While total U.S. retail sales (ex-automobiles) have shown a compounded annual growth rate of 5.6 percent between 1992 and 2005, department stores sales have actually declined (see graph above). Between 2000 and 2005, U.S. department store sales have fallen by 14 percent.

While Wal-Mart, Target, and other discounters have taken significant market share from traditional department stores, there are other factors that have caused the sales decline in department stores.

• Luxury shoppers, traditionally the loyal customer base of department stores, have shifted buying to specialty retailers such as Tiffany, Coach, and others.
• Mall traffic has declined over the past five years.
• Department stores are their own worst enemy. Shoppers need a degree in math to shop in a department store. Department store ads read like standardized tests in school: “Take 50 percent off the already-discounted price. Take another 15 percent off if you buy before 11am; take another 10 percent off if you sign up for the store-brand credit card; and take 5 percent more off if it is a full moon.” What’s the final price?
• Department store innovation has been lacking in recent years. Historically, department stores offered one-stop shopping for fashion merchandise. However, specialty shops have captured much of the fashion market. Unfortunately, department stores have made little or no change to their real estate portfolio, merchandise mix, branding, customer service (customer service levels are eroding), and distribution logistics.
• In an effort to regain market share, department stores have become more promotional. Thus, they have stooped to the same competitive differential that Wal-Mart and other discounters use: low price. That is a losing game.
• Online retailers are also squeezing department store market share.

As a result of these pressures on the department stores, the industry is undergoing rapid consolidation. In 2005, a flurry of merger and acquisition activity took place among both higher-end and mid-market competitors. When the dust settled, a single national department store competitor had emerged; regional retailers had strengthened their brands; and one luxury player had gone private.

• In March 2005, Federated announced the acquisition of May Company. Federated emerged as the only national traditional department store competitor with over 800 stores coast-to-coast.
• In July, Belk acquired 47 Proffitt’s and McRae’s department stores from Saks. This strengthens Belk’s market share in its Southeastern markets.
• In the fall, Saks agreed to sell its northern department store group to Bon Ton. These brands included Carson Pirie Scott, Bergner’s, Boston Stores, Herberger’s, and Younkers.
• In October, a private equity group acquired luxury department store retailer Neiman Marcus, including the Bergdorf Goodman units.
• Early this year, Federated sold off (or converted) its acquired upscale Lord & Taylor units.
• Federated is re-branding most of the acquired May stores.

If all of these changes don't create confusion in consumers’ minds, we’ll be shocked.

Leased Department Business Is Tough

Conceptually, operating leased departments in retail stores is a tough business: as an operator, they have very little control over their destiny. The term “leased department” means that a retailer sub-contracts with an outside vendor to sell a specialized product category within the retailer’s store. In the past, consumer electronics and appliances were often leased operations in mass market retailers. However, the use of leased departments has waned in the U.S.; Finlay is one of the few remaining leased department operators.

The graph below illustrates leased department sales in traditional department stores. Clearly, leased department sales are declining.

Source: US Dept. of Commerce

 

The graph below illustrates leased department sales as a percentage of total sales of traditional department stores. Leased departments are falling out of favor with traditional department store operators.

Source: US Dept. of Commerce

For customers, leased departments are transparent; they don’t know that they are dealing with outside vendors’ employees. Shoppers can use their store credit cards. Finlay’s jewelry advertisements are combined with the host store’s ads. Finlay’s name is never exposed to the buying public.

Until recently, Finlay operated leased jewelry departments in most of American’s major department stores, including Federated, May Company, Dillards, some Saks brands, and others.

There are a few other leased jewelry operators, but they, too, are a vanishing breed. Recently, Belk acquired Migerobe, which operated leased departments in 36 Belk stores; it has been folded into Belk’s operations and no longer exists as a stand-alone entity. Ultra Jewelers has operated 31 leased jewelry departments (as of 2005), but it is not a major player in that sector of the industry. Beyond the jewelry industry, companies like Circuit City (when it was Wards Company) was a major operator of leased departments in discounters. However, they discontinued their leased operations many years ago. There are apparently still a few leased operators of shoe departments in some stores; beyond that, there are very few leased department operators left in the U.S.

Finlay: How Does It Compare?

For its size, Finlay’s store operating statistics compare favorably with other mass market jewelers.

Finlay’s sales per store are about $950,000 per unit. Based on an average unit size of about 800 square feet, the company’s sales per square foot is just under $1,200. That is far above the typical independent jeweler who generates revenues of about $400 per square foot or a mass market chain with revenues in the range of $800 per square foot.

The graph below summarizes the average revenue per store for Finlay and Carlyle as compared to others in the jewelry industry.

Source:  Company Reports

Finlay’s average ticket is well below the typical specialty jeweler, but this is logical since the company’s high-ticket diamond sales mix is almost nil (Finlay sells almost no engagement rings, which have an average value of $2,750 in America). Further, most fashion jewelry – which is an impulse item – typically carries a lower average price. At expected, Carlyle, a guild jeweler, generates an average ticket of about $1,000. The graph below compares Finlay’s average ticket with others in the industry.

Source:  Company Reports

Finlay’s sales mix is substantially different from other mass market chain jewelers. It sells far fewer diamonds. Interestingly, Carlyle also has a lower-than-expected diamond sales mix, as the graph below illustrates.

Source:  Company Reports

Financials Have Strengthened

As Finlay has exited the Federated/May doors, it has generated substantial cash and paid down its debt. Further, inventory levels have dropped substantially. In addition, a large number of the exited doors were generating below-average sales. For example, the doors that Finlay is exiting at Belk were generating about $575,000 per unit, well below the company average of $950,000 per unit. The doors that the company is exiting at Federated were generating about $842,000 per unit, also below the corporate average. Finally, as a result of good expense management, the company’s operating expense ratio declined during the most recent quarter.

A Touch of Irony

Finlay was recently honored by Stores magazine, the publication of the National Retail Federation, as being one of “The Nation’s Hottest Retailers” in 2006, based on the increase in its revenues, profits, and units in 2005. Finlay probably won’t make that list in 2006.