Three years ago, J.C. Penney (OTC:JCPN.Q) made a surprising decision to reenter the appliance market after more than three decades on the sidelines. Then-CEO Marvin Ellison was searching for ways to drive more traffic to JCPenney stores and diversify away from the highly weather-sensitive apparel business. The company seemed to have a brief window of opportunity to make a name for itself in the major appliance business, as customers were rapidly abandoning longtime appliance market leader Sears Holdings.
However, the appliance experiment didn't work out as well as Ellison had hoped. Now, new CEO Jill Soltau has decided to exit the business again as she tries to turn around the struggling department-store chain.
Appliances: The good, the bad, and the ugly
J.C. Penney's move into the appliance market wasn't a complete bust. Between early 2016 and mid-2017, the company added appliance showrooms to about 600 stores. This enabled it to seize a roughly 1% share of the U.S. appliance market -- and drove a big increase in J.C. Penney's home department sales, which rose from 12% of the company's total sales in fiscal 2015 to 15% in fiscal 2017.
Yet a challenging aspect of the appliance business is that margins tend to be low. J.C. Penney's efforts to lure shoppers away from Sears by offering promotional pricing added to the gross margin pressure. The appliance sections didn't produce nearly enough incremental sales to make up for the negative impact they had on the company's gross margin.
To make matters worse, J.C. Penney's appliance sales started to decline a few quarters ago, even as Sears accelerated its rate of store closures. The declines appear to have come after the company pulled back on discounting in an effort to shore up its profitability.
The underlying problem is the cutthroat nature of the appliance business. Lowe's, The Home Depot, and Best Buy have come to dominate the market in recent years as Sears has lost share. Discounters like Costco Wholesale have added to the pressure on pricing. J.C. Penney may have had an opportunity to carve out a profitable niche for itself, but only by being aggressive on discounting and marketing for several years -- a strategy that would have led to sizable near-term losses. J.C. Penney simply doesn't have the financial strength to make that kind of investment.
J.C. Penney reverses course
Even before Jill Soltau was hired as CEO last October, J.C. Penney's leaders seemed to be wavering in their commitment to the appliance business. Thus, the company's recent decision to exit the appliance market was hardly surprising.
According to J.C. Penney's recent announcement, the department store chain will stop selling major appliances as of Feb. 28. It will also stop selling furniture in its stores, except for a few locations in Puerto Rico. (Furniture will still be sold online through jcp.com.) However, the company will continue to sell mattresses in more than 450 stores and online.
J.C. Penney indicated that the financial performance of its appliance and furniture departments was the main driver of its decision to scale back its efforts in the latter market and exit the former entirely. The company added:
While configurations vary by store, we are finalizing new layout options, including the reduction of store space previously dedicated to appliance and furniture showrooms to maximize efficiencies, reduce inventory and create an enhanced shopping experience that inspires repeat shopping trips. Optimizing the allocation of store space will enable us to prioritize and focus on the Company's legacy strengths in apparel and soft home furnishings, which represent higher margin opportunities.
One more reason to shrink the stores
Given the extent of J.C. Penney's recent struggles, focusing on its strongest categories makes sense. That said, some parts of its announcement don't add up. Most notably, it's not clear how exiting the appliance market will help J.C. Penney reduce inventory, since the company never carried any appliance inventory other than floor models. Increasing the space allocated to clothing or soft home items would tend to promote higher inventory levels, all else equal.
Indeed, J.C. Penney's management has indicated recently that its ideal store size is 70,000 to 90,000 square feet. Most of its stores are dramatically larger than that. Thus, a typical JCPenney store already has more than enough space for the company's apparel and soft home offerings.
As a result, it is more important than ever for J.C. Penney to tackle the thorny question of how to shrink its stores to a more appropriate size. There's no easy answer, as the company doesn't have the capital it would take to subdivide its stores en masse.
In the short term, J.C. Penney may have to consider other uses for its space. For example, it could expand the toy and baby sections it has added to its stores over the past couple of years if they have been successful. (Those merchandise categories appeal directly to J.C. Penney's core target audience of moms.) We'll learn more about the company's plans on its earnings call at the end of this month.
Check out the latest J.C. Penney earnings call transcript.