How Macys can avoid bankruptcy

Executive Summary and Introduction

The retail industry is undergoing fundamental change as it relates to business operations. Advances in technology, product offerings, logistics, and data have all creating significant headwinds for incumbent retail players. From a technology perspective, the internet has provided consumers with much more pricing power then in prior business cycles. Consumers have many more options to cater to their demands. As such retailers have lost significant pricing power as it relates to product offerings. The advancement of technology has all be eliminated information asymmetry which allowed retailers to prosper for so long. In addition, as more competitors enter the market, they are no longer restricted by geographic and logistic boundaries (Agrawal, 2009).

Changing consumer shopping habits have also created large shifts in how products and services are delivered to consumers. Customers are now willing and much accepting of online orders. Advances in logistics have allowed companies such as amazon to deliver products within a single day in certain instances. The added convenience of not leaving the home creates a compelling value proposition of emerging online retailer. These trends were exacerbated during the recent COVID-19 pandemic as consumers quickly adopting online shopping trends to mitigate the impact of the virus on their health and wellbeing. During the pandemic online retail sales surged as consumer looked for efficient and low-cost solutions to their needs.

Due to these pressures, many incompetent and once powerful retailer operations have gone bankrupt. JC Penny, Sears, Neiman Marcus, Payless, GNC, and Brooks Brothers are but a few of the many casualties caused by traditional retailers’ inability to properly adapt in a changing retail environment. Likewise, many of these companies did not possess a sustainable competitive advantage that could allow them to compete. Retailers who have strong competitive advantages not only can better compete with online retailers, but in many instances flourish. For example, low cost producers such as Costco and Walmart have actually gained market share and are expanding to other markets overseas. Other retailers such as TJ Max, Ross, and Burlington Coat Factory occupy as unique niche that is difficult online retailers to dislodge. Still others have actually acquired emerging online retailers to better compete and gain product know how. Each of these strategies have been viable as they each leverage the retailer’s strength in a respective operations category. To survive, retailers are going to need to adopt many of these trends that are currently underway in the market and apply them to their current business operations.

As it relates to Macy’s the company has strong business element that will allow to better compete while also continuing to remain profitable. First, it has one of the most recognizable retail brands in the industry. Consumers often view the brand favorably relative to peers in the industry. Events such as the “Macys Thanksgiving Day” parade or the “Macys Fourth of July Fireworks Show” are both hallmarks of American tradition. The companies flag ship store in Herald Square, New York has become a tourist attraction and represents many of the best elements of American retail shopping. Likewise, the company benefits from extensive and highly competitive real estate portfolio that can be leverages in various ways to add value to shareholders. Currently the real estate portfolio is valued higher than the actual company itself as it relates to market capitalization. As such, the market is heavily discounting the store operations of Macys. All of these assets can be used to derive a strategy that can be beneficial for all stakeholders. In this instance, it will allow Macys to remain a small, nimbler and more competitive retailer. It also keeps retail employees employed and retains valuable jobs in the economy. Shareholders benefit as assets within the company are fully appreciated by the market.

Macys and the Link to Agency Theory

A part of the role of the executive leadership team at Macys is to increase shareholder wealth. This is directly correlated to the agency theory of strategic management. Here, executives including the CEO and CFO act as stewards of shareholder capital. As Macy’s is publicly traded, its investors demand an adequate rate of return on their investment given the risk of the investment. In this instance, investors demand a return in line or above that of other publicly traded peers. Unfortunately, over the last 5 years Macys has significantly underperformed dropping over 50% over this time frame. For comparison the S&P 500 is up 43% of this same period, resulting in a 93% variance.

