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Federated Department Stores' acquisition of The May Department Stores will give the company added national scope and reduce costs, but Federated will still face the challenges of department store retailing, which has been in decline for decades, according to Wharton faculty and retail analysts.

The $17 billion deal, announced last week and expected to close this fall, will create a national network of nearly 1,000 department stores -- many of them under the Macy's flagship brand -- with sales of $30 billion a year. As many as 100 stores, primarily in areas where Federated and May outlets overlap, are expected to close.

The latest merger is a continuation of years of department store consolidation, points out William Cody, managing director of the Jay H. Baker Retailing Initiative at Wharton. "Department stores are at the point where consolidation at this level is one of the only ways they will ever be a viable model going forward, particularly at the mid-market, which is the bread-and-butter of this deal," says Cody.


"Federated is better regarded strategically," says Cody. "May had some positives in some operations, but all in all, Federated is doing a much better job in retailing." Federated is more fashion-oriented while May has focused more on competitive pricing, leaving it more vulnerable to competition from a range of retailers operating at discount price-points, including Kohl's, Cody adds.


Burt P. Flickinger III, managing director of New York business consulting firm Strategic Resource Group, says May acquired damaged goods with its 2004 purchase of Chicago-based Marshall Field's. "The Marshall Field's acquisition was more badly broken than anticipated and it brought The May Company to its knees," says Flickinger, noting that May has less management depth than Federated. May chief executive Gene Kahn abruptly resigned weeks before the merger was announced on February 28.

Federated has made strides in developing more efficient global sourcing, sharper fashion merchandising and more sophisticated database marketing programs, which will help the company hold its own against stiff competition from lower-priced retailers as well as high-end luxury brands, says Flickinger.

Observers also note that the acquisition of May gives Federated a nationwide network of stores, allowing it to better compete against national discount chains such as Target and Wal-Mart, large specialty apparel chains such as The Gap and The Limited, and home furnishings stores like Bed Bath & Beyond. "They want to go more national," says Wharton marketing professor Xavier Dreze. "The idea is you make it national, or global, and you get economies of scale in communicating the message to the consumer. You can go with more mass media, which would be more efficient." According to Dreze, Federated is likely to fold May stores with little reach beyond their own regions, such as Strawbridge's in Philadelphia. "When they look at all their brand names ... the more local ones will be the first likely to be rebranded." Federated has said it will not change any May operations until 2006.


According to Wharton marketing professor Z. John Zhang, the merged company will also be able to cut costs and enjoy new clout with suppliers. "People have learned from Wal-Mart that size does matter. Bigger is better simply because you can squeeze the suppliers and take advantage of the synergies." Federated has said the merger is expected generate savings of $450 million a year by 2007, Zhang adds. "At the two department stores there are all the people who order the merchandise. Now [management] can lay off a lot of those people because it only needs one set of them."

The deal will benefit Federated but may hurt consumers over time, Zhang notes. "In the short term, I think the consumer may see some benefits simply because the costs are lower and the department stores will want to keep their customers in the areas where they do compete. In the long run, though, the reduction of stores will reduce competition."


Zhang points to a growing polarization among consumers who are gravitating to lower-priced apparel at Wal-Mart and Target, but also to high-end offerings at stores such as Neiman Marcus, Nordstrom and Saks Fifth Avenue. These kinds of stores are faring well at the expense of mid-priced department stores such as those operated by Federated and May. "Overall, you have a large number of value-conscious customers, and that is what Wal-Mart is tapping into," says Zhang. "At the same time, you also have very wealthy people. The income distribution has become more skewed in the past 10 to 20 years, so you have fewer people in the middle."

Lois Huff, senior vice president at Retail Forward, the consulting and research firm, says shoppers are saving so much on low-priced, commodity apparel at stores such as Target or Kohl's that they are able to set aside more money for some high-end luxury brands. "There is a lot of bipolar purchasing," she says. Shoppers "can go down and get some great fashions at the lower prices, but then they also go up and get something that really satisfies the ego." As a result, she says, business at top-of-the-line department stores, including Nordstrom, Neiman Marcus, Bloomingdale's and Saks Fifth Avenue, is booming.


She and others say it will be difficult, but not impossible, for Federated or any department store retailer to succeed. "Given the competitive landscape and the pressure on the traditional department stores, they have to change the model they have been operating under for so many years," says Picciola of Morningstar. "They will survive, but we don't see them thriving. You can live in a mature industry if you figure out where the opportunities lie and understand how to position yourself to really capture those opportunities."
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