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COVER STORY: Get over it

The economic boom of the 1990s left the nation's retail industry with a shopping hangover — consumers spent themselves into a frenzy and developers built lots of new space to fill retailers' expansion plans.

The new millennium brought a wake-up call. Recent times have been tough on retailers and property owners alike — the party is definitely over. And even though economic recovery is on the horizon, competition continues to be the driving force behind who wins the hearts and pocketbooks of consumers over the long haul.

Sometimes there is room for only first and second place. Sometimes they've learned to co-exist, but in other cases, at least one competitor has left the field altogether.

In the following 2002 update on the state of the retailing industry, we explore a few of the different strategies being used by competing property owners and retailers to win market share, attract customers and ensure their survival.

Life in mall-land

Consolidation and competition among malls is quickly shaping some of America's biggest mall markets.
By Ben Johnson & Mike Fickes

Big-time REIT consolidation. Constantly changing tenanting strategies. Old malls finding ways to survive — by some estimates, 15%-20% of all regional malls are now “greyfields,” a new category of mall-in-decline. These are the signs of the times in mall-land in 2002.

“It's a mature industry that is bifurcating into winners and losers very rapidly,” says Doug Healy, principal and managing director of Lend Lease's retail group.

It is no coincidence that most of the winners are owned by the nation's largest mall REITs. Their focus is on so-called “fortress” properties yielding sales of at least $450 per sq. ft.

But many regional malls are in a clear state of decline. “What we are seeing today is that many of the new regional centers are bigger, more elaborate and more up-to-date than competing centers and so they can extend their trade areas far beyond the halfway points and cannibalize their neighbors' business,” says Michael Beyard, senior resident fellow of retail and entertainment at Washington, D.C.-based Urban Land Institute.

Here we focus on three sets of competitive malls that are faced with unique new challenges, but are still finding ways of getting over their inherent deficiencies by pushing ahead with much-needed changes.

Can GGP “corner” Tysons?

One way to get over your competition — especially if it's sitting eyeball-to-eyeball with you right across the street — is to buy it.

Example: Chicago-based General Growth Properties (GGP), the No. 2 mall REIT, already owns the tony 810,000-sq.-ft. Tysons Galleria in McLean, Va., just outside Washington, D.C., with anchor tenants Macy's, Neiman-Marcus and Saks Fifth Avenue. The mall has carved out the top upscale position in the market since opening in 1988.

Recently Morgan Stanley confirmed rumors that GGP is ready to buy either all or part of neighboring Tysons Corner Center for at least $500 million.

Tysons Corner, the 8th-largest U.S. mall and the largest in the D.C. metro area (2.1 million sq. ft. and 250 stores), has dominated the mass market since it opened in 1968. With six upper and upper-middle market anchors — Bloomingdale's, Hecht's, JCPenney, L.L. Bean, Lord & Taylor and Nordstrom — it dubs itself “The mall with everything.”

Snapping up Tysons Corner Center from its current owners, L&B Realty Advisors of Dallas, would make sense for GGP. Consolidation in the mall sector has been heightened in recent months by the $5.3 billion sale of Rodamco North America's mall portfolio to Simon Property Group, Westfield and The Rouse Co.

But whether the Tysons Corner Center purchase happens or not, the 20-year difference in the two malls' ages has spawned some striking contrasts in their tenanting strategies.

Tysons Galleria, opened just before the deep recession of the late-1980s, originally missed the mark as an upscale center. Its developer, Homart Development Co., a Chicago-based merchant developer and wholly owned subsidiary of Sears, aimed the Galleria as the upscale alternative to the existing competition.

“We designed Tysons Galleria as an upscale neighbor for Tysons Corner,” says Michael Richwine, a former Homart executive and currently a senior vice president with Colliers Bennett & Kahnweiler in Chicago. “But when we opened, in the slow period of the 1980s, we found it difficult to lease.”

Foiled by the economy, Homart signed tenants that mirrored those in Tysons Corner. As a result, the Galleria struggled for market identity until 1995, when GGP purchased the mall and devised an immediate turnaround strategy. “General Growth took the property back to its original upscale positioning idea,” Richwine says.

