Time is brief, so I will cut right to the chase.
Department stores are about to get punched in the face by the brands they have pushed around for years with their frequent discounts and crappy shopping environments. Now, amid department stores continuing to struggle to get consumers into their hulking stores instead of them making a visit to a website, major apparel and accessories brands have had enough. It's as if leading brands are the wolves slowly gaining in number readying to pounce on an injured opponent.
What Coach (COH) announced on Tuesday -- that it will exit a whopping 25% of its wholesale doors in North America over the next 12 months -- is a huge stake in the ground. Looking at it another way, it's a dagger in the heart of the established ways brands have interacted with department stores. Coach's CEO Victor Luis told me in an interview that while he appreciates department stores are still an important distribution channel, no longer will the company sit back and watch its products be on markdown of 25% off, ultimately destined for the 50% off clearance table at the end of the quarter.
Practices such as these have tarnished Coach and many other brands in part due to overexpansion by the brands themselves, but also department store execs believing that deep discounts are the only marketing tool in their arsenal. If department store execs would hire attendants at various shops in the store -- which would be costly, yes -- they would learn that best-in-class customer service coupled with great product are two of the best marketing mechanisms in the book.
When was the last time someone in a Macy's (M) men's department asked you if you needed help? Exactly.
I suspect a host of brands ahead of the holiday season will announce sweeping changes to how they approach department stores. Michael Kors (KORS) , which reported earnings Wednesday morning, could curtail wholesale distribution by more than Coach given its gross overexpansion into the channel the last five years. Yes, so take the time to listen to Michael Kors' earnings call, folks. Furthermore, Polo Ralph Lauren (RL) (which also reported Wednesday) is likely to follow suit within the next 18 months and cut wholesale distribution. The company is aggressively moving to overhaul its operating model so that less inventory finds its way to off-price retailers such as TJ Maxx (TJX) and Ross Stores (ROST) -- it's a practice that, like Coach, has cheapened the Polo brand. To cut off the off-price channels, Polo has to cut off its underperforming sites in department stores.
So yes, listen to Polo's earnings call, too.
Kudos to all the brands for taking the short-term revenue hit (I won't say profit hit because many of these locations are underperforming, low-volume doors that may not be profitable) in an effort to drive a healthier business longer term. Efforts such as these have been a long time coming. Having said that, this situation (and it will be a situation everyone is talking about real soon) will create quite the conundrum for department stores. For example:
What brands take the place of the exited major brands? Likely lower-quality brands, which in effect will turn supposed full-price department stores into nothing more than outlets with food courts nearby.
Customers are retrained to visit the retail stores of the major brands for the best possible product, and forget visiting the department stores.
Customers are pushed even more into the lower-margin online channel. Hence, department stores become less productive during a time of rising hourly wages. Here come more store closure announcements early next year.
I think it's telling that not one of the 11 Wall Street analysts I contacted to discuss what Coach announced got back to me. What does it say? It says major brand exits from department stores are not something Wall Street has taken seriously in their models. They will be forced to do so now, which could lead to another re-rating of the sector (if weak second-quarter results don't force it alone).
