Your phone beeps. It’s an email from Kohl’s. Those Nike joggers you added to your cart last night went on sale. You’re redirected to the Kohl’s app and a recommendation pops up for a matching hoodie, also on sale. The store in your town has both in stock, just your size. You make your purchase and earn $10 in Kohl’s Cash, plus rewards. An hour later, you walk into the store to pick up your new outfit. While you’re there, you return the headphones you ordered on Amazon last week. Then a pair of Cole Haan’s catches your eye, and they’re on sale. You head to the register and redeem the reward balance in your virtual wallet. You exit the store, both purchases in hand. Your phone beeps. It’s an email from Kohl’s.
A glimpse into the lifecycle of the modern-day Kohl’s customer shows just how much retail has changed over the past decade. The rise of e-commerce and Amazon has allowed consumers to buy virtually anything at the touch of a finger. Brick-and-mortar companies have been forced to adapt, and fast. Some have stayed relevant; many have not.
The COVID-19 pandemic has only accelerated the industry’s digital shift and shoppers’ need for convenience. Last year’s public health and economic crisis was a breaking point for department stores J.C. Penney, Neiman Marcus and Lord & Taylor – all of which filed for bankruptcy – and Macy’s, which is in the process of closing a fifth of its stores.
Kohl’s Corp., a $16 billion retailer based in Menomonee Falls, stands at a critical juncture. Its physical footprint spans 1,162 stores in 49 states. In 2019, Kohl’s had the second highest sales per store in the mass apparel sector, behind Nordstrom Rack, according to the National Retail Federation. Meanwhile, its online business has picked up steam, swelling to 40% of total sales in 2020, up from 4% in 2010 and from 24% in 2019.
However, total sales have largely flattened since 2014, which analysts chalk up to the gradual loss of in-store business.
[caption id="attachment_524535" align="alignright" width="300"]
Michelle Gass[/caption]
Still, Kohl’s says its physical footprint remains profitable and, under the leadership of chief executive officer Michelle Gass, has continued to test new ways of bringing its now 65 million-customer base through the door.
Now, in the wake of a devastating year, resulting in a 20% drop in sales, and in the face of mounting competitive pressure, Kohl’s is being forced to innovate again.
The company is several months into its new long-term growth strategy and claims it’s making progress, but activist investors who together own a 9.5% stake aren’t satisfied. In February, the group launched a highly publicized campaign to replace five of Kohl’s 12 board members, blaming leadership for a “chronically underperforming” stock price and pre-pandemic financial struggles.
The group, which includes Macellum Advisors GP LLC, Ancora Holdings Inc., Legion Partners Asset Management LLC and 4010 Capital LLC, says the retailer’s new growth initiatives are no different from its 2014 Greatness Agenda, which failed to meet goals. It questions Kohl’s ability to achieve current growth aspirations without major changes to the board.
But Kohl’s has stood its ground, defending its leadership and its new plan, which includes growing sales and operating margin by capitalizing on apparel trends and improving its women’s business.
“We are leaning into categories where we have demonstrated momentum and will drive more growth opportunities into the future,” Gass said, announcing the new initiative in October. “The recent environment has accelerated our path forward and presented a unique opportunity to capture market share from retail industry disruption.”
Big plans
At the heart of the company’s plan is a new consumer-facing vision: “To be the most trusted retailer of choice for the active and casual lifestyle.”
Athleisure and casual fashion has exploded over the past five years, and the pandemic fanned the flame as people traded jeans for sweatpants while stuck at home.
Kohl’s active category has more than doubled since 2013; today it generates 20% of total sales. The retailer is working to grow the segment to at least 30% by expanding top brands Nike, Under Armour and Adidas, and adding new brands such as Calvin Klein, Eddie Bauer and Lands’ End. Not to mention its own private label athleisure brand, dubbed FLX, which recently launched in more than 300 stores and online.
For Dodgeville-based casual clothing retailer Lands’ End, selling through Kohl’s means gaining access to a sizable new audience.
“What we’ve seen with Kohl’s is they’re our type of customer, but they’re new to Lands’ End,” said Jerome Griffith, chief executive officer of Lands’ End, at DA Davidson’s annual consumer growth conference. “Half or more of the customers that shop with us in these new channels had never shopped at a Lands’ End before, which is one of the reasons why our name is getting out there more.”
