Go Small or Go Home? Retailers Turning to Downsized Stores for Growth

Retailers are facing some challenges as shopping patterns change and sales dollars move online.

Younger shoppers in particular are more inclined to look for good value in their shopping experience. Leaders such as Wal-Mart and Target, together with well-known department stores like Macy's(M -2.68%) and J.C. Penney (JCPN.Q), have had to employ creative solutions to reach this youthful consumer base and other new markets

On this video segment, Fool analysts Vincent Shen and Sean O'Reilly discuss these solutions and how these players will drive growth over the following years.

A full transcript follows the video.

This video was recorded on Nov. 10, 2015.

Sean O'Reilly: So taking a step back and just give our listeners some perspective. I've been a Fool for two years now and one of the first major stories that Mark Reeth and I used to cover when we did a consumer goods-based show back in the day, was J.C. Penney.

This is when they were in some serious trouble. This was late 2013, early 2014, I mean it was like, "Are they going to survive the holidays?" Actually that Christmas, Christmas 2013, they had to issue a bunch of stock for cash in order to have cash for inventory purchases and stuff for the holidays. I mean, it was getting tight.

Vincent Shen: Very dire straights, I'm sure.

O'Reilly: And so, of course, they announced a bunch of store closures. I mean, they were going to close, I think 92 give or take two or three stores in 2014. But the interesting story of the last few years and the two, bringing it back around, the two major stories that we've seen with department stores is not only has J.C. Penney -- the most troubled department store -- been closing stores. But the strongest player here, arguably -- Macy's -- has been closing stores too. Everybody has been trying these store concepts. So what's been going on with these four department stores in light of these facts?

Shen: Sure. So like you mentioned, the store closings of J.C. Penney's, especially during that -- when they're still on the downward rung -- essentially, it was pretty bad. The past year, they announced they were going to be closing about 40 locations in its weaker locations, the weaker stores, pretty much.

O'Reilly: Well -- and this was the joke -- again, harkening back to two years ago, so good luck finding that on YouTube. But it was like, I remember I lived in Indianapolis for a time, and they were closing a J.C. Penney store in some farm town in Indiana, two hours [away], and I was like, "Why was this ever here in the first place?" But anyway.

Shen: Well, actually, the interesting thing is, some of the steps that they're taking, that these stores are taking that we'll talk about in a few minutes here, kind of addresses the potential that they see in smaller markets.

So J.C. Penney closing 40 stores, I'm sure they're going to end up closing more too as these leases expire. They're going to look at which locations are performing well, not performing well, and obviously, I think overall that's just part of their turnaround.

O'Reilly: Keep the major open ones.

Shen: For Macy's, they also announced they'd be closing about 35 to 40 underperforming locations. And the big thing here is they actually mentioned that though they're closing [what] represents about 5% of their total store base, it only represents about 1% of the revenue.

O'Reilly: That's just under 1,000.

Shen: So that gives you an idea how poorly ...

O'Reilly: Automatic win. Automatic win.

Shen: Exactly. So again, I think the stocks actually traded down a little bit on the Macy's news, but overall, investors should really keep in mind that this is basically the management team cleaning house here and trying to shore up their operations into their strongest sources, which makes perfect sense to me.

Overall, with those store closings that we just discussed, that is also shifting with some openings too. But the thing is, they're not opening their typical anchor stores in malls. They're shifting to a lot, and this is a trend that we're going to see among many of the bigger retailers, toward these off-price, more discount-based pricing and smaller footprint stores.

So Macy's announced they're going to have their Backstage. It's Macy's Backstage. And then we also have Nordstrom Rack, Off Fifth by Saks Fifth Avenue.

O'Reilly: Which has been hugely successful -- Nordstrom Rack.

Shen: And also Neiman Marcus Last Call, Kohl's is also doing ...

O'Reilly: Is that a bar?

Shen: So Kohl's is also doing something similar, and the main theme here is smaller footprint. And what that means is, again, they can avoid the shopping malls -- a lot of which are struggling overall, unless you're in the top-tier, targeting the top-tier of wealthier customers and shoppers -- and so that they can basically target urban areas where you can have, a smaller store can fit basically into the general spaces that are available in those kinds of areas.

They also target smaller markets where, OK, we don't have to open this massive store. We can open something maybe 50% the size, and that can be sustained by a smaller city or town, for example, that you mentioned like that small one in Indiana. So this is a big push from them. And in general, the retail sector is seeing a trend for shoppers who are looking for value offerings -- so, companies like TJX and Kohl's.

O'Reilly: That have not been struggling.

Shen: They have not been closing locations. They had a few rougher quarters as well ...

O'Reilly: Well, I was actually referring to a Ross and TJ Maxx. Those stores are killing it. I mean they've had a great five, six years. The other thing that I wanted to add some color on was the smaller format store-within-a-store concepts that these guys have been doing.

And we can obviously talk about this a little bit later and everything, but they're trying to make the best use possible of their giant stores that remain by having the store within a store. That way you have a reason to go in there. And the best example of this is J.C. Penney's relationship with Sephora.

Their former chairman and CEO actually got his start at, the owner of Sephora, which is, oh shoot, what is it? The French company.

Shen: I do not recall. [It's LVMH Moet Hennessy Louis Vuitton, aka LVMH.]

O'Reilly: Anyway, yeah. But the owner of Sephora, they have this relationship with J.C. Penney, and that's why there's Sephora in there. That's regularly highlighted in J.C. Penney's quarterly conference calls like, "Our Sephora store-within-a-store concept..."

Shen: Well yeah, that's drawing the customers in through the door, and guess what? When they're there, they're going to do other shopping in other departments, and it's been a huge boon for them.

O'Reilly: Evil scheme.

Shen: So going back to the, some of the smaller kind of discount store concepts that these retailers are launching into, this is something that's leaked through to a lot of the, I feel, the retail sectors.

So for example, Wal-Mart, Target [are] doing the same thing. They're trying to open smaller locations in the cities to attract -- everybody wants to attract millennial, younger shoppers who are looking for good value and more discount merchandise. And again, this also applies to Whole Foods. They have their 365 concept.

O'Reilly: Which I can't wait to visit.

Shen: Which they are experimenting with now, and the whole point of that is that it's the Whole Foods 365 brand, so lower prices to, again, appeal to younger shoppers and people who are in these urban areas where they can't potentially launch a full-size Whole Foods in every city.