Professors Theresa D. Williams and Frank Acito prepared this case for class discussion rather than to illustrate either effective or ineffective handling of an administrative decision. The support of Susan Burns, OVP, Employment Initiatives & College Relations, at Federated Department Stores; Jim Sluzewski, VP of Corporate Communications, at Federated Department Stores; and Jenn Nagaj, Executive Editor, at WetFeet, Inc., is gratefully acknowledged.

Copyright © 2005 by the Center for Retailing, Kelley School of Business, Indiana University. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of The Center for Retailing.

The drawing of the Clock Tower on the cover is by James Stettles: It is from the 1930 Arbutus, courtesy of the Indiana University Archives.

Strategic Reinvention and a Co-Branding Decision: The Federated Department Stores Case - Part A

“In the end, you [need] an idea that grows sales. And that was the thing that drove us.”

—Susan Kronick, Federated vice chair

In May 2003 Federated Department Stores, Inc., co-branded all of its regional headquarters department stores with the historic and nationally recognized Macy’s nameplate, in an effort designed to help Federated build a national brand for its regional stores and boost long-term sales. Such a boost, experts agreed, was needed because the department store sector had been challenged by an overcrowded marketplace in recent times.

THE DEPARTMENT STORE SECTOR DILEMMA

“For department stores, the glory years are over,” explained Lois Huff and Cliona Hooper in a 2000 report for Retail Forward, a consulting and market research firm that specializes in retailing. “The last twenty years have seen the sector struggle in light of new competition, rapid industry consolidation, a pervasive internal focus, and changing shopping patterns.” Moving into the twenty-first century, industry experts had started to see what Lois Huff and Linda Hyde (for Retail Forward) termed the “the department store dilemma”: Even as department stores remained profitable and provided stable earnings streams, eroding market share, propelled by escalating competition, created a vicious cycle department stores had been unable to break. The competition was no longer just from their counterparts; competition from lifestyle-focused specialty retailers (e.g., Urban Outfitters, Sephora, Williams-Sonoma, and L.L. Bean), upgraded discount retailers (e.g., Target), and off-mall moderate promotional stores (e.g., Kohl’s) plagued department stores.

As consumer options expanded, so too did consumer expectations: Shoppers came to expect well-edited assortments and quality goods at more competitive prices. Lois Huff and Julie Campitelli (for Retail Forward) found that only 20% of department store shoppers felt that department stores were “offering more clothing styles or brands that they like[d]” than they had the year before (2002). Huff

Federated Department Stores: Part A 2

and Campitelli also reported that more than 50 percent of shoppers believed that “discount store clothing is just as fashionable as clothing at department or specialty stores.” Meanwhile, as they struggled to compete on price, department stores lowered service levels and discontinued departments, eliminating some of the very areas that once set them apart from mass merchandisers and specialty retailers. While Federated cited changing “customer trends and preferences for self-serve retail environments” as the impetus for these changes in its 1996 Annual Report, Huff and Hyde believed the sector’s response to those customer preferences had been inadequate: “The level of personal service has been reduced and has not been replaced with adequate means to facilitate self-service. And consumers are fed up with having to wander the store looking for a staffed checkout counter.”

At the same time, vendors broadened their distribution, creating additional problems as customers came to see all department store merchandise as the same and as widely available. “In an attempt to be all things to all consumers,” explained Paula Kalandiak for Wells Fargo Securities, “[department] stores tend to offer a broad selection of brands in all product categories, but most of the brands are the same from one department store to the next.” Not only were the same brands often available at different department stores, they could also be found at vendor-specific retail locations, such as Kenneth Cole’s and Ralph Lauren Polo’s stand-alone stores. These factors worked together to give shoppers little reason to go to department stores in the first place. Furthermore, department stores had trouble luring new customers since, as Federated CEO Terry Lundgren put it, they “appeal to a broad cross-section of customers” (as a result of department stores’ “something for everyone” strategy), as opposed to the clear customer targeting that characterized specialty retailers. As large buyers sourcing merchandise from large vendors, department stores found themselves working on old timetables and with limited ability to respond to trends. Indeed, Huff and Hyde argued that “department stores require greater flexibility to respond to customers’ desires,” especially compared to specialty retailers’ ability to react to trends quickly owing to their more targeted sourcing and more direct control over merchandise development.

Perhaps most damaging to the department store sector, however, was (and is) the grip of promotional pricing. Kalandiak observed that “With product offerings so similar, department stores have tried to attract customers by outpromoting one another,” with frequent and highly publicized

sales. “They bombard consumers with coupons, discounts, and one-day sales, training them to shop only when goods are on sale,” explained Huff and Hooper. This practice taught customers to shop sales rather than stores—a habit that further induced stores to use sales to move inventory. “Ongoing reliance on promotional pricing may be driving short-term sales,” said Huff and Hooper, “but it

has destroyed department store pricing credibility.” The irony is that department stores first set themselves apart from other store models both by offering fixed prices, which introduced the notion of pricing credibility on a large scale, and by having advertised promotional sales. The two, it seemed, had come to cancel one another out and, as Kalandiak put it, “conditioned customers to wait for sales”—further damaging prospects for long-term sales growth.

Industry experts also agreed that department stores had lost much of their one-stop appeal and relative convenience. After decades of slowly increasing focus on those items that generated the greatest profits—namely, apparel, women’s accessories, shoes, and cosmetics—the full spectrum of

“Unless someone is willing to step forward and reinvent the department store model, it’s just moving deck chairs around on the Titanic.” —Allan Ellinger, partner, MMG Corp. (an investment bank)

Federated Department Stores: Part A 3

products once available at department stores had evolved to a more focused assortment. Large department stores slowly but surely closed electronics and toy departments, moved home furnishings to stand-alone stores (if they kept them at all), and eliminated most nonretail services. So, when shoppers looked for convenient shopping they turned elsewhere: “There has been a significant shift away from mall-based department stores toward off-the-mall formats,” according to a Lehman Brothers report, “as many consumers move toward the one-stop shopping convenience of mass merchandisers.” Even in those areas where department stores have focused their energies—primarily apparel—“discount stores and specialty apparel retailers continue to steal apparel market share, with no sign of slowing,” as Bill Dreher and Caroline Costin observed (for Deutsche Bank).

Moreover, since most department stores have traditionally been located in shopping malls, Huff and Campitelli pointed out that “the fate of the department store is inextricably linked to the fate of the regional mall,” itself facing limited expansion potential and increased competition from discount centers and upmarket lifestyle centers. Or, as Kalandiak put it, shoppers “have been going to strip centers, which are viewed as easier to shop,” while “department stores are now stuck anchoring regional malls where the traffic is down, yet occupancy costs continue to rise.”

At the same time, department stores had reduced staff at most stores, making many departments essentially self-service and eliminating an element that had previously set them apart from other retail options. Moreover, shopping habits at large had changed. Jason Asaeda (for Standard & Poor’s) defined one shopping trend that it believes is not short-lived, but an “enduring pattern of behavior,” as follows: “Cross shopping is the practice of patronizing stores across the economic spectrum to best meet one’s needs.” The same shopper might buy jeans at Neiman Marcus, for example, but get her underwear at Target. Huff and Campitelli agreed that shoppers no longer target one type of store: “Consumers are increasingly shopping a wide variety of retail channels based on a range of considerations that trigger store choice and purchase decisions.”

THE DEPARTMENT STORE SECTOR’S STRUGGLE FOR GROWTH

The financial record for the department store sector from 1999 to 2003 reflected the issues facing the sector. Even before the general economic downturn associated with the dot-com bust and 9/11, department store sales were not stellar, especially in comparison to the tremendous growth in other retail sectors. According to Huff and Hyde, department stores’ share of total general merchandise, apparel, furnishings, and other sales decreased every year from 1992 to 2001—dropping from 16.3% in 1992 (or $87.4 billion of the $536.9 billion total) to 10.6% in 2001 (or $95.5 billion of the $899.3 billion total). Lehman Brothers asserted that, “While the sluggish economy has negatively impacted retailing in general, we believe there are significant secular issues facing the department store industry, including increased competition from off-the-mall format stores [and] an apparel channel shift away from department stores to discounters and other value-oriented retailers.” In 2003, for example, department store sales declined by 2.7%, while specialty apparel sales increased 3.9% and discount store sales grew 6.4%. According to Chain Store Age magazine, “Department stores also have lost share to specialty apparel retailers that offer narrower but more focused, easier-to-shop, lifestyle-relevant assortments. The growth of specialty stores targeting midlife, up-market women has been particularly problematic for department stores because they precisely target the department store’s traditional core customer.”

Federated Department Stores: Part A 4

Across the sector, sales were generally flat or declining from 1999 to 2003 (Table 1). Kohl’s (discount) and Nordstrom (high-end specialty)—which varied from the traditional department store model—were the only department stores with consistent year-over-year growth.