Chart 1 – Macys 5 Year Stock Price Performance

This variance in performance is not entirely attribuated to management howerver, it certain periods mass optimism or mass pessism can cause a stock to decline irrespctive of its merits. Unforatuntely, in this case, the market appears to be heavily dicounting the current strategy at Macy’s as it relates to its overall busienss performance. Chart 2 below indicates Macys annual earnings per share trends since 2008. As can be seen from the trend, the company has not performed well in this regard either. Particualrly in recent years earnings have declined from a high of $5.10 in 2018 down to a loss of $12.68 in 2021. According the latest investor conference call Macy’s attributed this loss to the overall impact of COVID-19 on its business. This is true, as a department store, consumers did not need nor desire to pruchase clothing and other appareal. Instead, as the company cited, consumers traded down to purchase necessity items. Competitors with strong strategic plans flourished during this period as Macys experienced large annual losses. This potentially indicates a need for a strategic shift in the company operations. For one, the company has experienced 5 years of stock price declined indicated the market pessimism surronud the current plans of Macys, in addition, the company has experience 3 years of decline earnigs per share numbers also indicating a decline business model. While this has occurred compeititors such as Walmart, Costco, TJ Max, and other have gained market share. As the principles of the orgnaization, the exectuvies must shift their focus on the competitive strenghts of the Macys brand in order to help mitigate the declining trend of business performance.

Chart 2 – Macys EPS Trend Since 2008

External Factors that Impact Strategic Management – Economic

As mentioned in the introduction, the growing proliferation of the internet around the world has ushered in a new manner of commence. As more individuals gain access to the internet, it will allow others to better facilitate transactions, exchange goods and provide services without regard to geographic restrictions. The retail sector is no different in this regard as online sales growth in heavily outpacing brick and mortar sales growth. Chart 3 below indicates the change the growing trend of online sales. As indicated by the chart, there has been a dramatic shift of towards online retail sales that has been occurring over the past 15 years in the United States. As the chart indicates are ever larger portion of total sales are being garnered by online channel. In addition, very surprisingly, a majority of retail sales are still occurring in Brick and Mortar stores (Reynolds, 2000). As of 2020, roughly 79% of all sales were still occurring in a physical store. From this information, a strategy that relies on an omni-channel presence will be critical to the future of retail operations. As such, the strategic focus of management will be to leverage its superior retail locations and marry them with an unrivaled online shopping experience. This will allow the customer to be serviced how and when they want to be serviced without regard to physical limitations (Dawson, 2000).

Chart 3 – Comparison Between Ecommerce Sales and Total Retail Sales

Chart 4 – Growth Rates of Ecommerce vs Total Retail Sales

External Factors that Impact Strategic Management – Political

From a political standpoint, Macys faces moderate tailwinds as it related to government intervention. The retail industry employs millions of Americans and therefore is a critical generator of economic activity. As such, the government will occasion employ political responses to shore up and support retail industry. During COVID-19, the government provided three rounds of stimulus payments aimed at directly infusing liquidity in the economic system for consumers to purchase goes and services. In addition, the government provided grants that can leverage to keep individuals within the retail sector employed while also preventing lay-offs. These policies, although helpful, are only temporary solutions for the overall retail sector can cannot be relied upon in the future.

In addition, government policies have aimed to recently increase the minimum wage from a federal standpoint to $15 an hour. Certain state level officials have also introduced legislation to increase the minimum wage to $15 an hour. History, Macy’s has paid lower salary and wages to its front-line employees, these wages are supplemented through sales bonuses and other forms of compensation related to credit cards opened. These incentives, can allow certain associates to make more than their managers if their sales figures are high. In other instances, some sales associates can make much lower figures than $15 an hour. By raising the overall cost of employment, Macys will face a significant headwind as it relates to selling, general and administrative expenses. These labor increases cannot be passed on to consumers as competitors of Macys already operate with razor thin margins. In many instances, the shareholders of Macy’s will pay for these labor increase to the extent that they can not pass them along to consumers. Shareholders will pay with lower profitability and a lower potential for dividend increases in the future (Groothedde, 2005).