Another key focus for Kohl’s is beauty. The historically underperforming category for Kohl’s is about to get a makeover thanks to a huge partnership deal with San Francisco-based beauty retail giant Sephora. Beginning this fall, Sephora will open locations inside 200 Kohl’s stores, expanding to 850 stores by 2023. The 100-plus brand assortment will launch Aug. 1 on Kohls.com.
Kohl’s, with a 70% female customer base, considers this partnership a game changer.
“We fully expect that we will see a halo effect across the store.” said Gass during Bank of America’s Consumer & Retail Technology Conference in March. “… Make no mistake, this is one of the biggest, newest different moves that we’ve ever had to accelerate our top line.”
The 2,500-square-foot front-of-store shops are poised to grab the attention of new, younger customers by offering an experience that shoppers couldn’t get online.
“We’ve seen that (younger) shoppers like this idea of inspiration, discovery and storytelling,” Jen Johnson, senior vice president of corporate communications for Kohl’s, said in an interview with BizTimes Milwaukee. “They come in and look for ideas … as opposed to real purpose-driven customers.”
Kohl’s rolled out its Outfit Bar concept last year to the same effect. Both in stores and online, it displays various combinations of products and brands for a “solutions-based” experience.
Together, the Sephora partnership and active casual expansion contribute to the company’s ongoing efforts to revive its women’s apparel category, having restructured leadership and exited 10 down-trending brands since late 2019.
The activist investors say the company’s brand churn is a symptom of “shiny object syndrome” – brand launches are exciting but ultimately distract management from more pressing issues without impacting top-line growth.
Kohl’s works to evolve and attract new customers while balancing a long-held reputation – one that’s built on Kohl’s Cash, coupon mailers, and discount programs. And company leaders say there’s room for growth there, too.
“We’re continuing to bring in some really great aspirational brands, but we need our customer to know that we’re still a very strong value player, and she’ll feel that through the rewards program that we have, through the pricing that she gets, through the offers that she has,” said Johnson.
Kohl’s loyalty program has grown to 30 million members since its 2014 launch. Those shoppers spend two times more than non-loyalty members. Its private credit card, which has 29 million holders, generated 56% of sales in 2019. Kohl’s Cash, loyalty rewards and charge card were recently integrated under one “Kohl’s Rewards” program, making it easier for members to use and understand. The move also allows Kohl’s to leverage its large customer database to deliver targeted offers and personalized content for a lower cost, Gass said during the BofA conference.
“One of the side benefits that we’ve had with loyalty and focusing on it has been email acquisition,” she said. “Our email file is the biggest it’s ever been, and that allows us to reach customers a lot more efficiently as part of the marketing transformation we’re making.”
Kohl’s says it connects with its customers more than 10 times per week.
General expenses were down 12% in 2020 thanks in part to new digital marketing efforts. Still, the activist investor group criticizes Kohl’s historically print-based, and pricey, advertising strategy for years of rising costs amid stagnant sales.
With how much Kohl’s has spent annually on marketing, about $1 billion, and on omnichannel fulfillment, its inability to gain market share is “highly disappointing,” the group wrote in a letter to shareholders.
Company leaders don’t disagree it’s time for an upgrade, but not until new strategies are thoroughly tested.
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Kohl’s recently launched its private label athleisure brand, FLX, in 300 stores and online.[/caption]
Industry headwinds
Given the state of the apparel retail sector today, it’s unclear that either plan – Kohl’s management or the activist investors’ – is strong enough.
Sephora’s deal with Kohl’s replaces its longtime 600-shop-in-shop partnership with struggling
J.C. Penney.
“Sephora is one of the few reasons why people have gone to J.C. Penney in recent years,” said David Swartz, equity analyst at Morningstar Research Services LLC. “But that didn’t keep J.C. Penney from going bankrupt.”
What’s more, a similar partnership between Ulta Beauty and Target is set to launch at more than 100 Target stores around the same time Sephora will roll out at Kohl’s, which Swartz said could “blunt” the effort.
“People take far more trips to Target than they do to Kohl’s. … So, if they’re going to have opportunities to buy cosmetics that were not previously available at Target, that will perhaps keep some people from going to Kohl’s,” he said.
Target may not be a traditional department store competitor of Kohl’s, but both retailers – and many of their rivals – primarily serve one market: the shrinking middle class.