TABLE 1

Selected Department Stores’ Net Sales, 1999–2003

Net Sales ($B)

Company 1999 2000 2001 2002 2003

Federated Department Stores 16.0 16.6 15.7 15.4 15.3

Kohl’s Corp. 4.6 6.2 7.5 9.1 10.3

May Department Stores 13.6 14.2 13.9 13.5 13.3

Neiman Marcus Group 2.9 2.9 3.0 3.0 3.1

Nordstrom 5.2 5.5 5.6 6.0 6.5

Sears, Roebuck 39.5 40.9 41.0 41.4 41.1 Sources: Company annual reports. Dreher, Bill and Caroline Costin. Federated Department Stores: Blooming with Cash. (Deutsche Bank, August 24, 2004). Lehman Brothers. Federated Department Stores: Is the Snoopy Balloon Full of Cash? February 21, 2003.

TABLE 2

Department Stores’ Share Prices, 1999–2003

Share Prices (High-Low, $)

Company 1999 2000 2001 2002 2003

Federated Department Stores 57.06–36.44 46.06–21.00 49.90–26.05 44.26–23.59 50.60–23.51

Kohl’s Corp. 40.63–28.63 66.50–33.50 72.24–41.95 78.83–44.00 65.44–42.40

May Department Stores 45.38–29.19 33.94–19.19 41.25–27.00 38.86–20.10 30.82–17.81

Neiman Marcus Group 32.00–21.13 39.63–19.38 41.01–23.53 39.80–23.75 55.25–25.90

Nordstrom 44.81–21.69 34.50–14.13 22.97–13.80 26.87–15.06 35.50–15.00

Saks 39.50–14.63 16.25–7.63 14.23–4.60 15.75–8.55 15.81–6.66 Sources: Asaeda, Jason. Retailing: General, industry survey (Standard & Poor’s, May 20, 2004). 2003 figures for Federated, Nordstrom, and Saks from company annual reports.

Similarly, share prices declined for Federated, May, Nordstrom, and Saks, with only Kohl’s and Neiman Marcus trading higher in 2003 than in 1999 (Table 2).

Finally, the five-year compound annual growth rate (CAGR) for department store sales from 2000 to 2004 averaged –0.7%, and only Neiman Marcus and Nordstrom logged positive CAGRs for the period (Table 3).

All of these figures reflected what Kalandiak called “a mature sector with little opportunity for unit expansion.” While department stores continued to make money, overall sales experienced little growth and their traditional market share was eroding as shopping patterns changed, leading experts to agree with Huff and Hyde’s assessment of the sector’s need to find or create new markets.

Within the sector, the results for Federated were mixed. On one hand, things were looking up: After a decade of struggles, Federated’s debt was under control (see Exhibit A) and it owned divisions that operated across the country. Datamonitor recognized Federated as “a leader in the mature U.S. department store industry.” In 1998, Federated dove into e-commerce with Macys.com and the

Federated Department Stores: Part A 5

acquisition of Fingerhut Companies, a leading direct-marketing Internet company in 1999. On the other hand, the e-commerce bubble burst and the Fingerhut acquisition quickly became a very public disappointment, one that wasn’t behind the company until it divested itself of Fingerhut in 2002.1

TABLE 3

Department Stores’ Five-Year Sales Cumulative Average Growth Rate

Company CAGR 2000–2004 (%)

Dillard’s –3.2

Target Group –3.1

Federated Department Stores –2.9

Sears, Roebuck –2.4

J.C. Penney –1.3

Saks –1.2

May Department Stores –0.8

Neiman Marcus Group 3.6

Nordstrom 4.8

Average –0.7 Source: Dreher, Bill and Caroline Costin. Federated Department Stores: Blooming with Cash. (Deutsche Bank, August 24, 2004).

TABLE 4

Department Stores’ Same-Store Sales, 1999–2003

Same-Store Sales (% Change)

Company 1999 2000 2001 2002 2003

Federated Department Stores 4.5 2.0 –5.3 –3.0 –0.9

May Department Stores 0.5 0.0 –4.4 –5.3 –2.8

Kohl’s Corp. 7.9 9.0 6.8 5.3 –1.6

J.C. Penney –1.1 –2.4 3.3 4.3 0.9

Sears, Roebuck 1.8 2.3 –2.3 –5.5 –2.8

Nordstrom –1.1 0.3 –2.9 1.4 4.1

Neiman Marcus Group 11.8 11.8 –4.6 4.1 3.8 Sources: All Federated data from the company. Other 1999–2001 data from Lehman Brothers. Federated Department Stores: Is the Snoopy Balloon Full of Cash? February 21, 2003. Other 2002 data from Kalandiak, Paula. Federated Department Stores, Inc., electronic research report. (Wells Fargo Securities, September 18, 2003). Other 2003 data from Dreher, Bill and Caroline Costin. Federated Department Stores: Blooming with Cash. (Deutsche Bank, August 24, 2004).

Furthermore, sales declined from the year-earlier results in 2001, 2002, and 2003, after a strong showing in 1999 and 2000 (see Table 1). Same-store sales (considered a key indicator because it excludes growth from new stores), which rose in the bustling retail economy of 1999 and 2000, fell in each of the next three years for most department stores (Table 4). Finally, Federated’s CAGR for the period was –2.9% compared to an industry average of –0.7% (see Table 3).

Furthermore, a weak economic climate had an adverse effect on consumer spending for the “soft” products sold at department stores such as home textiles and apparel—as Dreher and Costin noted, “during economic downturns . . . consumers curb their discretionary purchases, particularly on

Federated Department Stores: Part A 6

apparel.” However, Federated boasted a strong cash position at the end of the period. As the Lehman Brothers report pointed out, “Despite sluggish top-line growth, Federated continues to generate significant cash flow,” with cash and equivalents rising every year, from $218 million in 1999 to $925 million in 2003—an increase of more than 400% (see Exhibit C).

A number of factors contributed to Federated’s strong cash position. Federated’s gross margins were among the highest in the industry and actually increased from 2001 to 2003 (Table 5). Operating margins averaged 9.1% over the period, compared to an industry average of about 7.9%—and ticked in at a healthy 8.8% in 2003. Industry experts such as analysts for Lehman Brothers and Citigroup Smith Barney cited Federated’s strong gross and operating margins over the period as one of its strengths.

Earnings per share took a hit in 2001, but closed the period at $3.71 (Table 6). Federated’s 2003 repurchase of 16.5 million shares of stock for $645 million—and 5.7 million more shares for $280 million in 2004—is evidence of the company’s strong cash flow, which can offer financial stability in slower periods or provide the capital required for strategic growth.

TABLE 5

Department Stores’ Gross and Operating Margins (%)

Gross Margin (%)

Company 1999 2000 2001 2002 2003

Federated Department Stores 40.3 40.2 39.1 40.0 40.4

Kohl’s Corp. 33.9 34.1 34.3 34.4 33.0

May Department Stores 32.4 31.1 30.6 29.9 29.7

Nordstrom 34.8 33.6 32.9 33.2 34.6

Sears, Roebuck 35.6 34.8 36.0 38.0 36.2

Operating Margin (%)

Company 1999 2000 2001 2002 2003

Federated Department Stores 10.6 10.2 7.1 8.7 8.8

Kohl’s Corp. 9.7 10.5 11.2 11.8 9.8

May Department Stores 13.3 12.3 10.8 9.5 9.6

Nordstrom 5.2 2.4 2.6 3.2 5.2

Sears, Roebuck 6.1 5.4 2.9 5.0 2.9 Source: Company annual reports.

TABLE 6

Department Stores’ Earnings per Share, 1999–2003

EPS ($) at Fiscal Year End

Company 1999 2000 2001 2002 2003

Federated Department Stores 3.76 4.20 3.03 3.21 3.71

Kohl’s Corp. 0.76 1.09 1.43 1.85 1.69

May Department Stores 2.60 2.62 2.21 2.00 2.08

Neiman Marcus Group 1.90 2.75 2.29 2.08 2.60

Nordstrom 1.46 0.78 0.93 0.66 1.76

Federated Department Stores: Part A 7

Saks 1.30 0.53 0.00 0.39 0.51 Source: Company annual reports.

FEDERATED EVALUATES ITS POSITION WITHIN THE INDUSTRY AND MAKES A MOVE

In 2000, Federated declared its intent to “reinvent the department store” and began testing a range of store enhancements—from open-sell cosmetics to enhanced junior’s and young men’s departments to limited food service—in an effort to improve the physical shopping experience at its regional department stores and attract customers. Many of those enhancements were combined and tested in a prototype store, which Chain Store Age named the “Store of the Year.”

The Reinvent Concept Is Tested

Dubbed the “Store of the Future” by Federated, it opened in Easton Town Center in Columbus, Ohio, in October 2001. This 240,000-square-foot store included larger fitting rooms complete with comfortable waiting lounges that offered Internet access and local phone service, improved in-store signage, automatic price checkers that allow customers to calculate sale and special promotion prices, and small shopping buggies (essentially upscale shopping carts) in the home department. Central areas featured large plasma video screens with closed-circuit programming, local news, and stock tickers. A spa and supervised play area were included, as well as services that harked back to the glory days of department store shopping: interior designers, coat check, and personal shoppers. The 40,000-square-foot furniture department grouped merchandise by lifestyle and incorporated a full-line interior design studio in addition to design kiosks to help customers envision different fabrics and finishes.

