Fool on the Street: The Secret of Kohl's Success

Fundamentally, retailing is about merchandising, and companies that sell goods that customers find appealing tend to do quite well. Of course, there are many ways to slice and dice product selection; almighty Wal-Mart (NYSE: WMT) focuses on price, while Nordstrom (NYSE: JWN) and Neiman Marcus target consumers more interested in fashion than cost.

Off-mall department store operator Kohl's (NYSE: KSS) tends to fit somewhere in the middle, so while its primary focus is "to differentiate through really high recognizable brands," shoppers undoubtedly like that it is an affordable shopping destination, which comes in especially handy when shopping for an entire family. And its retailing success has carried over well into investing, as shareholders have been duly rewarded by Kohl's apparel savvy and ambitious store expansion philosophy. A presentation at last week's Bank of America Annual Investor Conference by President Kevin Mansell allowed the company to fill the investment community in on current ambitions and past secrets to its success.

Highly recognizable brands
One of Kohl's first forays into partnering to develop an exclusive national brand was the 2004 launch of a Daisy Fuentes line of clothing and related accessories. The brand initially accounted for less than 1% of total company sales, but Mansell stated that "we're now running at about 9% of our total sales behind exclusive national brands," meaning the initiative is starting to make a meaningful impact on Kohl's top line.

Two recent endeavors include Simply Vera Wang, in cooperation with wedding-fashion icon Vera Wang, and a just-launched partnership with Food Network in the housewares division. Mansell also cited an existing deal with Elle magazine and the creation of a New York design office to "give us better proximity to our resources."

Mansell also touched on delivering "superior value" in the company's exclusive brand focus, which boils down to selling customers quality, fashionable goods. Quality comes from controlling production and making sure the right suppliers are chosen, and fashion is enhanced by not only finding popular styles, but reducing cycle times and best ensuring that products make it to store shelves as quickly as a fashion trend is discovered. Kohl's mentioned it has reduced cycle times somewhere between 30 and 60 days across its entire business.

Cross-selling
Kohl's has had an impressive run of same-store sales increases and years of rapid growth via new-store expansion. But even the most storied retailer eventually succumbs to a fashion faux pas or two, and at some point down the road, Kohl's will saturate the domestic market with its freestanding or strip-mall-based department stores. Thus, it has identified a "cross-shopping opportunity" by which it is looking to improve the penetration of its traditional customer base.

Mansell estimates that average transaction size runs about $50 at Kohl's, and that the average shopper hits Kohl's five to six times per year. Furthermore, "those transactions occur with purchases in only one of our six major lines of business," which includes the men's, women's, and children's clothing sections; footwear; home; and accessories. So what better way to double or triple transaction size than by finding ways to entice consumers into multiple business lines?

Moves to drive cross-selling include expanding brands "across the whole store," such as selling Simply Vera Wang in the women's and home sections, for instance. A partnership with Ralph Lauren (NYSE: RL) to sell the Chaps brand already spans the men's and women's sections, and there are plans to expand outside of "just Missy sportswear" and into the plus-size business. Marketing also constitutes an important ingredient in making shoppers aware of the brand breadth and encouraging them to hit other areas of the store.  

Other opportunities
Co-developing brands has proven quite lucrative at Kohl's, but it also pursues its own private-label brands, which tend to carry even higher profit margins, as well as the sale of outside brands such as Nike (NYSE: NKE) and a recent launch of the Tony Hawk brand, also in the footwear business.

We already touched on inventory management in reducing cycle times, and Mansell talked of moves for "improving allocations and receipt flows" and striking the right inventory balance among stores. There is also a regional focus on product management to account for differences among climate and consumer tastes across the country.

The Foolish bottom line
When it works, retailing appears straightforward, and Kohl's success may appear little more than a common-sense approach to selling what consumers demand. But if it were that easy, firms such as Bakers Footwear (Nasdaq: BKRS), and Sears (Nasdaq: SHLD) could improve their fortunes by emulating the strategies of peers that aren't currently as top-line challenged. If they want to copy Kohl's, they'd better get started soon. Kohl's is well on its way to locking up the most appealing partners in the fashion industry and a potentially defensible competitive advantage in the mostly undifferentiated retail industry.  

For related Foolishness:

• Last month we questioned if Kohl's was cool.
• And second-quarter results revealed that hot is the new cool.