 2008, while the 817-store Kohl's intends to tack on 400 stores to the chain by 2010, some inside urban malls. The company has also said it will remodel at least 40 older stores by the end of 2007. But Robin Lewis, a retail consultant and newsletter publisher in New York City, says Kohl's will grow sales faster than Penney because its corporate structure is less bureaucratic and layered. "Kohl's has an advantage because it is leaner and meaner," says Lewis. "It can respond more quickly, and its low-cost business model gives it greater flexibility."

Yet both stores these days are looking to pull in more younger female customers. Walk into any newly remodeled JCPenney and behold a spiffy new map at the door to ease your shopping and a customer-service desk right at the entrance. Clothes are neatly grouped by lifestyle, trendy denim in one spot, work outfits in another. And they're labeled clearly, unlike in older stores. In early fall, Penney even sponsored the MTV Video Music Awards, running a series of live ads during the broadcast. It's a fairly radical move, given the store's uncool heritage.

Kohl's, on the other hand, is trying to soften its linoleum-floored, no-frills, discount image. Its new stores--and the 40 old ones on track to be remodeled--have a decidedly more feminine look. The merchandise is less cluttered and more invitingly displayed, some of it on mannequins, fixtures not previously seen in Kohl's. Fitting rooms are larger and more comfortable too. "Both chains have made a tremendous effort to freshen up their stores and their image," says Amanda Nicholson, assistant professor of retail management at Syracuse University's Whitman School of Management. "They've relaunched their private labels, reduced merchandise cycle times and introduced new lively and appealing graphics and put them front and center in their stores."

There's also plenty of action in the retail-technology department. New point-of-sale software at both chains has helped them keep the optimal mix of inventory on store racks, according to Citigroup's Weinswig. "It's increased profit margins and made them more efficient," she says. Specifically, Penney will have installed 35,000 new devices at checkout counters by the end of the year.

Is this a newly minted version of the classic Macy's vs. Gimbel's rivalry? "It's absolutely a battle," says Steven Keith Platt of the Platt Retail Institute, an industry think tank in Hindale, Ill. "They're both going after the same market--the female. She controls the purse strings." Both chains dismiss the notion of a retail slugfest. But it is clear that each chain is borrowing a page from the other's business model. For example, 22 of the 25 stores that Penney opened in the third quarter were situated in very Kohl's-like locales, a different approach for the mall-based Penney. Myron (Mike) Ullman, the former Macy's honcho who is now CEO of JCPenney, bristles at the comparison. "Let me point out that James Cash Penney opened his first store in 1902, off-mall. This is not new for us," he says. "Kohl's is a great competitor. But this isn't their turf. We had to put stores where people are in order to grow."

Meanwhile, Kohl's, a chain known for selling brand-name merchandise at discount prices, is adapting Penney's successful, exclusive-label strategy--that is, getting well-known designers or brands to create products that will be available in its stores only. It already has partnerships with Estee Lauder, which has created other exclusive brands for the retailer; Ralph Lauren (Chaps); skateboarder Tony Hawk; and Cuban-American model and actress Daisy Fuentes. Next up in early 2007: a blockbuster partnership with designer Vera Wang and an exclusive housewares partnership with the Food Network. Says Kohl's president, Mansell: "We're creating an umbrella of 'only at Kohl's' to highlight our differentiation. It's what our core female customer wants." For the moment, private labels and exclusive national brands account for about a third of Kohl's revenues.

Despite Kohl's new marketing initiatives, Penney still has the edge in private brands. About 45% of its revenues come from the store's 34 exclusive labels, like a line of women's working clothes by Nicole Miller and bedding, bath items and linens from home-design celebrity Chris Madden. In early 2007, the retailer will introduce two new exclusive Liz Claiborne lines and launch its biggest house label yet, Ambrielle, a collection of intimate apparel that is likely to compete with Limited's Victoria's Secret chain. "It's clear to our customers that our brands have the style and quality that are comparable to higher-end department stores, at a smarter price. That may sound casual, but it's our underlying premise," says Ullman, who points out that the retailer's seven major private brands contributed $5 billion in sales to the company's coffers this year.

Penney has another feather in its cap: a more established online presence than Kohl's. Last January, in fact, its online sales hit $1 billion--and in the third quarter, sales via the Internet rose an impressive 27%. Ullman boasts that the company is "the largest mass merchant" online. A key advantage: the infrastructure set up to support the company's decades-old catalog business.

The ability to buy wares at a mouse click is invariably a big selling point for time-pressed customers. But ultimately the revival of Penney and the continued success of Kohl's can be traced to one thing: women are simply finding things in these stores that they want to buy. And it has certainly helped that Wal-Mart botched an attempt to upgrade the fashion quotient in its apparel offerings. "JCPenney and Kohl's finally got the merchandise right," says Nicholson. "It's hipper, and it's not boring anymore."

Is it possible that these stores are becoming--egads!--cheap chic, as Target was a few years ago? Consultant Wolfe thinks so. "It's almost cool now to say 'I bought it at Penney's,'" he says. Suzanne O'Callahan, 35, a mother of four and a regular Kohl's shopper, certainly agrees. "I just walked through Macy's and didn't find anything, but I've been here for about an hour already," she said, her arms full of clothes, on a recent afternoon at the new Jersey City store. "I always shop at Kohl's. And so do my friends." For JCPenney and Kohl's, comments like those must sound as joyful as jingle bells.

With reporting by Wendy Malloy / Brandon