According to Tom Cole, Federated vice chair (responsible for Federated Logistics, Federated Systems Group, and Financial, Administrative and Credit Services), the Easton store “became one of our best stores and still is.” The best elements of the Easton Town Center store—the improved floor plan, edited assortments, price checkers, better signage, and expanded fitting rooms—formed

the basis for a company-wide reinvention plan for Federated’s stores. In 2002 eight stores opened under the new model and 34 existing stores were retrofitted with reinvent elements. The “reinvent” strategy was designed to appeal to a new generation of shoppers who tend to shop at specialty retailers and may associate

department stores with their mothers or grandmothers. “Department stores have been overlooked by a lot of people,” explained Carol Sanger, Federated VP of corporate communications and external affairs. “Department stores are not often perceived as dynamic.” By changing the physical space and visuals of its stores, Federated hoped to win these consumers over to the department store format.

Experts from Lehman Brothers and Robertson Stephens to Standard & Poor’s and Retail Forward (2002) lauded Federated’s reinvent concept. They also held up Federated’s private brand program as

“The decision to incorporate the Macy’s name nationally should allow Federated to stand for more than just price/promotion.” —Credit Suisse First Boston, 2004

Federated Department Stores: Part A 8

a shining example of how department stores needed to develop their private labels into private brands. Huff and Hooper, for example, cited Federated’s I.N.C. private brand as an example for other stores to follow in a Retail Forward report. Bill Dreher and Janet Kloppenburg (for Robertson Stephens) asserted that, “Federated’s private label division, Federated Merchandising Group (FMG) [now Macy’s Merchandising Group], is one of the most developed in the industry,” and that it “offsets ‘brand migration’ and ‘sameness’”—factors identified as working against the sector as a whole.

Yet industry experts demanded more dramatic change, deeper change, and total reinvention of the department store model. Huff and Hyde acknowledged that “increasing shopping efficiency, creating a more compelling merchandise offer, and providing a stronger price-value relationship” were important improvements, but also argued that “the department store needs to reinvent itself” and predicted that those department stores that survived continued consolidation would do so by “adopting a more focused strategy, creating a unique personality by taking back creative control over their merchandise assortments from the designers, making service a hallmark, and looking for non-traditional growth opportunities.”

Federated executives also knew the reinvent changes were not going to be enough and considered them only a starting point. “The reinvent idea changed our culture entirely towards this idea of continuous improvement and change, change, change,” said Tom Cole. As Huff and Campitelli explained, fixing the model was one thing, but “Former department store shoppers . . . will need an extremely compelling reason to abandon current shopping patterns for department stores.”

FEDERATED RECOGNIZES THE CHALLENGES OF MULTIPLE DIVISIONS

At the beginning of 2002 Federated consisted of the upscale department store division Bloomingdale’s and five regional department store divisions operating under six nameplates: Macy’s (operated by the Macy’s East and Macy’s West divisions); Rich’s, Lazarus, and Goldsmith’s (all three operated by the Rich’s/Lazarus/Goldsmith’s division); Burdines; and The Bon Marché. According to Federated and others, these stores shared nearly identical customer profiles and carried common merchandise. Even their private brand assortments were more or less the same, since the private brands for all five were developed centrally by FMG. “They’ve been basically the same store for a long time,” said Brenda Gilpatrick, president of Gilpatrick Marketing Group, about Rich’s and Macy’s.2

Yet for all these similarities, the divisions operated independently, each with its own branded credit card, producing its own advertising and marketing, and buying and planning its own merchandise. Tom Cody, Federated vice chair (responsible for legal and human resources), explained the downside of this structure: “We couldn’t leverage the skills outside of a specific division and across the company so that we could win with the customer everywhere we do business. Everything was a negotiation.” Carol Sanger noted another problem associated with the divisions’ independence: “Before, a [division] principal could simply choose to ignore a corporate directive, or across the country you’d have 10 or 15 translations of the same directive.”

Moreover, customers did not experience brand association among Federated’s divisions: Most shoppers had no idea that Rich’s and The Bon Marché were owned and operated by the same company. As Carol Sanger explained, “Prior to the decision to operate under one name, we had a

Federated Department Stores: Part A 9

large stable of regional nameplates that were well known within their regions, but not very well known outside those regions. Someone who wasn’t familiar with Federated wouldn’t have known or understood the size and scope of the company. They wouldn’t have recognized the size of our workforce, the level of our philanthropy and community support, and the resources we possess as a corporation. We were an invisible corporate entity.”

The problem with the lack of brand association was further outlined by Ronnie Taffet, VP of public relations for Macy’s Corporate Marketing: “Although we were part of the same company, the divisions couldn’t leverage the Macy’s identity from coast to coast. In fact, before full brand conversion, we couldn’t even leverage our activities across the Macy’s East and Macy’s West divisions because we operated so differently.” And, though Macy’s sold through Macys.com, the other divisions had no online e-commerce presence.

Furthermore, all five divisions still followed the thinking that a department store catered to a wide range of customers. In 1996, then-CEO Jim Zimmerman cited department stores’ ability “to meet a wide range of needs for family and home under one roof” as a major advantage. Thus, even as Federated had increased the proportion of exclusive merchandise in its stores, the merchandise assortments were not focused on a particular customer demographic or profile but still aimed to

offer something for everyone. Largely because of this, plus the dependence on regional name recognition and association, each of the regional nameplates lacked a well-defined brand image. “Before, for example,” said Sherry Hollock, Federated DVP of organization

development, “we were so intent on communicating the flavor of Florida—the colors, the images, the palm trees—in everything we did for Burdines, that we missed our opportunity to communicate the customer experience.” Rather than developing the brands, “we spent much of our time and resources trying to define the differences among our regional divisions,” Hollock said.

Complicating the situation was the fact that some of these divisions operated in the same markets: Metropolitan Atlanta was home to 16 Rich’s stores and eight Macy’s stores (part of the Rich’s/Lazarus/Goldsmith’s and Macy’s East divisions, respectively), and south Florida was home to 15 Burdines stores and six Macy’s stores (part of the Burdines and Macy’s East divisions, respectively). This direct competition for customers between two Federated divisions mirrored the internal competition that existed between all divisions. According to Tom Cody, Federated has “some very competitive people, and in many cases they were competing against each other inside the company.” Sheila Field, SVP of marketing for Macy’s West, also saw “a lot of competition among divisions—especially those divisions that had stores in the same markets. No one wanted to share their marketing calendars or best practices because they wanted the best ideas for themselves.”

THE CO-BRANDING CONCEPT IS TESTED

In February 2003, Federated took its first step toward national brand building by resolving its issue of direct internal competition in the Southeast: It announced the strategic integration of Rich’s and Macy’s stores in Atlanta.

“Former department store shoppers . . . will need an extremely compelling reason to abandon current shopping patterns for department stores.” —Lois Huff and Julie Campitelli, Retail Forward

Federated Department Stores: Part A 10

In a press release announcing the decision, then-CEO Jim Zimmerman said, “The consolidation of Rich’s and Macy’s store operations under a Rich’s-Macy’s nameplate will enable the company to concentrate its management resources and capital spending on one brand.” As part of this strategy four Macy’s stores in the Atlanta area were closed in April 2003. The remaining 28 Federated-owned stores in the Southeast began operating as Rich’s-Macy’s.

Rich’s was particularly ripe for this initial co-branding for several reasons. “Atlanta is an important and unique market for us—the only one with such an extensive concentration of both Rich’s and Macy’s stores competing head-to-head,” explained Zimmerman. In addition to being in a market that was also home to Macy’s stores (creating direct competition between Federated divisions), Rich’s was also headquartered in Atlanta, a rapidly growing market: According to census figures, Atlanta’s metropolitan population grew by 35% between 1980 and 1990 (from about 1.9 million to nearly 2.6 million); from 1990 to 1999 it grew another 25% to 3.2 million. Terry Lundgren, then Federated president (now also CEO and chairman), touched on the opportunity offered by the Atlanta market: “Rich’s-Macy’s customers also will have a common credit card, which gives them the ability to shop and make merchandise returns at a Macy’s store anywhere in the country. For a city with as many travelers, out-of-town visitors and transplanted residents as Atlanta has, we think this will be a tremendous advantage.” The advantage Lundgren cited was two-fold: First, the many people who had moved to Atlanta from other areas of the country were less likely to be strongly attached to the regional Rich’s brand and more likely to be familiar with the Macy’s brand; second, reciprocity between Rich’s-Macy’s and other Macy’s stores (to make exchanges and use credit cards) would appeal to shoppers with ties to other parts of the country.

