Two years ago, department store giant Macy's (M -7.72%) decided to explore the possibility of creating a Macy's off-price business. After years of market share losses to off-price retailers like TJX Companies (TJX 0.58%), it made sense for Macy's to try moving into this growing segment of the retail market.

The first six Macy's Backstage pilot stores opened in the New York metro area during fall 2015. During 2016, Macy's further developed its off-price business by opening a handful of Backstage off-price stores within existing Macy's locations. The company has been particularly pleased with the economics of the store-within-a-store concept.

Exterior of Macy's store advertising Macy's Backstage.

Macy's has started adding Backstage off-price stores to some of its full-line locations. Image source: Author.

I visited one of the stores-within-a-store -- at the Galleria in White Plains, New York -- on New Year's Eve. What I saw suggested that adding Backstage off-price sections to Macy's full-line stores could be a profitable strategy in many cases.

What's in the store?

Plus size ladies' department in Macy's Backstage

There was plenty of apparel to be found at the Macy's Backstage store. Image source: Author.

One of the biggest risks of putting an off-price store within a full-line location is that it could cannibalize sales from the rest of the store. Why would customers pay full price when they can find the same items for less in a different part of the store? (TJX has had great success marketing T.J. Maxx and Marshalls as offering department store-type merchandise for 20%-60% less.)

There were plenty of racks of clothing in the Macy's Backstage store. As a result, the full-price and off-price sections of this Macy's store are competing with one another to some extent.

On the other hand, Macy's management has emphasized that the Backstage stores also carry a lot of merchandise that wouldn't be found in a typical Macy's. Toys and home decor have been two particularly successful non-traditional merchandise categories.

Kids' toy department inside of a Macy Backstage store

Macy's Backstage stores sell toys and other items that regular Macy's stores don't offer. Image source: Author.

Based on the overall merchandise selection and store configuration, the Macy's Backstage store looked eerily similar to a Marshalls store I visited later the same day.

Some deals are better than others

There was a wide range in the amount that items were marked down at the Macy's Backstage location I visited. Two pairs of pants on the same clothing rack illustrate the range of discounts.

The first pair of pants was priced at $19.99 compared to a $36 MSRP: a modest 44% discount. The other pair was marked down to $9.98 from a $59.50 MSRP and had a yellow "buy one get one free" tag. This meant it was effectively selling for more than 90% off.

Close-up of price tags on two pairs of pants

Some Macy's Backstage merchandise is deeply discounted. Image source: Author.

Even moderately discounted merchandise could make Macy's Backstage an attractive option for many shoppers. For customers, part of the appeal of TJX's business model is that there are good deals available no matter when you shop. By contrast, Macy's full-line stores tend to rely on coupons, a steady stream of "one-day sales," and other promotions to drive customer traffic.

If there aren't good deals available in the Macy's full-line store on a given day, the availability of 40%-50% discounts in the Macy's Backstage could keep customers from walking out and going to T.J. Maxx or Marshalls instead.

Better sales productivity

Furniture department of a Macy's Backstage store

The furniture section of the full-line store looked like a ghost town when I visited. Image source: Author.

The main level of the White Plains Macy's store was fairly busy when I visited. That part of the store features the jewelry and beauty sections and most of the men's and women's apparel. By contrast, the home section on the lower level was nearly deserted.

The Macy's Backstage store occupies perhaps a quarter to a third of the lower level. Given the lack of traffic in the surrounding home department, the Backstage store doesn't have to meet a very high bar to be a better use of space. Macy's management has indicated that, on average, adding a Backstage store to a full-line Macy's increases the sales for that location.

Sure enough, the White Plains Macy's Backstage was quite busy. It was a fairly dramatic contrast with the rest of the lower level. The first floor location has the secondary benefit of providing an exterior entrance from Main St. directly to the Macy's Backstage store, which is prominently advertised on the street outside.

Interior of a Macy's Backstage store

There were plenty of shoppers at Macy's Backstage on New Year's Eve. Image source: Author.

Macy's Backstage seems promising

At this point, the Macy's Backstage store-within-a-store concept is less than a year old. Clearly, Macy's is still within the test-and-learn stage. However, based on my visit to the new Backstage store in White Plains, New York, this concept looks very promising.

Macy's full-line stores already rely on coupons and discounts to drive customer traffic. Very little merchandise is sold at full price. Thus, investors may be exaggerating the downside risk of Macy's Backstage cannibalizing full-price sales.

Meanwhile, with mall traffic on the decline, most Macy's stores have more space than they really need. Installing a Macy's Backstage store could significantly improve the sales productivity of these locations, leading to higher overall profitability.