The move was a huge success. The upscaling of the Galleria's tenants raised the mall's sales per square foot from a meager $300 in 1995 to some $600 in 2001, one of the highest rates in the country.

Pioneering problems

Up until the late-1990s, Gwinnett Place Mall ranked as the dominant regional mall 20 miles north of downtown Atlanta, sitting smack in the middle of one of the nation's fastest-growing counties (Gwinnett) and having the local retail market virtually all to itself since opening in 1984.

“Gwinnett [Place] was fairly upscale and drew not only from Gwinnett County, but also attracted day-trippers from locations as far away as South Carolina,” says Donna Mitchell, director of consumer marketing with Jones Lang LaSalle Inc. in Atlanta and formerly part of the Urban Retail Properties team that managed the mall.

But success lured others. “Gwinnett Place has been a magnet, drawing other retailers into the area,” says Todd Jeska, research manager in the Atlanta office of Marcus & Millichap.

By the mid-1990s, local retailing circles were buzzing about a big new mall just northeast of Gwinnett Place, a proposed joint venture that included Simon Property Group, the largest mall REIT in the nation. Gwinnett Place's management wondered how a new player would impact business.

The answer arrived shortly. First Simon purchased the 1.24 million-sq.-ft. Gwinnett Place in 1998 from Corporate Property Investors. A year later, Simon opened the 1.8 million-sq.-ft. Mall of Georgia in Buford, just 13 miles Northeast of Gwinnett Place on Interstate-85.

Mall of Georgia's anchors include a broad selection of big box, department store and entertainment retailers: Bed, Bath & Beyond, Barnes & Noble, Dillard's, Galyan's Trading Co., JCPenney, Lord & Taylor, Nordstrom, Regal Cinema and IMAX 3-D, Rich's, Staples Office Supply and Vans Skate Park.

Gwinnett Place anchors — JCPenney, Macy's, Parisian, Rich's and Sears — offer a solid middle- to upper-middle market. But this roster is chock full of traditional department stores which have seen their fair share of challenges in the past few years.

Another major project crowded Gwinnett Place's backyard. Last year, Mills Corp. opened the 1.3 million-sq.-ft. Discover Mills outlet center just three miles north of Gwinnett Place. “This eliminates the outlet option for Gwinnett,” says Mitchell. “Together Mall of Georgia and Discover Mills have sandwiched Gwinnett into the everyday, convenience niche.”

Simon executives concede that Gwinnett Place has survived by morphing into a new market niche.

“Gwinnett is a mature center with committed, loyal customers who visit this mall for convenient and quick shopping experiences,” says Leslie Swanson, divisional vice president of marketing with Simon. “Eighty percent of the customers visiting the Mall of Georgia are day-trippers drawn from a 50-mile radius. Many come from just over the border in South Carolina.”

But other, older malls in the Atlanta area have fewer options, as both their structures and customer demographics decline. Last December, the 36-year-old Avondale Mall in East Atlanta closed. The message it sent to other owners — innovate or evaporate.

“Northlake Mall [owned by Simon] and North Dekalb Mall [owned by General Growth] are both due for a revamping, mainly due to the rapidly changing demographics in their immediate area,” says Jeska.

That is why REITs like Simon and GGP want to dominate big-city mall markets — they have more power to control their properties' competitive sets of tenants and negotiate leases.

“We sold Phipps [Plaza in Buckhead] to Simon a couple of years ago in recognition that the two of us were competing and knocking each others' brains out for tenancy,” says Healy.

With its six regional malls in the area, Atlanta is a Simon sort of town.

Nowhere to hide

Just north of Sacramento, Calif., the Arden Fair Mall had its own way within its 10-mile trading area since 1957. Starting out as a single-level mall, it doubled in size thanks to expansions in 1989 and 1994 to become the largest mall in the Sacramento area. It also brought the first Nordstrom to town.

Today, the primary marketing circle around the mall contains about 1 million people, according to Tina Sigman, marketing manager with Macerich Management Co., which has managed the mall since June 1999 for co-owners Heitman Capital Management Co. and Arden F&M Partners.