FEDERATED TAKES CO-BRANDING TO A NATIONAL LEVEL

Although details were not publicly available, Federated concluded the Rich’s-Macy’s co-branding such a success that, in May 2003, it announced its plan to co-brand its non-Macy’s regional department stores to include the Macy’s name in August 2003. Once the co-branding was complete, The Bon Marché would operate as The Bon-Macy’s with divisional headquarters in Seattle and 48 locations in Idaho, Oregon, Washington, and Wyoming. Lazarus would operate as Lazarus-Macy’s, with 42 stores in Ohio, Kentucky, Indiana, Pennsylvania, and West Virginia. The five Goldsmith’s locations in Tennessee would operate as Goldsmith’s-Macy’s. Lazarus-Macy’s and Goldsmith’s-Macy’s (along with Rich’s-Macy’s) would be run by the Rich’s/Lazarus/Goldsmith’s-Macy’s division headquartered in Atlanta. Effective February 1, 2004, 56 stores in Florida would operate as Burdines-Macy’s and Miami divisional headquarters would assume responsibility for the Florida Macy’s stores previously run by the Macy’s East division.

Customers at these stores received new credit cards bearing the combined nameplate that were accepted at every Macy’s and Macy’s co-branded store in the country and online at Macys.com. Although some customers expressed disappointment at the name change—especially customers who had shopped at the regional stores their entire lives—in the end, Terry Lundgren noted that “business improved gradually in most of the markets,” presumably indicating customers’ acceptance of the name change and association with the nationally known Macy’s nameplate.

Industry experts agreed with Dreher and Costin that the co-branding was “a logical and effective strategy for Federated as it enables the company to unite its operations under one powerful name and capitalize on the branding power of its most famous department store name.” A new central

Federated Department Stores: Part A 11

marketing function, headed by a chief marketing officer for Federated, was created to support the co-branding strategy. Federated Corporate Marketing, based in New York, was headed by Peter Sachse, who had served as president and chief operating officer of The Bon Marché division before assuming the chief marketing officer position. Terry Lundgren explained the co-branding strategy: “By layering the powerful Macy’s national brand onto Federated’s strong divisional operations and regional nameplates . . . we not only will be able to fully capitalize nationally on the powerful Macy’s brand for the first time, but we will be able to operate more efficiently as a company.”

While cost savings were welcome, they were not the central goal of the co-branding strategy. Lundgren was very clear that the primary driver was sales growth, not cost savings: “We’re very, very good at managing to the bottom line. And while there were efficiencies certainly, that was not the reason for going to the common nameplate. The reason was to drive top line sales.”

The co-branding strategy went beyond simply adding the Macy’s nameplate to the existing stores. The nameplate change was an important signal to customers that differences should be expected, so Federated had to develop a strategic plan to ensure that the customer’s experience and product choices would also reflect a change. As an initial step, this required a careful re-examination of the core customer to understand what was important in terms of offerings and the in-store experience.

In order to bring customers into the newly co-branded stores, Federated launched a marketing campaign that used the Macy’s red star (a symbol first used by R. H. Macy himself; as the story goes, Macy had a star tattooed on his arm after a star helped guide him through a storm at sea) and adopted the instructional and congratulatory “way to shop” slogan for all co-branded stores. The hyphenated nameplates were used in the ads (Figure 1). Campaigns informing customers of the name shift and playing up the value of the Macy’s name were launched in all affected markets.

RE-IDENTIFYING THE CORE CUSTOMER

For generations department stores had operated on the assumption that they appealed to a cross-section of the population, or at least a cross-section of rather broadly defined socioeconomic groups. They offered something for everyone within that category because that was who, it was thought, bought their goods. True, most shoppers were women, and they were catered to with full-service and expanded women’s apparel departments. Federated knew that 75% of its customers were women, as was typical, experts agreed, of department stores in general. And, according to Federated, women’s merchandise accounted for 60% of the company’s total sales in 2004 (Figure 2).

Beginning in 2002, Federated undertook extensive research to uncover more specifics about its customers. Through the consulting firm McKinsey & Company, the company talked to more than 2,400 women in 15 major markets. Participants were asked about their shopping preferences, habits, opinions about Macy’s, and their experiences at 28 competitors’ stores. Sifting through all the data, Federated discovered the characteristics of its core customer, those shoppers who identified Macy’s as their favorite store. “We spent a lot of time, effort, and energy on trying to understand our core customer, and we learned a lot about her and how she shops—how often and how frequently she shops in our store,” recalled Janet Grove, Federated vice chair (responsible for merchandising and product development).

Federated Department Stores: Part A 12

FIGURE 1

FIGURE 2

19% Home and miscellaneous

21% Men's and children's

27% Women's apparel

33% Feminine accessories, intimate apparel, shoes, and cosmetics

Source: Federated Department Stores, 2005 Corporate Fact Book.

Federated learned that its core customer is a woman who works, is most often married, and may or may not have children (50/50 split). She is between 25 and 54 years old, but neither her age nor her ethnicity defines her decisions. Her average household income is $75,000 a year. She shops a lot—about 78 times a year for the merchandise sold at a headquarters department store—and spends approximately $5,000 a year, which is twice as much as the average shopper. She is fashion-conscious, and 70% of her shopping trips involve looking for clothes. She is also “diverse,” coming from many ethnic and racial groups. The problem, from Federated’s point of view, was that she was spending only 19% to 25% of her shopping budget at Federated stores.

Experts agreed that the department store in general needed to play a new game, one that did not depend on constant markdowns and little-bit-of-everything assortments, or it risked losing any hope of sales growth. Federated decided to play to its strengths in crafting its sales strategy, and “focused attention on the specific merchandise categories each core customer is interested in,” explained Janet Grove, in hopes of getting more business from existing customers. “The best path to growing our business,” said Tom Cole, “was getting more of [the core customer’s] wallet.”

To this end, Federated developed lifestyle profiles for its core customer to help it edit assortments and define its national brand. Based on research involving more than 2,400 customers nationwide, Federated broke out the core customer into four lifestyle profiles3:

• Katherine/Traditional: “She relates to a conservative view of things, from her home and her car to the pets she owns and the vacations she takes. Katherine is neat and confident. She puts the most effort into traditional occasions. She concentrates on her home, husband and family.”

• Julie/Neo-Traditional: “She’s still very classic, but will go for trends in a safe, secure form. Family is important to her, but so is she. She wants more convenience and comfort in her life. Julie has a career and her husband helps more with the kids. She’s more casual at home, where elements of the past blend with the present.”

Federated Department Stores: Part A 13

• Erin/Contemporary: “Individuality is key, and a contemporary viewpoint is reflected in how she looks and what she thinks. She’s fashion-conscious and technology-oriented, owning every gadget available. Her career is consuming, so she unwinds through sports and spas. Erin’s home is minimalist, showing her preference for clean affordable design.”

• Alex/Fashion: “She is a truly dedicated follower of fashion. She tends to be less brand loyal, instead pursuing the latest, newest, hippest thing—whatever that might be and wherever that might take her. Alex is status-conscious, and she’s fickle. She will pick up on whatever is hot, and drop whatever is not.”

Products in particular and the shopping experience in general were to be tuned to the tastes and desires of these fictional personalities devised to represent real customers and their buying habits. Susan Kronick explained how these lifestyle types play into Federated’s day-to-day efforts: “It’s presentation in the stores, but it’s also how the buyers in the division look at editing their assortments now by lifestyle. They actually have these women in their heads when they go to market and go to buy. And it’s a pretty dramatic change.” Janet Grove added that the lifestyle types are also very important during product development and brand strategy planning. Though women make up the vast majority of Federated’s customers, similar profiles were also developed for male customers.

Tailoring Assortments to the New Lifestyle Types Incorporating these lifestyle types, Federated concentrated on improving its assortments: Terry Lundgren cited “editing our assortments and making sure that our assortments are differentiated” as two major priorities for the organization. Federated also focused on moving all of its traditional stores more up-market. Part of that strategy includes tighter editing of assortments in general, but especially of moderate and basic items. Lundgren spelled out the vision guiding Federated’s approach to assortments: “We’re a fashion retailer. That’s how we differentiate ourselves. We sell basic products, certainly, but where we really step away from the mass merchandisers is that we sell fashion. And that makes us different and is a unique offering.”

A key element of improving assortments was the 20/20 initiative, an inventory control and markdown system: The top 20% and bottom 20% sell-through of assortments are identified; the top 20% is reordered and quickly restocked in stores, and the bottom 20% is marked down to move it out of stores and free up floor space for more of the top 20%. The 20/20 initiative was first tested in the Bon-Macy’s division, where it was so successful that the new system was quickly rolled out to all Macy’s divisions. Deborah Weinswig (for Citigroup Smith Barney) greeted the initiative as a positive approach that would “benefit both gross margins and sales.” The 20/20 initiative also contributes to the editing of assortments by identifying and moving out those items that aren’t as attractive to the core customer. And it takes advantage of the need to place merchandise on sale and department stores’ reputation for markdowns by strategically targeting what that merchandise will be. It is, according to Dreher and Costin, “a seemingly intuitive method of markdown optimization.”

Federated also focused on further development of its private brands, especially on turning them into private brands that spanned various departments within the stores (Exhibit D). “Core customer profiles have allowed the brands to focus and spend time on quality,” said Janet Grove. “We’ve been able to upgrade all our private brands through our focus on the specific merchandise categories each core customer is interested in.” Targeting assortments to specific customer profiles, makes it

Federated Department Stores: Part A 14

possible to redirect time and money that was previously spent on wider assortments for all private brands into fewer, higher quality items. Targeting assortments to specific customer profiles also clarified the stores’ wares: As Grove put it, “We don’t confuse the Traditional [Katharine] customer by putting Fashion items in her Traditional Charter Club brand.”