External Factors that Impact Strategic Management – Cultural

From a cultural aspect, Macys and retailers in general employ a diverse array of individuals. Retail jobs are often lower paying buy provide an entry point for which employees can gain knowledge, skills and insights. Macys currently employees over 100,000 employees with a large amount of diversity in their operations. Macys is also a global brand and as such operates with a high degree of cultural sensitivity the customs in the countries in which they operate. Table 1 Summarizes the information presented above

Table 1 – Economic, Political and Cultural factors

Economic Factors

Political Factors

Cultural Factors

1. High online commerce adoption rates

2. Strong retail competitors who are looking to take market share at the expense of profitability

3. American retail is oversaturated and requires a reduction in physical space

4. Consumers are purchasing less apparel and clothing on a per capita basis

1. Strong government design to maintain high retail employment

2. High design for intervention to help support the retail environment during economic contraction

3. Heavy emphasis on increasing labor costs to $15 an hour federally

4. Movement shut downs have exacerbated adverse retail trends

1. Macys benefits from a very diversified customer, vendor, and employee base

2. International operations provide the company with unique global perspectives

Strategy to Turnaround Macys

The strategy to turnaround Macys will involve shifting operations to a small, more streamlined omnichannel experience. The strategy will also involve leveraging its valuable real estate assets to realize value for shareholders. Finally, the strategy, will leverage the Macy’s brand to specific markets segments that are less price conscious and are instead value oriented.

To begin the retail sector is oversaturated. Annual per capita spending on clothing has declined for the nearly 40 years. As a result, clothing makes us a smaller and smaller portion of the overall consumers retail purchases. In addition, exacerbated somewhat due to COVID-19, consumers have less discretionary income by which to purchase clothing and apparel products. Those who do, are often looking for the best available price and thus do so online. As a result, clothing has become a much more commodity business, with consumers caring less for mediocre brands and only spending more dollars on perceived “high value” brands. As such many of the prior high value brands simply do not provide a compelling value proposition as consumers no longer see them as high value. Men’s Warehouse went bankrupt as it no longer could sell its high-priced suits and accessories which were more like commodities due to the advent of the internet. The same fate applied to Brooks Brothers as consumers looked to simply buy similar products at a much lower price. Chart 5 uses US. Census data to showcase the steep decline in apparel spending on a per capita basis relative to tother expenditures. Notice, how the decline has persisted for over 40 years with little to no change in the interim.

Chart 5- Per Capita Expenditures on Clothing

Likewise, the United States has too much retail square footage. Relative to other countries, America has over 7 million more square footage dedicated to retail space per capita than any other country in the world. The trend of less consumer spending on apparel, the influx of lower margin internet competitors, and a highly saturated retail footprint, will lend to a massive reduction in both retailers and the space used by them. We have already experienced this with the massive amounts of bankruptcies that were discussed in the introduction. This trend is expected to occur well into 2025 as the United States economy realigns its retail footprint. According to research from Cushman and Wakefield the number of US malls is expected to decline for 1150 down to 850 within the next 5 years. The closures will hit C and D class malls the hardest as their footprint has the lower productivity and the lowest sales per square foot. As a result, many of these locations will be replaced with the highest and best use for the real estate.

Chart 6 – Retail Space Per Capita

We have seen a number of C and D class retail REITS file for bankruptcy within the last few years. Of note both CBL properties and PREIT have filed for bankruptcy in 2021 indicating the perilous situation of owners of low-class retail real estate. The primary catalyst for this bankruptcy was the COVID-19 pandemic dramatically reducing sales followed by a slew of bankrupt tenants such as JC Penny, Tailored Brands and Asena Retail Group. The inability to pay rent ultimately resulted in lower revenues and inability to service their debt. Both entities are looking to recapitalize and function as much smaller and leaner operation.

However, Macys, has a very strong competitive advantage in that most of all its high value locations are located in A level mall. Here, these malls have fared much better and have very high occupancy rates, sales per square foot and consumer traffic. Throughout the pandemic A-Class malls, which are characterized by high sales per square foot, actually saw a slight increase in foot traffic in 2020. Owners of high-class malls such as Simon Property Group and Brookfield Property Partners delivered strong results relative to competitors in the field. In fact, Simon Property group, despite the pandemic has occupancy rates at 92% at the end of 2020.