But only a year later, in August 2000, a cloud appeared on Arden Fair's horizon. Urban Shopping Center's new Galleria at Roseville opened just 25 miles to the north, with the goal of marketing to 580,000 people within a 30-mile radius. Arden Fair braced for a potential 15%-20% loss in sales.

Indeed, the mall witnessed a staggering sales decline during the Galleria's first year of business. “We realized a 10% loss in sales initially,” Sigman admits. Since then, however, Arden Fair has recouped its losses and seen its sales increase, she says.

“There was a lot of excitement about the Galleria when it first opened,” says Garrick Brown, research director with Colliers International in Sacramento. “People wanted to check out the new mall. So it doesn't strike me as out of the realm of possibility that Arden Fair lost and then regained sales.”

In tenant terms, the two malls are virtually identical. Each has a tad over 1 million sq. ft. Both have the same four anchors: JCPenney, Macy's, Nordstrom and Sears. The Galleria has 126 retailers; Arden Fair has 169. The Galleria positioned itself as a middle to upper-middle market fashion mall. Ditto Arden Fair.

After two major renovations in the past decade, Arden Fair could have rested on its laurels to a certain extent — after all, its 25-mile trading area has a population of more than 1.5 million people and the average household income is nearly $63,000. But instead, Arden Fair moved quickly to upgrade its facilities. A $12 million renovation completed in fall 2001 added soft seating areas, second-level carpeting and a new customer service center. It also included remodeling the food court, improving parking circulation and redesigning the main entrance.

Arden Fair also renovated its advertising campaign and snagged some new national tenants. Today it is 99% leased, but more may be needed.

Now that Westfield has purchased the Galleria as part of Rodamco North America's retail portfolio sell-off, it controls two of the area's four largest malls, including Downtown Plaza, which it bought in 1998.

Even more competition looms on Arden Fair's horizon — GGP has announced plans to build the five-anchor, 1.3 million-sq.-ft. Lent Ranch Marketplace in South Sacramento/Elk Grove. It has already signed Macy's, Dillard's and Gottschalks as anchors.

Those plans, though, have been stalled by county and state government opposition. And, it turns out Westfield is partially funding a local-opposition lawsuit alleging environmental concerns about the project. Westfield also stands to lose customers from its Downtown Plaza mall, which is located 15 miles from the Lent Ranch property.

Stay tuned for more on this one.

Mike Fickes is a Baltimore-based writer.

Retailers wage slug-fest

An iffy economy, tough competition and limited growth potential have retailers in a tug-of-war.
By Ben Johnson & Elyse Umlauf-Garneau

Many of the most familiar retail names are struggling to hold their own in an economy where consumers are still in a belt-tightening mode. They're also operating in an environment where discounters are making deeper incursions into traditional retail territory and wooing customers with top-name brands and rock-bottom prices. Some also face limited growth opportunities because of saturated markets.

Here we look at three highly competitive retailing categories — grocers, office products and department stores — with unique glimpses into how the main protagonists are competing against both each other as well as tough new competitors.

Food fight

A few years ago, the food category was dominated by a bunch of traditional grocery stores, including national players Safeway, Kroger and Albertson's. Today, you can add a bevy of new entrants that have gobbled up market share, including discounters Wal-Mart, Target, Kmart and Meijer, and discount clubs like Costco and BJ's Wholesale.

“The retail food industry is facing the ongoing fight for share of stomach,” quips Chuck Cerankosky, managing director for McDonald Investments in Cleveland.

In addition to the discounters, traditional grocers are also competing with restaurants and take-out providers. “Years of affluence have made meals taken away from home an increasing part of American culture. It's the biggest overlooked competitor by outside observers,” he says.

And recently, grocery chains have seen an unusual recession. As consumers faced a slowing economy last year, they shaved precious dollars and cents off their grocery lists to help put their household budgets in order. This came as something of a surprise because many industry-watchers had always viewed food spending as somewhat recession-proof.