Federated’s widely recognized success with private brands dates back to 1994, when it acquired Macy’s, then considered the industry leader in private label goods, and merged the Federated Merchandising organization with Macy’s Product Development organization to form the Federated Merchandising Group (FMG) in New York. Datamonitor summed it up: “Within the traditional department store industry, Federated historically has been the most successful marketer of private brands . . . [which] has shown an impressive growth from 5% of total company sales in 1994 to approximately 16% of company sales in 2001.” FMG’s approach has been to work on private brands that can span departments rather than private labels, which are often limited to very specific departments.

True private brands have three key advantages for department stores. First, they offer customers what Asaeda called “a unique product mix,” lending exclusivity to their shopping experience, which in turn creates a “retail identity,” attracting customers to the store. “Exclusive merchandise is critical to the success of department store retailers, given that a main criticism of that format has been sameness across all stores,” according to Kalandiak. Second, private brands offer value since they are typically priced 25% lower than similar goods from market brands. Finally, as Janet Grove explained, they offer the company a great deal more flexibility and control over assortments. Rather than picking elements from a collection developed by an external designer or company, Federated itself develops the products from start to finish and is able to coordinate them with other product lines and private brands. This provides what Asaeda called “marketplace flexibility” and speed, which, as Huff and Hooper noted, “is a fashion necessity.” With the co-branding of its traditional department stores, Federated hoped to increase its private brand sales from almost 16% of total sales in 2001 to 20% long term.

Improving the In-Store Shopping Experience The final element of the co-branding strategy included plans to introduce reinvent features, first tested in the Easton Town Center store in 2001, to the stores in six major markets in 2003. One hundred million dollars in reinvent capital was allocated between Atlanta, Seattle, Columbus, Cincinnati, Pittsburgh, and Memphis. In 2004, an additional $100 million of reinvent capital was concentrated on Burdines-Macy’s stores in Florida as they converted to the new nameplate. The reinvent efforts focused on transforming traditional department stores into rejuvenated shopping destinations, with many of the features of the Easton “Store of the Future”: increased space, improved layouts, and more services and conveniences.

THE DEPARTMENT STORE SECTOR DILEMMA REMAINS

For Federated, new inventory management processes designed to limit markdowns, as well as improved national identity from co-branding and increased private brand development, all promised to exert pressure on the operating margin. However, the net results for Federated of the efforts to increase sales are yet to be determined.

Federated Department Stores: Part A 15

Through 2003 the sector as a whole continued to see less than impressive same-store sales. Although luxury store performance improved, there was no other indication that the overall trend was reversing for the department store sector, which continued to claim a smaller and smaller market share. Shoppers continued to be drawn to a combination of off-mall retailers (for both convenience and value), specialty apparel retailers (for lifestyle-targeted merchandise), and upgraded discounters (for value) in lieu of department stores. With continued consolidations and the saturation of the sector, growth was thought to be more likely to come from new customers, not from additional stores. According to Huff and Hooper, “In many ways [department stores] will be turning back the clock. They will seek to recreate the strengths on which their heritage was founded,” suggesting that future growth for the sector will come from those stores that offer customers some reason to return to the grande dame of retail, some sense of excitement and convenience that drew them to department stores a century ago.

Federated Department Stores: Part A 16

SOURCES CONSULTED

Asaeda, Jason. Retailing: General, industry survey (Standard & Poor’s, May 20, 2004).

Byron, Ellen. “Lundgren, CEO of Federated, Is Retail Innovator.” Wall Street Journal, January 21, 2005.

Datamonitor. Federated Department Stores, Inc., November 2004.

Dreher, Bill and Caroline Costin. Federated Department Stores: Blooming with Cash. (Deutsche Bank, August 24, 2004).

Dreher, Bill A. and Janet Joseph Kloppenburg. Federated Department Stores. (Robertson Stephens, March 22, 2001).

Huff, Lois and Julie Campitelli. Industry Outlook: Department Stores. (Retail Forward, February 2004).

Huff, Lois and Cliona Hooper. Industry Outlook: Department Stores. (Retail Forward, March 2000).

Huff, Lois and Linda Hyde. Industry Outlook: Department Stores. (Retail Forward, June 2002).

Lehman Brothers. Federated Department Stores: Is the Snoopy Balloon Full of Cash? February 21, 2003.

Lundgren, Terry. “Ask Terry.” Coast to Coast (Fall 2003).

Jette, Julie. “Tips to Reinvent the Department Store.” HBS Working Knowledge, April 18, 2005, http://hbswk.hbs.edu/pubitem.jhtml?id=4758&sid=-1&t=special_reports, accessed August 2005.

Kalandiak, Paula. Federated Department Stores, Inc., electronic research report. (Wells Fargo Securities, September 18, 2003).

Moin, David. “More Muscle for Macy’s: Federated Rebranding Rebuilds $13.5B Chain.” Women’s Wear Daily, September 14, 2004.

“New Ads Tout Macy’s as National Brand.” HFN (December 2003).

Palmieri, Jean E. “Federated’s New Look.” Daily News Record, November 29, 2004.

Schlosser, Julie. “Question Authority: Holiday Shopping Is His Department.” Fortune, October 18, 2004.

“State of the Industry: The Top 100 Retailers.” Chain Store Age (August 2004).

Stein, Jeffrey S. and Neil Goldfarb. Federated Department Stores. (KeyBanc Capital Markets, July 29, 2004).

Weinswig, Deborah. Federated Department Stores, Inc. (Citigroup Smith Barney, August 11, 2004).

Federated Department Stores: Part A 17

EXHIBIT A

A Brief History of Macy’s and Federated Department Stores

In 1858 Rowland H. Macy opened R.H. Macy & Co., a dry goods store, in New York City. By 1877 it had become a full-fledged department store, among the first in the United States. Distinguished from earlier stores both by their large size and the organization of merchandise by department (hence, the sector name), department stores led a great retailing shift that took place in the United States, Great Britain, and France in the mid-nineteenth century. Put quite simply, what we now know as “shopping” came into existence during that time.

Before this time, to step into a shop was a statement of intent to buy something. The consumer would tell the shopkeeper what he or she wanted, and a long discussion about the price to be paid would ensue. The notion of buying things as a pleasant or even convenient activity was unknown. In contrast to their predecessors, department stores organized goods for customers’ convenience, rather than the shopkeepers’, and grouped merchandise by type. They displayed fixed, advertised prices and offered diversified merchandise, giving customers a choice between similar goods. Early department stores grew out of dry goods establishments, but before long, special buildings were constructed to entice customers with elaborate displays, grand architecture, restful tearooms, and the promise of entertainment and diversion along with goods and services. Shopping as a pastime came into being.

In 1902 Macy’s moved to its current location on Herald Square, and in 1924 the 7th Avenue addition made it the largest department store in the world. Federated Department Stores was formed in 1929 as a holding company for three family-owned stores—Abraham & Straus in Brooklyn; F&R Lazarus in Columbus, Ohio; and Filene’s in Boston—that agreed to link their financial interests while maintaining their stores’ unique identities. The next year Bloomingdale’s joined Federated. For decades, Federated Department Stores and R.H. Macy & Co. were famous rivals. The Bloomingdale’s and Macy’s rivalry in New York was particularly acute, with each claiming to be the best department store in the city.

More than just a place to shop, department stores often offered their customers a sense of escape and luxury. They also added extensive services such as free alterations, bridal salons, travel agencies, and gift wrapping to their array of consumer enticements. By instituting in-house credit programs during the Great Depression in the 1930s and following America’s expanding population to the suburbs in the 1950s, 1960s, and 1970s, department stores ruled the retail roost throughout much of the twentieth century.

During this time Federated acquired retail chains across the country. By 1987 Federated divisions included department stores (Abraham & Straus based in Brooklyn, Bloomingdale’s based in New York, Bullock’s based in Los Angeles, Burdines based in Miami, Filene’s based in Boston, Foley’s based in Houston, Goldsmith’s based in Memphis, Lazarus based in Cincinnati, and Rich’s based in Atlanta), specialty stores (The Children’s Place based in New Jersey, Filene’s Basement based in Boston, I. Magnin based in San Francisco, and MainStreet based in Chicago), discount stores (Gold Circle based in Columbus, Ohio), and supermarkets (Ralph’s based in Los Angeles). Similarly, Macy’s expanded by opening stores well beyond the confines of Manhattan and by acquiring other

Federated Department Stores: Part A 18

department store chains such as LaSalle & Kock (based in Toledo) in 1923, Davison-Paxton (based in Atlanta) in 1924, and O’Connor Moffat (based in San Francisco) in 1945.

