Nordstrom's big, beautiful stores are losing ground

SEATTLE — For many years, Nordstrom has been regarded as a poster child for how traditional retailers should respond to the rise of e-commerce.

But, as the past year has shown, even Nordstrom isn't immune from the larger forces rocking brick-and-mortar retailers these days, with department stores hit particularly hard.

While Nordstrom's total sales have risen over the past year, its profits have not.

And perhaps most worryingly, sales at the company's full-line stores — the big downtown or mall anchor operations that bring the bulk of Nordstrom's business and have shaped its reputation for stellar customer service — have logged five straight quarters of year-over-year declines.

Whether that extends into a sixth quarter, including the all-important holiday shopping season, will be revealed Thursday when Seattle-based Nordstrom reports its fourth-quarter and year-end results.

"The scary thing for retailers is: What if you did everything right and you're still performing poorly," said Neil Stern, an analyst with retail consultancy McMillanDoolittle. "Which, I think, is kind of the Nordstrom story right now."

Since early on in e-commerce's transformation of retailing, Nordstrom has invested heavily in technology, improving its website, pushing out new mobile shopping features, and integrating its online and in-store inventory systems. It also grew its assortment of merchandise online and expanded its warehouses to handle more internet orders.

That paid off as Nordstrom outshone other retailers and grew its online sales, a rapid growth that's continuing even now. But it's come at a price — namely, higher expenses.

And Nordstrom, like other retailers, is being buffeted by a sea change in consumer spending habits. It's not just that purchases are increasingly shifting online. It's also that mall traffic is reportedly declining, shoppers are more apt to flock to discounters such as T.J. Maxx, and consumers are looking to spend their money on experiences rather than things.

The recent news from other retailers has been gloomy. Macy's, Sears, Kohl's, J.C. Penney and Target all reported weak-to-dismal holiday sales. Macy's and Sears also announced dozens of store closures nationwide. Even Amazon, whose sales soared in the holiday quarter, couldn't meet Wall Street's revenue and profit expectations.

While Nordstrom has announced a few store closures over the years, including one full-line store in San Diego last year and one slated to close this year in Santa Ana, Calif., it has not announced more widespread closures along the line of Macy's or Sears/Kmart.

Nonetheless, Nordstrom said earlier this year that "we're always keeping a pulse on performance and real-estate agreements."

Nordstrom realizes it needs to make some changes — fast — and has started to do so. But it's an open question whether the company can turn around the sales trajectory, especially at its full-line stores, and whether it can do so fast enough.

It's hardly alone.

"A lot of retailers are flailing," Stern said. "They know they need innovation, something breakthrough, but they don't know quite how to do it."

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Judging solely on overall sales, Nordstrom has not done badly, logging year-over-year quarterly revenue increases for much of the last two years.

For the nine months ended Oct. 29 — the latest reported — the company logged net sales of $10.26 billion, up 3 percent from a year ago. (Overall revenue, including credit-card revenue, was up 1.9 percent.)

In comparison, Macy's net sales during that same period fell 5.2 percent, while Kohl's declined 2.6 percent.

But Nordstrom's profits were a different matter. Though the company remained profitable throughout most quarters of the last two years, the profit declined in many of those quarters.

For the latest nine months reported, Nordstrom saw its profit fall nearly 64 percent, to $153 million.

There are several reasons for the gulf between top-line and bottom-line results during those months.

The company's $197 million write-down last quarter for its $350 million purchase of online retailer Trunk Club in 2014 was a hit to its bottom line. Without that write-down, Nordstrom would have logged a profit, rather than loss, that quarter.

Higher markdowns on items to reduce inventory also ate into profits.

Store openings — Nordstrom opened 26 new stores, including three full-line stores and 23 Nordstrom Rack off-price stores — undoubtedly boosted overall sales. But more stores meant more operating expenses.

And "Nordstrom's full line stores are expensive to open and operate, and they take time to get up to speed and make a full contribution to the bottom line," said Neil Saunders, managing director of retail for research firm GlobalData.