According to Nancy Aversa, an analyst with Victory Capital Management in Cleveland, “We tend to think between 25% and 30% of the household budget is allocated for food purchases. But when times are tough that's an easy place to tighten the belt. Whenever customers are trading down the price spectrum, it puts pressure on margins.”

But new evidence suggests that consumer confidence is bouncing back, which could allay fears of grocery price wars and put a higher premium on convenience and customer service — the strength of traditional grocers.

So who is best positioned to win this war? For now, at least, Kroger is a leading candidate.

“New data suggest that Kroger continues to weather the Wal-Mart storm reasonably well,” says John Heinbockel, head of food and drug retail investment research at Goldman Sachs in New York. “The company has modestly lowered its square footage growth target for 2002, a tacit recognition of the food retail market's chronic overstoring. These are all signs of a rational, well-positioned company likely to benefit from improving operating momentum as 2002 progresses.”

Meanwhile, Albertson's is still trying to turn the corner. “It had a great deal of trouble assimilating the acquisition of American Stores [which added Acme Markets, Savon and Osco Drug under the Albertson's banner] that led to sharp earnings disappointment and management changes. That is being followed by a very hard look at all operating assets and new strategies,” says Cerankosky.

In March, Albertson's announced it was selling eight stores in Missouri and closing a ninth there. It is also closing stores in Memphis, Nashville, Houston and San Antonio and division offices in Memphis and San Antonio.

While supercenters focus on lower-quality goods at lower prices, Safeway and Kroger offer quality products, great selection and convenience.

And they are stocking more unique private-label items on their shelves. “Kroger has done well in its private-label products, especially natural foods, and these are higher margin product that will enable it to differentiate itself from the competition,” says Aversa. “It's something Wal-Mart doesn't offer. We're seeing recognition that there are other ways to fight competition other than on price.”

Office supplies vs. demand

Some 80 million sq. ft. That is how much space is occupied by the three largest office products retailers, so if hope springs eternal that the moribund sector may be on the verge of an uptick, that is big news.

“Our view has been that a sales recovery in the office products space would lag the recovery that is underway in the broader consumer space. We may now be witnessing the first signs of such a recovery,” says Aram Rubinson, retail analyst with UBS Warburg in New York.

Together, the top three players in the sector — Staples (with about 1,300 stores), OfficeMax (with about 1,000 stores) and Office Depot (with about 860 stores) — are desperately trying to pull out of a prolonged slump. “It's a $190 billion market and it's concentrated — 80% or better — among three players,” says Aversa of Victory Capital Management. “For any one of them to grow, they're taking share away from the other.”

Adds Geoff Wissman, vice president of Retail Forward Inc., in Columbus, Ohio, “From a growth standpoint in the U.S., it's going to be based on what the market will grow. Then it'll be a dogfight among them in terms of who will gain or lose market share. They're at the point where they're saturated across the marketplace. Last year we saw all three — Staples, Office Depot and OfficeMax — close stores and exit markets where they didn't have a dominant position.”

OfficeMax is finding out the hard way that there may only be room enough for two, say retailing analysts.

“After eight quarters of operating losses, we believe OfficeMax has reached an inflection point,” says Danielle Fox, head of JP Morgan's equity research in the office products sector. “Over the next year, it either gets back in the game or already nervous vendors pull the plug on whatever support remains. We think OfficeMax is furthest behind with the least attractive assets and we remain skeptical that it will stage a successful turnaround.”

That leaves the game between Staples and Office Depot, but both face serious challenges. “It takes a completely different management philosophy and group of skills to run a company approaching saturation versus one in a very hyper-growth mode,” says Wissman.

Staples plans to add $200 million of operating profit in 2002, thanks to better buying, a richer merchandise mix and cost reductions (not to mention slowing its new-store growth to 75 stores this year from 113 in 2001). It is also experimenting with a new “Dover” prototype store concept that is slightly smaller than traditional stores (20,000 sq. ft. vs. 24,000 sq. ft.).

Dan Wewer, an analyst with Deutsche Bank Securities in New York, says the company need only generate a 3% sales pop on the remodeled stores to realize a return on capital in excess of 12%.