The turnaround strategy at Macys will look to leverage its extensive real estate portfolio to deliver value for shareholders through various JV ventures with other strong reputable operators. Here, the strategy for Macys will shift partially to a landlord that operates a very highly desirable real estate portfolio. These locations can then be further diversified to provide hotel, office, and residential components to limit the company’s reliance on a declining retail business. The company could sublease a portion of its stores to other, faster growing, and much more popular retailers. Macys would collect the rent payments which can then used to update the value of its real estate portfolio through further investment. The risk of investment is minimized through the use of joint venture partners who can help carry the burden of cost and financial resources while the buildings are being renovated.

To begin the market cap of the company is only $5 Billion dollars today. The value of Macy’s real estate alone is $21 Billion. As noted in the introduction the market believes the retail operations of the business are worth a negative $16 Billion dollars due the detailed reasoning discussed above. The turnaround strategy will look to unlock the $21 Billion of real estate value and grow it through renovations and mix-use development. This will provide stable rental income for Macys, lower its dependence on retail, and attract consumers with much more vibrant and relevant retailers. An investor report from Starboard investors highlights the $21 Billion real estate value

Chart 7 – Macys Real Estate Value

The strategy will first infuse Macys with a large amount cash through 50/50 joint ventures. This case can then be used to help maintain the dividend to shareholders while also investing in the future of the company through mixed use development. The partner providing the capital for their half of the joint venture will have real estate expertise that can be used to own, develop, and lease high quality real estate. The cash generated from selling the half the properties in the JV can also be used to paydown and streamline operations of the business. Likewise, certain non-performing locations cans be sold altogether to provide further liquidity to the organization and allow it to mitigate the negative influences facing the retail industry. Chart 9 below provides a SWOT analysis of the strategy and how it will impact the overall strategy of Macys.

Chart 8 – Proposed Ownership Structure.

Chart 9 – SWOT Analysis of Strategy

Strengths

· Strong and compelling retail locations in growing market

· Ability to generate stable and consistent rental income

· Diversify income with multiple sources of income

Weaknesses

· Redevelopment opportunities have long lead times and require significant investment.

· Potential construction delays could harm returns

· Tenants may be difficult to attract to locations

Opportunities

· Mixed-use development such as residential, office, and hotel properties

· Properties can be sold for immediate cash infusion to pay down debt

· Ability to partner with an experience’s real estate operator

Threats

· Competing real estate and other offerings

· Market dynamics such as an economic recession

How the Strategy Supports Innovation and Change

The strategy supports innovation and change that is already underway within the retail environment. As indicated above, retailing is a declining business. Consumer purchasing habits are changing, online competition is very strong, and products no longer have the brand appear that they once did. Likewise, the retail footprint is shrinking as America is over retailed. As such the strategy support innovation as it capitalizing on many of these trends and competitive advantages that only Macys has. For one, online sales are just 20% of total retail sales. Many online retailers including Amazon are looking for a physical presence to expand their brands. Macy’s can help deliver this through is high sought-after locations. The strategy support innovation as many of the world leading retailers and innovators are continually looking for physical locations in which they can continue to innovate. Amazon is looking to locate further into cities to provide same day deliver to more Americas. In order to do that it can leverage the retail footprint of Macys to further innovate. The live-work-play innovation still continues to grow as younger individuals want to be located near their place of employment. By establishing mixed use developments, Macys can also capitalize on this trend and innovation as well (Varley, 2003).

Development an Implementation Plan

The implementation plan was discussed in detail above. To summarize, the plan is for Macys to unlock value through JV partnerships with established real estate developments. Macys will still maintain control of the entity but will sell a portion of the real estate to various joint venture partners. The company will separate its retail into Mall locations and Standalone locations to attract different JV partners. The proceeds that are earned from the portion of real estate sold to the JV will be used to either pay down debt, continue to pay the dividend, or reinvest back into mix used development. This plan appeals to all stakeholders as dividend investors maintain their income streams. Stockholders looking for capital appreciation will participate in the upside and growth in value of the real estate portfolio. JV partners will participant in the profits generated from the stable rental income. Macys will have a much more diversified revenue stream, a higher stock price, less debt, less risk, and less reliance on its own retail operations.