Macy's needs to be 'extremely careful' about this

Cheap is chic, and that isn't changing anytime soon.

So after major department stores from Saks to Nordstrom—even the ultra high-end Neiman Marcus—have built out their square footage in the off-price sector, it makes sense that Macy's would eventually consider the idea.

But as the retailer begins ironing out the details for its pilot off-price locations—which it began sharing with investors in a call Tuesday—the company faces a set of headwinds that its competitors didn't have to grapple with.

People shop in Macy's department store in New York.
Stan Honda | AFP | Getty Images
People shop in Macy's department store in New York.

Among them, what would an off-price unit look like for a retailer that's already ubiquitous for promotions and moderate price tags? Will there be enough of product and pricing differentiation between the two businesses to avoid brand degradation—something for which Coach is often criticized?

What's more, is Macy's too late to the game, as it faces competitors that have already taken a huge bite out of the market?

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"The traditional bricks-and-mortar retailer has to be extremely careful not to tarnish the brand," said Antony Karabus, CEO of HRC Advisory firm.

Even as consumers start to feel more financially stable, the off-price retail market has shown no signs of slowdown. According to Customer Growth Partners, the category's sales are growing at more than twice the speed of the overall apparel market, ringing in about $38 billion each year.

While that spells opportunity for new entrants into the category, the competition isn't abating. TJX recently said it sees potential to grow from nearly 3,400 stores to 5,150 locations long term. On its earnings call Wednesday, it boosted that figure to 5,475. Among the department store set, Nordstrom plans to nearly double its store count to 300 by 2020.

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"Obviously there's always challenges in starting a new business, and particularly one where there's very successful competitors," CFO Karen Hoguet said on a call with investors. "But our team thinks they have the opportunity to compete quite effectively against these players."

Hoguet said the company views off-price as an opportunity to bring a new customer into Macy's, similar to when it launched outlet stores for its higher-end Bloomingdale's concept. At first the company was concerned that those outlets would cannibalize sales at its full-line shops, but "what we found is it served as an entry point for the customer."

"Instead of taking business away from the base Bloomingdale's store, we actually brought new customers," she said.

Nordstrom has cited similar findings from the expansion of its off-price Rack business, saying in its most recent earnings call that one-third of its Rack shoppers also visit its full-price locations.

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Although Hoguet was mum on many of the details regarding Macy's pilot locations, she said they would operate in a manner similar to traditional off-price stores. That way, they wouldn't directly compete with the company's 13 Bloomingdale's outlets.

She added that the firm plans to build out its Bloomingdale's outlet business, though the company declined to share additional details or sales figures for the unit after the call.

As for Macy's test locations, there are still a number of kinks to work out, notwithstanding the role of digital. Before greenlighting a full-fledged expansion into off-price, Hoguet said, "We'll let the customer vote and see what she says."

"[Macy's] does a fantastic job of testing new initiatives before broadly rolling out new strategies/processes," Morgan Stanley analyst Kimberly Greenberger wrote in a note to investors on Wednesday. "This leaves us quite confident [it] will only pursue profitable new avenues of growth, a key differentiator, in our opinion."

Still, investors responded with hesitation toward Macy's new initiatives and outlook for the new year, sending shares down about 3 percent on Tuesday; however, the stock regained some ground Wednesday, trading up nearly 2 percent.

"We believe the changes the company has made to its structure and leadership all make sense, as does the idea of trying to find new ways to drive sales growth," Wells Fargo analyst Paul Lejuez wrote in a note to clients on Tuesday.

"For investors, the issue may be that the timing on building new growth vehicles is not likely to be quick..., the environment remains highly challenging, and the heightened level of investment is not likely to generate the same level of returns as it has in the past."

Macy's said in its earnings release Tuesday that it expects capital expenditures for 2015 to increase to $1.2 billion from $1.07 billion last year, reflecting new investment in growth initiatives.