Then, in a highly leveraged and bitter takeover bid, Campeau Corporation acquired Federated in April 1988, paying $6.6 billion in cash for the company (at one point R.H. Macy & Co. emerged as a potential “white knight” to save Federated from Campeau). Campeau sold a number of Federated divisions to pay for the deal: Filene’s and Foley’s were sold to May Department Stores Company; Bullock’s and I. Magnin were sold to Macy’s; and The Children’s Place, Filene’s Basement, MainStreet, Gold Circle, and Ralph’s were sold to various buyers. Campeau combined Federated’s remaining divisions with those of Allied Stores Corporation, which Campeau had acquired in 1986. The Allied divisions included Stern’s (based in Paramus, New Jersey), Jordan Marsh (based in Boston), Maas Brothers (based in Tampa), and The Bon Marché (based in Seattle). All of the Allied and Federated divisions began as family-owned, single-location retailers in the 1800s that expanded and consolidated throughout the 1950s, 1960s, and 1970s along with the industry at large. Despite the sell-offs Campeau made, the debt remained. In 1990 Federated filed for bankruptcy protection and reorganized its debt of more than $8 billion. The next year consolidation among divisions with stores in the same regions began in earnest; Maas Brothers and Jordan Marsh stores in Florida, for example, were all converted to the Burdines nameplate.

In 1992 Federated Department Stores emerged from Chapter 11, not to mention several years of turmoil and constant change, as an independent, publicly traded corporation—no longer under Campeau’s aegis—with 220 department stores in 26 states and annual sales of about $7 billion. These holdings consisted of several divisions: the upscale department store Bloomingdale’s; headquarters department stores A&S/Jordan Marsh (based in Brooklyn), The Bon Marché (based in Seattle), Burdines (based in Miami), Lazarus (based in Cincinnati), and Rich’s/Goldsmith’s (based in Atlanta); and the moderate department store Stern’s (based in Paramus, New Jersey). That same year Macy’s filed for bankruptcy. Two years later, in 1994, Federated acquired its long-time competitor, creating the largest department store retailer in the country. Consolidation, nameplate changes, store closings, centralization of key corporate functions, and selling off of divisions continued: During the mid-1990s Federated converted all Bullock’s and I. Magnin stores in the Western United States to the Macy’s nameplate, bought the Los Angeles–based Broadway Stores, and merged its A&S/Jordan Marsh division into the Macy’s East division. Then, in 1998, major investment agencies deemed Federated’s debt investment grade, making its recovery from bankruptcy official. In 2001 Federated acquired Liberty Houses stores, Hawaii’s largest retailer, which became part of the Macy’s West division.

Federated Department Stores: Part A 19

EXHIBIT B

Federated Timeline

1830 Shillito’s founded in Cincinnati by John Shillito.

1841 Eben Jordan and Benjamin L. Marsh open Jordan Marsh in Boston.

1851 Simon Lazarus opens F&R Lazarus & Company in Columbus, Ohio.

1858 Rowland H. Macy opens R.H. Macy & Co. as a dry goods store in New York City.

1865 Wechsler & Abraham founded in Brooklyn.

1867 Rich’s founded in Atlanta by Morris Rich.

Stern Brothers (later Stern’s) founded in New York City.

1870 Goldsmith’s founded in Memphis.

1872 Bloomingdale Brothers founded in New York City.

1881 William Filene’s Sons Co. founded in Boston.

1888 Straus family acquires a general partnership with Macy’s.

1890 The Bon Marché founded in Seattle.

1893 Straus family buys out Wechsler’s interest, changing Wechsler & Abraham to Abraham &

Straus. Macy’s and Abraham & Straus maintain a close association.

1898 Burdines founded in Miami.

1902 Macy’s moves to Herald Square.

1907 Bullock’s founded in Los Angeles.

1923 Macy’s acquires LaSalle & Kock of Toledo, Ohio.

1925 Macy’s acquires Davison-Paxton (later becomes Davison’s) of Atlanta.

1928 Hahn Department Stores is founded to bring chain-store advantages to family-owned

department stores.

1929 Federated Department Stores is formed as a holding company (similar to Hahn) by Abraham

& Straus, F&R Lazarus, and Filene’s of Boston.

1930 Bloomingdale’s joins Federated.

1935 Jordan Marsh founds Allied Department Stores, a successor to Hahn.

1939 Both Federated and Allied offer customers “pay when you can” credit.

1945 Federated moves its offices to Cincinnati (from Columbus).

Macy’s acquires O’Connor Moffat & Company in San Francisco.

1947 O’Connor Moffat & Company stores assume Macy’s name.

Federated Department Stores: Part A 20

1951 Allied acquires Stern’s.

1956 Burdines becomes a division of Federated.

1959 Federated acquires Rike’s (based in Dayton, Ohio) and Goldsmith’s (based in Memphis).

1962 Federated acquires William H. Block Company of Indianapolis.

1964 Federated acquires Bullock’s and I. Magnin, both based in Los Angeles.

1976 Federated acquires Rich’s, based in Atlanta.

1982 Rike’s and Shillito’s merge to create Shillito-Rikes.

1985 Davison’s stores (based in Atlanta) assume the Macy’s name.

Edward S. Finkelstein, CEO of Macy’s, organizes executives and succeeds with a leveraged

buyout of R.H. Macy & Co.

1986 Shillito-Rikes and Columbus-based Lazarus merge; the Federated division operates as

Lazarus.

Campeau Corporation acquires Allied Stores Corporation.

1987 Federated buys Allied’s Indianapolis-based Block’s division, incorporating it into Lazarus.

1988 Campeau acquires Federated.

Federated’s Filene’s and Foley’s divisions are sold.

Macy’s buys Federated’s Bullock’s and I. Magnin.

Allied and Federated consolidate divisions.

1989 Federated forms its Financial, Administrative and Credit Services operation to centralize

credit services for its department store divisions.

1990 Both Federated and Allied file for bankruptcy.

1991 Divisional consolidation begins. All Florida stores begin operating under the Burdines name.

1992 A new public company, Federated Department Stores, emerges; it includes the former Allied

Stores Corporation, which has merged into Federated.

Macy’s files for bankruptcy.

1993 Federated centralizes all divisional accounting and accounts payable departments.

1994 Federated acquires Joseph Horne Co. of Pittsburgh, adding the ten Pennsylvania stores to its

Lazarus division.

Federated acquires R.H. Macy & Co.

A&S/Jordan Marsh merged into Macy’s East division.

I. Magnin chain is discontinued; the stores are sold or converted to Macy’s or Bullock’s.

Federated Department Stores: Part A 21

Federated Logistics is formed to coordinate the company’s distribution facilities and

functions in the Northeast.

1995 Rich’s/Goldsmith’s and Lazarus divisions are consolidated into a single

Rich’s/Lazarus/Goldsmith’s division.

Federated acquires Broadway Stores, based in Los Angeles. The Broadway, Weinstock, and

Emporium stores are converted to Macy’s or Bloomingdale’s, sold, or closed.

Federated Logistics expands to cover all divisions.

A&S stores, already operated by Macy’s East, are converted to the Macy’s nameplate.

1996 Jordan Marsh stores are converted to the Macy’s nameplate.

Bullock’s stores are converted to the Macy’s nameplate.

Bloomingdale’s opens its first stores in California.

Macy’s West division launches Macys.com.

1998 Federated’s debt is rated investment grade by major agencies.

Federated launches Macy’s by Mail and relaunches Macys.com.

1999 Federated acquires Fingerhut Companies.

2001 Federated closes its Stern’s division and converts the stores to the Macy’s and

Bloomingdale’s nameplates.

Federated acquires Hawaii’s Liberty House, which then becomes part of the Macy’s West

division.

2002 Federated disposes of Fingerhut.

2003 Federated integrates the Macy’s nameplate with its regional department stores, creating Bon-

Macy’s, Burdines-Macy’s, Goldsmith’s-Macy’s, Lazarus-Macy’s, and Rich’s-Macy’s.

Federated Corporate Marketing established in New York.

Federated opens Bloomingdale’s stores in Atlanta.

Federated board begins quarterly dividends.

2004 Federated forms Macy’s Home Store division, a centralized organization for the strategy,

merchandising, and marketing of all home-related categories for its 425-plus Macy’s stores.

Federated Department Stores: Part A 22

EXHIBIT C

Department Store Balance Sheets

Federated Department Stores Balance Sheets, 1999–2004

Fiscal Year Ended 1/29/00 2/3/01 2/2/02 2/1/03 1/31/04 1/29/05

Assets ($M)

Cash & equivalents 218 222 636 716 925 868

Accounts receivable 4,313 2,435 2,379 2,945 3,213 3,418

Merchandise inventories 3,589 3,626 3,376 3,359 3,215 3,120

Supplies & prepaid expenses 230 121 124 124 99 104

Deferred tax assets 172 4 21 10 — — Assets of discontinued operations 0 1,436 744 — — — Total current assets ($M) 8,522 7,844 7,280 7,154 7,452 7,510 Property & equipment, net 6,828 6,621 6,506 6,379 6,174 6,018

Goodwill — 305 262 262 260

Intangible assets, net 1,735 617 378 378 378 378

Other assets 607 492 575 268 284 719

Total assets ($M) 17,692 15,574 15,044 14,441 14,550 14,885

Liabilities & Shareholders’ Equity ($M)

Short-term debt 1,284 1,117 1,012 946 908 1,242

Accounts payable & accrued liabilities 3,043 2,642 2,645 2,584 2,613 2,707

Income taxes 225 245 57 71 362 352

Total current liabilities ($M) 4,552 4,004 3,714 3,601 3,883 4,301 Long-term debt 4,589 3,845 3,859 3,408 3,151 2,637 Deferred income taxes 1,444 1,362 1,345 998 998 1,199

Other liabilities 555 541 562 672 578 581

Shareholders’ equity ($M) 6,552 5,822 5,564 5,762 5,940 6,167 Total liabilities & shareholders’ equity ($M) 17,692 15,574 15,044 14,441 14,550 14,885 Source: Federated Department Stores.