Meanwhile, the soaring, mostly double-digit growth in sales at Nordstrom's online sites has cost the company. Revenue from Nordstrom.com, Nordstromrack.com and flash-site sale HauteLook represented a fifth of Nordstrom's overall sales, Mike Koppel, the company's chief financial officer, said early last year. That was up from 8 percent five years ago.

But building out that e-commerce infrastructure, and factoring in the online business model, which has a "high variable cost structure driven by fulfillment and marketing costs," has meant that "expenses in recent years have grown faster than sales," Koppel said.

Deriving one-fifth of its sales from e-commerce is good, said Stern of McMillanDoolittle. But growing e-commerce with great customer service — such as with free shipping and free returns — "it costs you," Stern said.

"Those sales today are not as profitable as brick-and-mortar sales. That's the trap Nordstrom is in right now."

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To curb some of those expenses, Nordstrom cut up to 400 positions last year, representing about 6 percent of its workforce, and laid off 120 tech staffers. Last spring, executives also said they were looking at more cuts in the company's already-trimmed $4 billion, five-year capital-expenditure plan.

But it still will have sizable capital expenditures in the coming years, not least for the 363,000-square-foot flagship store it's building in Manhattan, which is expected to open in 2019. Nordstrom has not said how much it's spending on that flagship, but its five-year capital plan included an estimated total of $1.1 billion for both the Manhattan store and its recent expansion into Canada.

Nordstrom also faces a formidable competitor in hometown neighbor Amazon, which is already the country's biggest seller of clothes online and is likely to overtake Macy's this year as the nation's overall biggest seller of apparel, according to Cowen and Company.

Amazon, with its one-hour delivery and other innovations, is "erasing by the minute" whatever advantages physical stores might claim, such as the immediate gratification of being able to buy something to take home, said Stern.

Perhaps most troubling for Nordstrom is that its full-line U.S. stores have seen comparable sales declines each quarter since the one that ended in October 2015.

Nordstrom executives have tied much of that drop to a fall in mall traffic and have made moves to counter that.

The company has expanded its loyalty program to allow customers without a Nordstrom credit card to earn rewards — aiming to capture the one-fifth of Nordstrom customers who are not part of its loyalty program. Program members spend four times as much and make four times as many trips as nonmembers, executives have said.

The company has also focused more on limited-distribution collaborations with younger-skewing, in-demand brands including Madewell, Topshop and Brandy Melville — a tactic that Nordstrom says is working well.

Nordstrom is also hoping for higher-level ideas, recently creating the new position of chief innovation officer. It tapped a longtime company executive to fill the role, leading a team charged with finding better ways to tie together its full-line, in-store experience with its online experience.

"The way customers are choosing to shop in a more digitally connected world continues to change, and we know we need to find ways for our stores to evolve with them," Erik Nordstrom, company co-president, said in a statement about the new position. "This is a challenge but we also see a tremendous opportunity to leverage our stores in ways that will allow us to serve customers into the future better than anyone else."

(Nordstrom did not make executives available for this story.)

Nordstrom has already introduced features that tie its mobile app to its stores, including enabling customers to reserve items online to try on in stores and to search for items by preferred store.

It's also exploring other possibilities including tying its app more closely to its rewards program, and letting in-store customers know more about the broader array of items it carries online.

Nordstrom's Rack stores, meanwhile, have fared better than their bigger sibling, with comparable sales either rising, or falling less sharply than at the full-line stores.

The company has also been opening many more of the off-price stores than the full-line ones. As of October, Nordstrom had 123 full-line stores and 215 Racks.

As the Rack expands, however, there's the question of whether its sales are cannibalizing from the full-line stores.

"For a lot of people, their experience with Nordstrom now is Nordstrom Rack," said Stern, the McMillanDoolittle analyst. "That's a very different kind of model than the full-experience, full-service stores."

Wall Street analysts' takes have generally ranged from neutral to positive, though not enthusiastic, about Nordstrom, whose shares have been largely mired in the $40s to $50s range for the past year. Its shares closed at $45.69 Friday.

"Overall, Nordstrom is not in the worst place compared to other players in the space, but neither is it quite the robust business it once was," said Saunders of GlobalData. "It needs to adapt and evolve in order to survive."

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(Information from Seattle Times archives was used in this report.)