Going against the wishes of investors is always risky. Doing so and failing can tank investors’ faith in a company and cut off crucial funding, but sometimes, it can be the difference between growth and stagnation.
Macy’s (NYSE: M) is making that gamble. Last week, the evergreen department store, which has managed to stay in business for over a century and a half, elected not to spin off its e-commerce operation from its core brick-and-mortar business, despite pressure from one of its new stakeholders, Jana Partners.
Macy’s decision stands in stark contrast to another department store, Saks Fifth Avenue, which separated its e-commerce business from its physical stores last year, splitting up its omnichannel strategy into the online-only Saks and the brick-and-mortar brand SFA at the behest of parent company Hudson’s Bay Co.
Insight Partners, a venture capital firm, took a $500 million stake in the new digital brand, and reports hint at a potential IPO that could value the e-commerce spinoff at $6 billion.
Kohl’s (NYSE: KSS) is yet another department store facing the same pressures from investors, with new stakeholder Engine Capital urging the company to follow in Saks Fifth Avenue’s footsteps. But should Kohl’s and other department stores go that direction, or should they follow the path of Macy’s?
Why the split?
For many companies, e-commerce has been a revelation as a growth driver in the era of pandemics and quick commerce. So why break up a good thing? According to David Latona, CEO of supply chain services firm Tompkins Solutions, it’s all about the money.
“I think they’re trying to disconnect the two to show higher profits on their e-commerce site, without letting the retail brick-and-mortar drag the percentages on the overall EBITDA [earnings before interest, taxes, depreciation and amortization] down,” Latona told Modern Shipper. “I don’t see any real benefits to it. I see a lot of additional costs, and I see inventory management issues. But I don’t see any other benefits.”
In the case of Saks, the value is clear. Marc Metrick, formerly CEO and president of the combined Saks Fifth Avenue business and now CEO of the Saks e-commerce brand, told the Associated Press that the digital-only company “can grow bigger much faster” because it puts the company’s privately held digital assets –– which bring in about $1 billion in revenue annually –– on the public market.
In the case of Macy’s, investors noted that the company’s e-commerce operation, which is valued at nearly $8.5 billion, could be worth up to $14 billion as a stand-alone business. Similarly, Kohl’s, whose total valuation is about $7.3 billion, has been told by investors that its e-commerce brand could be valued at nearly $12.4 billion on its own.
The cost of doing business
From Latona’s viewpoint, spinning off e-commerce operations from brick-and-mortar businesses would undo the years of work spent trying to unify the two.
“Everybody has been trying very, very hard to homogenize their distribution platforms to encompass brick-and-mortar as well as e-commerce. From a software perspective, from a hardware or physical distribution perspective, everyone’s been trying to sew them together so that they didn’t have as many difficulties balancing their inventory with their customers’ needs across the country,” he explained. “So the costs associated with separating them are separate platforms, or they are physically separated within a distribution center, so you have two separate operations.”
That doesn’t mean it’s all been smooth sailing for brick-and-mortar. E-commerce sales for Q2 2020, the first pandemic-affected quarter, made up around 16% of total U.S. retail sales, up from about 11% the previous quarter, signaling a waning emphasis on the physical store.
“Brick-and-mortar stores typically have been in a downward cycle and have a lot more overhead and liabilities attached to them. From a human resources standpoint, from a property management standpoint, there’s a lot of aspects of it,” Latona acknowledged.
Watch: Will return to in-person shopping thwart e-commerce?
But plenty of department stores, Macy’s and Kohl’s included, have found new ways to get the most out of their brick-and-mortar locations. Many are equipping their physical stores with added storage, transportation and sortation capabilities so that they can double as microfulfillment or distribution hubs.
”You’ve got distributed inventory across the country and each one of these stores. So if somebody in Los Angeles wants a certain item from their retail store and it’s not available,” Latona explained, “you can go to the local store and get that item and ship it directly from the store to the individual, versus it having to come from a fulfillment or distribution center.”
In splitting up e-commerce operations from brick-and-mortar, a company like Saks won’t be able to use its physical stores to fulfill online orders in the way that a brand like Macy’s can. And that’s not the only way department stores can lose out on a better customer experience.
“As e-commerce has increased, a lot of the brick-and-mortar stores for these larger retailers have become logistics and returns centers,” Latona said. “And the idea is that you can take anything you buy online back to the store for an easy return.”
The metamorphosis of physical retail has made it so that brands can meet customers wherever they are, enabling them to offer a product at a store in Los Angeles to a customer in New York. Not only that, but customers can return items at any location, with the added benefit for the retailer of creating another channel through which to sell.
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Hudson’s Bay, the owner of Saks and SFA, has said that its brick-and-mortar and e-commerce brands will continue to work together to create a “seamless customer experience.” But the experience behind the scenes may not be so seamless, with two separate supply chains, two distribution networks and two pools of inventory to manage.
Still, it isn’t difficult to understand why separating the two businesses would be attractive to investors. Big-box stores have been closing left and right in recent years –– that includes Macy’s, which continues to cut back on its own number of department store locations.
But the idea that brick-and-mortar is dead is a myth. While many big-box stores are shutting down, brick-and-mortar is taking on new forms, with boutiques and other smaller locations replacing traditional anchor stores in malls and retail outlets.
The new wave of stores has been more than enough to offset the exodus of big-box locations. In fact, according to Forbes, growth in brick-and-mortar sales actually outpaced growth in e-commerce sales in 2021. For a national retailer like Macy’s or Kohl’s, the benefits of having as many physical locations as possible are undeniable.
“You’ve got forward-deployed inventory where the demographics are, where the population already lives,” Latona explained. “And that’s your biggest advantage of maintaining that brick-and-mortar footprint, as well as the reverse logistics of handling returns.”
It remains to be seen whether splitting up e-commerce operations from brick-and-mortar can hold long-term benefits for a company, but there may soon be a litmus test. With Saks aiming for an IPO in the first half of 2022, the new brand’s financials could be a bellwether for other retailers embracing a similar strategy. But if the results are lukewarm, the company may have just undone years of work for pocket change.
“Everyone’s just been trying for so long to put it all together,” Latona emphasized. “I can’t imagine them wanting to pull it apart, except for a fiscal benefit.”
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