“The whole apparel retail industry is kind of a blood sport,” said Swartz. “(Department stores and discount chains) are all fighting over a market that hasn’t grown very much.”
Plus, consumer spending on apparel has decreased since the 1980s, preventing retailers from raising prices, even while costs continue to rise.
Years of challenging market dynamics have wiped out several of Kohl’s competitors in the department store space, but that doesn’t mean apparel retail has gotten any less competitive.
“Competitors like Amazon are getting bigger and bigger,” said Swartz. “They’ve got infinite resources, which Kohl’s does not. Kohl’s is a viable business, but I don’t know that it’s going to get back to those glory days.”
Under these conditions, Swartz said, it’s unlikely Kohl’s can achieve 7-8% operating margin by 2023. Those numbers, both for Kohl’s and other department stores, peaked around the time Amazon started gaining market share in apparel. Swartz said it’s no coincidence. In 2019, Amazon surpassed Walmart as the largest apparel retailer in the U.S., according to Coresight Research.
Meanwhile, activist investors point fingers at Kohl’s board for allowing operating income and margin to decline in the first place. From 2011 to 2019, operating margin fell from 11.5% to 6.1%.
“The investor group is perplexed as to why a 6.1% operating margin was tolerated in 2019,” they said. “ …Where was the urgency back then, and why has it taken the board so long to oversee the construction of a plan to achieve improved margins?”
Kohl’s 2021 outlook, which includes 4.5% to 5% operating margin, barely measures up to 2019, which was an underperforming year in its own right with earnings down 13.7%.
There’s hope for Kohl’s earnings power, the group says, but under the leadership of a board with “more relevant retail expertise.”
The group’s slate of five nominees would replace what it says are the “least qualified” incumbent directors, including two Milwaukee-based execs: John Schlifske, chairman, president and CEO of Northwestern Mutual, and Jonas Prising, chairman and CEO of ManpowerGroup.
Kohl’s argues its current director slate “outmatches” the activist investors’ nominees in relevant experience, with backgrounds in retail, consumer-facing industries, technology, and investment and capital allocation. Four directors are current or former retail CEOs.
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A rendering of a front-of-store sephora shop planned for hundreds of Kohl’s locations.[/caption]
Up to the challenge?
Ironically, Amazon has helped play a role in Kohl’s fight to stay relevant and draw customers. In July 2019, Kohl’s launched its Amazon returns program, a service that allows customers to bring in their unwanted Amazon items, and Kohl’s will package and ship them, free of charge. The company hasn’t offered many details about the program’s impact thus far, but Gass said it drove at least 2 million new customers in 2020, a third of which were millennials.
The activist investor group is skeptical. The program has increased general expenses, with little to no revenue return. It could be years before seeing a benefit to the bottom line, even though the program has been advertised as “accretive today,” the group said.
The Amazon partnership was a pivotal step in Kohl’s ongoing shift from brick and mortar to omnichannel, a model that combines the traditional in-store shopping experience with modern-day e-commerce.
Since 2010, Kohl’s has invested hundreds of millions of dollars into an entirely new side of its business, including Kohls.com, its mobile app and fulfillment network of five new e-commerce fulfillment centers, in California, Maryland, Texas, Indiana and Ohio.
Stores have evolved into fulfillment “hubs,” where shoppers can pick up online purchases and shipments, and return Amazon items, at no additional cost. When Kohl’s was forced to close its entire store footprint for weeks amid the pandemic, it added free curbside pick-up to its stores’ omnichannel capabilities. Last year, stores fulfilled more than 40% of digital sales.
Not only are these programs convenient for customers, but they also drive store traffic, cut shipping costs and help manage inventory.
“What this means, going from brick and mortar to omnichannel, is that we actually see it being more beneficial than being just a digital business,” said Johnson.
Omni-channel customers are six times “more
productive,” or generating higher revenue per purchaser, than a digital-only customer and four times more productive than a store-only customer.
“When we get that customer who understands how to shop with us both in stores and online, they’re extremely loyal, they are extremely productive and it’s better for our business both ways,” said Johnson.
But the shift to digital has been one of Kohl’s greatest challenges, said Johnson.
“The current version of Kohl’s is motivated by challenges,” she said. “We like a good problem.”
The retailer expects to maintain 40% digital sales penetration over the next two years and anticipates that number may even dip later in 2021 as COVID-19 vaccination increases and shoppers who have been stuck at home for a year eagerly return to stores. Kohl’s is looking to capitalize on that pent-up demand.