“Staples is in the early stages of an important recovery in operating profit margin and return on capital, a trend that is sustainable for at least two to three additional years,” says Wewer. “We continue to see Staples as the biggest beneficiary from declining industry square footage growth.”

Staples is implementing other strategies as well — following the lead of Bed Bath & Beyond and The Home Depot, it has asked its top 300 vendors for a 1% price reduction and another 30 days in payment terms. It also hopes to expand its private-label program from 7% of sales today to 20% long-term. And, it is launching its Dover prototype into at least 25% of its stores by the end of 2002.

For its part, Office Depot is touting its customer service focus — its latest TV commercials feature celebrity experts in various fields. Will they be enough? Alone, not likely.

Department stores claw back

Traditional department stores, otherwise known as mall mainstays, are in a bind — discounters can do it cheaper and specialty stores can do it better.

Retail sales for March 2002 bear this out. Discount giants like Wal-Mart and Target posted strong gains.

Where does that leave old-liners Sears and J.C. Penney, the department store standard-bearers? “Sears and J.C. Penney are in a turnaround phase and they're desperately trying to gain back the market share they lost to discounters,” says Matt Spitznagel, an analyst with Chicago-based Northern Trust Bank.

It won't be easy, particularly since shopping patterns have changed. Discounters are winning out over traditional department stores because consumers have discovered the value and convenience of freestanding stores.

Both Spitznagel and Tim Kroll, an equity analyst with Chicago Capital Management in Chicago, point to Kohl's as one retailer to whom consumers are flocking and producing angst for department-store retailers. Kohl's has wooed time-pressed consumers who don't want to fight traffic or schlep through a mall and who demand speedy, centralized check-out.

Moreover, discount shoppers are finding quality merchandise. Target has forged strong relationships with hip designers and vendors like Sony, for example. Kohl's has allied with OshKosh. And, unlike old-line department stores, discounters are in an expansion mode.

And yet, Sears is slowly clawing back. Sears' CEO, Alan Lacy, is bottom-line- and return-focused. He has done much to improve return on capital, making more efficient use of resources and slowing down the growth of its Great Indoors concept, a home decorating and remodeling store. Expense management should help Sears generate double-digit earnings growth in percentage terms for at least the next two years.

It's no secret the retailer has one of the most enduring franchises in the U.S. and has relationships with six in every 10 U.S. households through its private-label credit card. It also hopes to make waves with its new private-label apparel line called “Covington.”

Sears is still spending money to spruce up its stores, though. The plan includes improving signage and lighting, making merchandise easier to find on shelves and widening aisles.

Sears plans to expand space devoted to home appliances, increase its consumer electronics focus on digital products, alter and consolidate its private-brand portfolio, expand home fashion offerings and ditch its floor coverings and window-treatment business.

J.C. Penney's latest strategy is to drive sales by boosting its advertising and promotions, closing underperforming stores and spiffing up its properties.

But its best move to date may be the hiring of CEO Allen Questrom in 2000. Questrom has a reputation as something of a retail turnaround artist and has been lauded for guiding Barneys New York and Federated Department Stores away from bankruptcy.

Penney, which celebrated its 100th anniversary in April, is converting to a centralized merchandising system, which should streamline inventories. “Being overinventoried has been a big problem with department stores in the last year and they've been working the excess inventory out by adding a very promotional strategy. That's been impacting earnings,” says Spitznagel.

Recent results for both Sears and Penney bear out a potential turnaround. Sears posted a $104 million increase in 1st-quarter 2002 operating earnings and raised its guidance for the rest of the year. Penney posted a stronger-than-expected 6.8% comp-store sales increase in March.

For many retailers, though, consolidation may be the key to growth. Though the proposed merger earlier this year between May and Federated Department Stores did not happen, others are expected to partner up.

“This is the only way these companies are going to grow. They don't have square footage expansion and most growth is coming from share buybacks or cost cuts,” says Spitznagel.

Whatever strategy they use to win the confidence of investors and consumers, department stores must demonstrate clear evidence of a turnaround, and soon.

Elyse Umlauf-Garneau is a Chicago-based writer.

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