Federated Department Stores: Part A 23

Kohl’s Corp. Balance Sheets, 1999–2004

Fiscal Year Ended 1/29/00 2/3/01 2/2/02 2/1/03 1/31/04 1/29/05

Assets ($M)

Cash & equivalents 13 124 107 90 113 117

Short-term investments 28 49 229 476 34 89

Accounts receivable 505 681 836 991 1,150 1,390 Merchandise inventories 794 1,003 1,198 1,627 1,607 1,947

Deferred income taxes 22 40 52 57 50 54

Other assets 21 26 41 44 71 47

Total current assets ($M) 1,383 1,922 2,464 3,284 3,025 3,643 Property & equipment, net 1,353 1,727 2,200 2,739 3,317 3,988

Favorable lease rights, net 133 66 175 180 236 225

Goodwill 20 127 9 9 9 9

Other assets 42 15 82 102 105 114

Total assets ($M) 2,931 3,855 4,930 6,316 6,691 7,979

Liabilities & Shareholders’ Equity ($M)

Accounts payable 336 400 479 695 533 705

Accrued liabilities 154 189 260 316 442 571

Income taxes 64 113 125 142 136 177

Current portion of LT debt & capital leases 12 17 16 356 13 4

Total current liabilities ($M) 651 723 880 1,508 1,456 1,123 LT debt & capital leases 495 803 1,095 1,059 1,076 1,103

Deferred income taxes 67 84 114 172 210 297

Other LT liabilities 33 42 49 65 134 157

Shareholders’ equity ($M) 1,686 2,203 2,791 3,512 4,149 4,967 Total liabilities & shareholders’ equity ($M) 2,931 3,855 4,930 6,316 6,691 7,979 Source: Kohl’s Corp.

Federated Department Stores: Part A 24

May Department Stores Balance Sheets, 1999–2004

Fiscal Year Ended 1/29/00 1/31/01 1/31/02 1/31/03 1/31/04 1/31/05

Assets ($M)

Cash 16 156 52 55 564 62

Receivables 2,173 2,081 1,938 1,776 1,788 2,294

Total inventories 2,817 2,938 2,875 2,857 2,728 3,092

Other current assets 84 95 60 99 88 129

Total current assets ($M) 5,115 5,270 4,925 4,787 5,168 5,577Net, property, plant & equipment 4,769 4,899 5,264 5,466 5,149 6,190

Property, plant & equipment — 8,167 8,996 9,205 9,103 10,178

Accumulated depreciation — 3,268 3,732 3,739 3,954 3,988

Intangibles — 1,312 1,612 1,617 1,672 3,236

Deposits and other assets 70 93 119 131 133 160

Total assets ($) 10,935 11,574 11,920 12,001 12,122 15,163

Liabilities & Shareholders’ Equity ($M)

Notes payable — — 78 150 — 368

Accounts payable 1,030 965 1,023 2,048 1,191 1,529

Current LT debt 259 85 255 139 239 145

Accrued expenses 892 871 900 — 1,016 1,269

Income taxes 234 293 272 264 325 158

Total current liabilities ($M) 2,415 2,214 2,528 2,601 2,771 3,469

Deferred charges to income 586 696 710 712 818

Long-term debt 3,560 4,534 4,403 4,035 3,797 5,662

Other LT liabilities 314 335 452 355 651 739

Shareholders’ equity ($M) 4,077 3,905 3,841 4,300 4,191 4,475Total liabilities & shareholders’ equity ($M) 10,935 11,574 11,920 12,001 12,122 15,163Source: The May Department Stores Company.

Federated Department Stores: Part A 25

Nordstrom Balance Sheets, 1999–2004

Fiscal Year Ended 1/31/00 1/31/01 1/31/02 1/31/03 1/31/04 1/29/05

Assets ($M)

Cash & equivalents 27 25 331 208 340 361

Short-term investments 26 — — — 176 42

Accounts receivable, net 617 722 699 759 667 646

Investment in asset-backed securities — — — — 272 422

Merchandise inventories 798 946 888 953 902 917

Current deferred tax assets — — — — 122 132

Prepaid expenses and other 97 120 139 152 46 53

Total current assets ($M) 1,565 1,813 2,057 2,073 2,525 2,572Land, buildings & equipment, net 1,430 1,600 1,761 1,762 1,808 1,780

Goodwill, net — 40 38 40 52 52

Tradename, net — 104 100 100 84 84

Other assets 68 52 95 122 101 117

Total assets ($M) 3,062 3,609 4,051 4,096 4,569 4,605

Liabilities & Shareholders’ Equity ($M)

Accounts payable 391 467 491 415 459 482

Accrued salaries, wages & related benefits 211 235 236 261 276 288

Other current liabilities 71 83 — — 315 354

Income taxes & other accruals 135 154 144 189 66 116

Current portion of LT debt 58 13 78 6 7 101

Total current liabilities ($M) 867 951 950 870 1,123 1,341Long-term debt, net 747 1,100 1,351 1,342 1,227 929

Deferred property incentives, net 195 275 342 383 408 367

Other liabilities 68 53 93,463 129 177 179

Shareholders’ equity ($M) 1,186 1,230 1,315 1,372 1,634 1,789Total liabilities & shareholders’ equity ($M) 3,062 3,609 4,051 4,096 4,569 4,605Source: Nordstrom.

Federated Department Stores: Part A 26

Sears, Roebuck Balance Sheets, 1999–2004

Fiscal Year Ended 1/1/00 12/30/00 12/29/01 12/28/02 1/3/04 1/1/05

Assets ($M)

Cash & equivalents 729 842 1,064 1,962 9,057 4,165Retained interest in transferred credit card receivables 3,211 3,105 — — — —

Net credit card receivables 18,033 17,317 28,155 30,731 1,956 1,239

Other receivables 404 506 658 891 733 642

Merchandise inventories, net 5,069 5,618 4,912 5,115 5,335 5,549Prepaid expenses, deferred charges & other current assets 512 486 458 535 407 493

Deferred taxes 709 920 858 749 708 475

Total current assets ($M) 28,667 28,794 36,105 39,983 18,196 12,563Property & equipment, net 6,450 6,653 6,824 6,910 6,788 6,749

Deferred income taxes 367 174 415 734 378 271

Goodwill — — 294 944 943 963

Tradenames & other intangible assets — — — 704 710 1,285

Other assets 1,470 1,278 679 1,134 708 643

Total assets ($M) 36,954 36,899 44,317 50,409 27,723 22,474

Liabilities & Shareholders’ Equity ($M)

Short-term debt 2,989 4,280 3,557 4,525 1,033 685Current portion of LT debt & capitalized lease obligations 2,165 2,560 3,157 4,808 2,950 330

Merchandise payables — — — 2,945 3,106 2,962

Income taxes — — — 787 1,867 412

Other liabilities 6,992 7,336 7,176 3,753 2,950 3,146

Unearned revenues 971 1,058 1,136 1,199 1,244 1,081

Other taxes 584 562 558 580 609 581

Total current liabilities ($M) 13,701 15,796 15,584 18,597 13,759 9,197Long-term debt & capitalized lease obligations 12,884 11,020 18,921 21,304 4,218 3,473

Pension & postretirement benefits 2,180 1,951 2,417 2,491 1,956 1,685

Minority interest & other liabilities 1,350 1,363 1,276 1,264 1,389 2,027

Shareholders’ equity ($M) 6,839 6,769 6,119 6,753 6,401 6,092Total liabilities & shareholders’ equity ($M) 36,954 36,899 44,317 50,409 27,723 22,474Source: Sears, Roebuck.

Federated Department Stores: Part A 27

EXHIBIT D

Federated Department Stores’ Private Brands Note that many of these span two or more departments, which is a key element of transitioning the old notion of private labels into private brands.

Brand Style Departments

Alfani Updated contemporary Accessories Men’s apparel Women’s apparel

American Rag Casual sportswear Juniors Young men’s

Charter Club Classic Accessories Home furnishings Intimate apparel Women’s apparel

Club Room (extension of Charter Club brand)

Classic Men’s apparel and accessories

First Impressions Layette and gift-giving Infant/toddler apparel

Greendog Trend-oriented Kids’ accessories Kids’ apparel

Hotel Collection Affordable luxury Upscale modern

Barware Bed and bath Tabletop

I•N•C International Concepts Updated casual and career Men’s apparel Women’s apparel Accessories

Style & Co. Updated moderate sportswear Women’s apparel

Tasso Elba Modern traditional sportswear Men’s apparel and accessories

The Cellar Everyday housewares and kitchenware, tabletop, and decorative items

Kitchen/housewares

Tools of the Trade Quality and value cookware and gadgets Kitchen/housewares

Source: Federated Department Stores, 2005 Corporate Fact Book.