“With so much time spent in their homes, working from home, etc., there will be a lot of opportunity for customers not only to be shopping in stores, but buying the kinds of things we sell, notably apparel, footwear, soon to be beauty, as they return to normal life, going to have to work, traveling, and the like,” said Gass during the company’s fourth quarter earnings call.
Location strategy
The relationship between Kohl’s digital and physical business is symbiotic. Digital sales are 10% higher in markets with stores. When the company closed 18 stores in 2016, web traffic in those markets took a hit.
Real estate strategy has a lot to do with Kohl’s ability to keep its stores productive, even amid pandemic-related disruption, said Ross Koepsel, principal at Milwaukee-based Founders 3 Real Estate Services.
Embarking on a nationwide expansion in the 1990s, Kohl’s sharpened its competitive edge by opening stand-alone stores strategically in suburban neighborhoods. Today, 95% of Kohl’s stores are located off-mall, which sets it apart from department stores like Macy’s and J.C. Penney – both have about 10 times as many mall-based locations as Kohl’s, according to Morningstar.
“When you don’t limit yourself to just mall locations, you have a much greater reach, put yourself closer to where your customers are and give them greater opportunities to shop your store,” said Koepsel.
Kohl’s says 80% of Americans live within 15 miles of one of its stores. And many locations are positioned around off-mall retailers with higher foot traffic, such as Target or Walmart. In southeastern Wisconsin, Kohl’s has 20 stores and 5,000 employees, with a total of 42 stores and nearly 7,000 employees across the state.
“Online, off-price (TJ Maxx, Ross Dress for Less, Burlington), and off-mall is what is winning in retail today,” said Mark Altschwager, senior research analyst at Baird. “As more millennials start families and move to the suburbs, Kohl’s value and convenience can become increasingly relevant to a new generation of shoppers.”
Another advantage for Kohl’s is ownership of 409 store locations, according to its 2020 10-K annual report.
“Owning their own real estate increases the viability of Kohl’s as a company and their value to shareholders,” said Koepsel. “It insulates them from some of the ups and downs that come with retailing and allows them to have more control over what they’re doing.”
That includes reducing store square footage to make way for complementary users, such as Planet Fitness and Aldi – other experimental partnerships masterminded by Gass – and ground leasing underutilized portions of its property to other retail business.
From a local perspective, Kohl’s has offered consistency during an era of big-box vacancies and retail turnover. In Glendale, the store-owned property saw the decline of Bayshore as a regional mall and, more recently, its rise as a modernized town center.
“During the entire Bayshore redesign, we incorporated the fact that Kohl’s would remain, so everything was designed and built around it,” said Mayor Bryan Kennedy of Glendale. “Kohl’s is very much an integral part of Bayshore. It’s part of what drives traffic to the area.”
Soon, Bayshore will gain a second anchor in Target, which is opening in the former Boston Store space adjacent to Kohl’s.
Another complaint of activist investors is Kohl’s board has “failed to capitalize” on its real estate assets and proposed a large-scale sale-leaseback transaction in order to create shareholder value. The company has repeatedly shot down the suggestion, citing inefficiency as well as bond indenture restrictions.
Koepsel said the argument is short-term versus long-term. While selling and leasing back its properties would immediately generate an influx of capital, Kohl’s is taking a long-term approach, eying the benefits of real estate ownership 10 or 20 years down the road, he said.
At odds
Throughout the proxy fight, Kohl’s management has touted its long-term approach as what’s best for shareholders and the future of the company, while painting the activists’ campaign as invasive, risky and short term. In March, the activist investor group reduced its director nominations from nine to five, claiming the purpose of its campaign is to assemble the “strongest possible” board of experienced leaders and shareholder advocates. The cohort is known for its role in the turnaround of Bed, Bath & Beyond in 2019.
The fate of Kohl’s current board rests now in the hands the company’s shareholders, who will vote at the annual meeting on May 12. If all five activist nominees were elected, they would represent a minority of the entire board, which means that the group’s proposed plans may not be implemented. Nevertheless, it would be an “important step in the right direction,” the group said.
Kohl’s stock price has shot up roughly 200% since November, which Swartz said, will likely deter shareholders from siding with the activists.
“It kind of undermines the whole idea that some big change is necessary,” he said.
