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Why Macy's Is Closing Even Profitable Stores

By Jeremy Bowman – Updated Jan 24, 2017 at 4:02PM

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The venerable department store is shutting down 100 stores even though they still make money. Here's why.

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It's no secret that department stores are having a rough time these days. Comparable sales over the holiday season fell at nearly every major chain, and total sales at department stores dropped 5.6% last year, according to the Census Bureau. 

Macy's (M -1.45%) may be the poster child for this declining industry. The company is more than 100 years old, and it has flagship stores in the downtown areas of major cities across the country. It's as synonymous with shopping as any other store.

It has, however, posted declining comparable sales for the last seven quarters in a row, and it's on its way to its eighth straight drop. Like its peers, Macy's has been squeezed by e-commerce competitors like on one side and fast-fashion purveyors like H&M and Uniqlo on the other. 

As part of its restructuring strategy, Macy's announced last year that it would shut down 100 stores, and it recently named 68 of them, saying it would lay off 10,000 employees in the process.

However, incoming CEO Jeff Gennette revealed an interesting fact about the store closures when he said that the stores the company is closing are still profitable. Gennette explained the reasoning:

Nearly all of the stores to be closed are cash flow positive today, but their volume and profitability in most cases have been declining steadily in recent years. We recognize that these locations do not yield an adequate return on investment and often do not represent a customer shopping experience that reflects our aspirations for the Macy's brand. We decided to close a larger number of stores proactively so we can invest in a winning customer experience in our most productive and highest-potential locations, as well as invest in growth sooner and more aggressively in digital and mobile. 

As much of the apparel retail industry is seeing, in-store sales are moving online and store traffic dwindling. Even J.C. Penney (JCPN.Q), which remains among the weakest department store chains years after Ron Johnson's gutting of the business, said all but four of its stores are profitable, though it is considering closing stores.   

Profitability is not the issue. The trend is. 

Playing defense

Macy's move underscores the fact that these businesses remain substantially profitable, but are in retreat as times change. In most industries, a company would attempt to turn around a store with declining volume that was still profitable, but the major department store chains recognize that these shifts are structural as declining retail traffic is not going away. 

Macy's also believes that not all of those stores' sales will be lost as some move to other stores and others go online. 

But these actions underscore the department stores' biggest problem. This retail format is more than a century-old and came to a rise to give customers a convenient place to shop for items ranging from apparel to jewelry to home goods to gifts. The central purpose department stores served in the pre-internet days is no longer necessary as all of those items can be purchased online or in specialty stores where customers might get better service or better-curated selection.

What it means for retail

While Macy's and other department store chains are seeing e-commerce sales grow by double digits, they are at a disadvantage against another subset of brick-and-mortar retail. The brands of Macy's and other department store chains are directly tied to the brick-and-mortar real estate and the in-store experience since Macy's brand is not associated with an actual product. Competitors like Michael KorsL Brands' (BBWI 3.67%) Victoria's Secret, or Lululemon therefore have an advantage as their brand value stems from products rather than stores. That may explain why those types of retailers have fared better in the e-commerce era as they've been able to rapidly build online sales. Victoria's Secret now derives more than 20% of its revenue online, partly as a result of its vibrant catalog business. 

Macy's plans to open more off-price Backstage stores within its department stores as well as BlueMercury beauty outlets to help drive traffic. But as it waves the white flag on even profitable stores, it seems like the tide is inevitably turning against the department store concept as a whole.

Jeremy Bowman owns shares of J.C. Penney. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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