Federated Department Stores: Part A 28

EXHIBIT E

Selected Department Store Income Statements

Federated Department Stores Income Statements, 1999–2004

Fiscal Year Ended 1/29/00 2/3/01 2/2/02 2/1/03 1/31/04 1/29/05

Net sales ($M) 16,029 16,638 15,651 15,435 15,264 15,630

Same-store sales (% change) 4.5 2.0 –5.3 –3.0 –0.9 2.6

Cost of sales ($M) 9,576 9,955 9,584 9,255 9,099 9,297

Gross profit ($M) 6,453 6,683 6,120 6,180 6,165 6,333

Gross margin (%) 40.3 40.2 39.1 40.0 40.4 40.5

SG&A ($M) 4,760 4,912 4,801 4,837 4,824 4,933

% of revenue 29.7 29.5 30.7 31.3 31.6 31.5

Operating income ($M) 1,693 1,691 1,104 1,343 1,341 1,400

Operating margin (%) 10.6 10.2 7.1 8.7 8.8 9.0

Pretax income ($M) 1,386 1,370 780 1,048 1,084 1,116

Income taxes ($M) 561 549 262 410 391 427

Net income ($M) 825 –184 –276 818 693 689

Recurring diluted EPS ($) 3.76 4.20 3.03 3.21 3.71 3.86

Average diluted shares 213 198 201 190 178 167Source: Federated Department Stores.

Kohl’s Corp. Income Statements, 1999–2004

Fiscal Year Ended 1/29/00 2/3/01 2/2/02 2/1/03 1/31/04 1/29/05

Net sales ($M) 4,557 6,152 7,489 9,120 10,282 11,701

Same-store sales (% change) 7.9 9.0 6.8 5.3 –1.6 0.3

Cost of sales ($M) 3,014 4,056 4,924 5,981 6,887 7,587

Gross profit ($M) 1,543 2,096 2,565 3,139 3,395 4,114

Gross margin (%) 33.9 34.1 34.3 34.4 33.0 35.2

SG&A ($M) 977 1,289 1,535 1,827 2,102 2,540

% of revenue 21.4 21.0 20.5 20.0 20.4 21.7

Depreciation & amortization ($M) 83 122 152 194 240 288

Preopening expenses ($M) 31 35 31 41 47 49

Operating income ($M) 448 651 838 1,078 1,007 1,237

Operating margin (%) 9.7 10.5 11.2 11.8 9.8 10.6

Pretax income ($M) 421 605 788 1,022 934 1,174

Income taxes ($M) 163 233 304 386 353 444

Net income ($M) 258 367 488 635 581 730

Recurring diluted EPS ($) 0.76 1.09 1.43 1.85 1.69 2.12

Average diluted shares 334 338 345 347 345 345Source: Kohl’s Corp.

Federated Department Stores: Part A 29

May Department Stores Income Statement, 1999–2004

Fiscal Year Ended 1/29/00 1/31/01 1/31/02 1/31/03 1/31/04 1/31/05

Net sales ($M) 13,562 14,210 13,883 13,491 13,343 14,441

Same-store sales (% change) 0.5 0.0 –4.4 –5.3 –2.8 –2.4

Cost of sales ($M) 9,370 9,798 9,632 9,463 9,378 10,212

Gross profit ($M) 4,496 4,412 4,251 4,028 3,965 4,229

Gross margin (%) 32.4 31.1 30.6 29.9 29.7 29.3

SG&A ($M) 2,686 2,665 2,758 2,772 2,686 3,021

% of revenue 19.4 18.8 20.5 20.5 20.1 20.9

Operating income ($M) 1,810 1,747 1,493 1,279 1,285 1,237

Operating margin (%) 13.3 12.3 10.8 9.5 9.6 8.6

Pretax income ($M) 1,523 1,402 1,139 820 639 803

Income taxes ($M) 596 544 436 278 205 279

Net income ($M) 927 858 703 618 641 555

Recurring diluted EPS ($) 2.60 2.62 2.21 2.00 2.08 1.80

Average diluted shares 327 309 292 286 307 308Source: May Department Stores.

Nordstrom Income Statements, 1999–2004

Fiscal Year Ended 1/31/00 1/31/01 1/31/02 1/31/03 1/31/04 1/29/05

Net sales ($M) 5,149 5,512 5,608 5,945 6,449 7,131

Same-store sales (% change) –1.1 0.3 –2.9 1.4 4.1 8.5

Cost of sales ($M) 3,360 3,650 3,766 3,970 4,216 4,559

Gross profit ($M) 1,789 1,854 1,844 1,975 2,233 2,572

Gross margin (%) 34.8 33.6 32.9 33.2 34.6 36.1

SG&A ($M) 1,516 1,722 1,699 1,783 1,899 2,020

% of revenue 29.6 31.6 30.6 30.0 29.4 28.3

Operating income ($M) 266 132 146 191 334 552

Operating margin (%) 5.2 2.4 2.6 3.2 5.2 7.8

Pretax income ($M) 332 167 205 196 398 647

Income taxes ($M) 130 65 80 92 155 254

Net income ($M) 203 102 125 90 243 394

Recurring diluted EPS ($) 1.46 0.78 0.93 0.66 1.76 2.77

Average diluted shares 142 131 135 136 138 142Source: Nordstrom.

Federated Department Stores: Part A 30

Sears, Roebuck Income Statements, 1999–2004

Fiscal Year Ended 1/1/00 12/30/00 12/29/01 12/28/02 1/3/04 1/1/05

Net sales ($M) 39,484 40,848 40,990 41,366 41,124 36,099

Same-store sales (% change) 1.8 2.3 –2.3 –5.5 –2.8 –1.6

Cost of sales ($M) 25,425 26,632 26,234 25,646 26,231 25,997

Gross profit ($M) 14,059 14,216 14,756 15,720 14,893 10,102

Gross margin (%) 35.6 34.8 36.0 38.0 36.2 28.0

SG&A ($M) 8,607 8,807 8,892 9,249 9,083 8,245

% of revenue 21.8 21.6 21.7 22.4 22.2 22.1

Operating income ($M) 2,413 2,187 1,178 2,081 1,198 487

Operating margin (%) 6.1 5.4 2.9 5.0 2.9 1.4

Pretax income ($M) 2,419 2,223 1,223 2,453 5,449 547

Income taxes ($M) 904 831 467 858 2,007 170

Net income ($M) 1,453 1,343 735 1,376 3,397 –507

Recurring diluted EPS ($) 3.81 3.88 2.24 4.29 11.86 –2.34

Average diluted shares 381 346 329 321 286 217Source: Sears, Roebuck.

Federated Department Stores: Part A 31

EXHIBIT F

Department Stores’ Gross Sales per Square Foot, 1999–2004

Gross Sales per Square Foot ($)

Company 1999 2000 2001 2002 2003 2004

Federated divisions

Bon-Macy’s 184 191 175 172 169 168

Burdines-Macy’s 168 173 159 155 129 166

Macy’s East 198 203 189 202 203 193

Macy’s West 200 209 186 179 179 183

Rich’s/Lazarus/Goldsmith’s-Macy’s 158 161 148 147 151 155

Federated Department Stores 193 199 185 185 181 187

Sears, Roebuck 327 333 318 303 302 n/a

May Department Stores 210 205 193 174 163 165

Kohl’s Corp. 270 281 283 284 268 255

Nordstrom 349 341 319 317 325 347

Neiman Marcus Group 490 502 481 478 550 532 Sources: All figures from company websites and annual reports.

1 Fingerhut was acquired as an entry into the Internet for Federated. It maintained a database of 30 million customers (mostly low to middle income) and operated several catalogs. Fingerhut was kept autonomous from central Federated operations, a decision intended to foster a separate, Internet-friendly business form, but which also prevented implementation of standard company checks and balances. In mid-2000 it was revealed that Fingerhut had a problem with credit delinquencies. Fingerhut had replaced its closed-end installment credit with revolving credit in 1998; the implementation of late fees, which included an inadequate provision for write-offs that same year; and an aggressive deferred credit program for new customers in 1999. All of these factors led to significant credit delinquencies, which resulted in a $150 million hit to Federated’s EBIT (earnings before interest and taxes) in the second quarter of 2000 and a reduction in earnings by $0.43 per share. In 2001 Federated downsized Fingerhut direct-to-customer operations, saving $40 million in overhead expenses, and focused on making the core Fingerhut catalog a smaller, profitable business with more selective credit extension, even though that meant fewer sales. Also in 2001, Federated eliminated some e-commerce sites, integrated others into Fingerhut.com, and closed or de-emphasized nonretailing activities (such as business-to-business services). 2 From “Shopping Landscape Changes,” Atlanta Journal-Constitution, January 17, 2003. 3 From Federated Department Stores, “Meet our Core Customer.” Coast to Coast (Fall 2003).