Department Stores FY2013: a blip or the start of a new era of sustained recovery?

Sales at department stores rose for the first time in 16 years in 2013 and by a solid percentage too. The uplift came from a splurge of high ticket consumption prior to the tax hike, investment in renovation and enlarging of city centre stores – not to mention much better management. Will it last? While the tax hike bonus was clearly temporary – even with another one due next year – there is a sense that the dark decades are over, and department stores have entered a more stable age, a boon for premium overseas brands. Overall the sector will continue to shrink as more stores still need to close or convert to shopping centres, but the leading businesses and stores are in good shape, showing unprecedented levels of innovation and retail marketing.

CHARTS

Chart 1: Top 30 Department Store Firms & Subsidiaries by Department Store Sales Only, FY2013

Chart 2: Leading department stores by Operating Margin, FY2013 (non-consolidated)

Chart 3: Top 50 Department Store Branches, FY2013

Chart 4: Top Department Stores by Apparel Sales, FY2013

Chart 5: Top Department Stores by Accessory Sales, FY2013

A solid foundation 

The combined sales of the 242 department stores in the Japan Department Store Association (JDSA) came to ¥6.22 trillion in FY2013, up 1.6%. This is the first time overall sales have increased in 17 years, and the second time same store sales have increased, rising 1.2% following last year’s 0.3% rise. Even more impressive was the fact that this was achieved despite a 1.4% contraction in total sales space.

Growth came from jewellery and watches, which jumped 15.5% and accounted for 5.1% of sales, followed by accessories, up 5.9%, apparel accessories, which rose 5%, and furniture, up 4.1%. Apparel rose just 0.2% although menswear increased by 1%. Food sales were flat.

Stores in the biggest cities had a fantastic year; for stores in the top 10 cities, sales increased by 3.0% overall and 2.7% on a same store basis, well above the national figure. Osaka led, up 5.4%, followed by Nagoya up 5.2%, and Tokyo rising by 3.5%. Sales at stores in the regions fell 1.0%, a reflection both of tougher trading but also the significant shrinkage in sales space. Chubu suffered the worst fall, down 1.9%, followed by Tohoku down 1.6%.

The top 100 stores by sales posted an increase of 3.5%, the third year of straight growth and a reflection of the much better performance of major stores. At the same time 15 stores saw sales drop 5% or more, three more than last year. Since the top 100 stores account for ¥5.2 trillion in sales and 85% of the market, for most international brands and suppliers these remain the focus and the lift in performance has been a boon for all.

The following sections provide summaries of results and major trends last year by company and store, as well as analysis of strategies and performance going forward.

Leading department store companies (see Chart 1)

• The top 30 firms had sales of ¥5.895 trillion, up 2.6%, a market share of 95%. The one point difference in growth with the sector overall confirms the increasing gap in performance between the leading chains and the rest.
• The top 10 businesses had sales of ¥4.494 trillion, up 2.7%, and a market share of 72%.
• The top four businesses alone, Isetan-Mitsukoshi, J Front, Takashimaya and Sogo Seibu, including their separate subsidiaries, between them control around ¥4 trillion of the ¥6 trillion department store market.
• The highest single increase in sales was recorded by Hankyu-Hanshin, up 11.7% thanks to the re-opening of the Hankyu Umeda flagship and the first full year at Hankyu Hakata, followed by Keikyu in Yokohama, up 11.5% also because of partial closure the year before due to refurbishment. Six firms posted sales of more than 5%.
• Profitability is clearly improving but this is very much a work in progress. Marui remains the most profitable department store firm due to its more SC like operations, although this isn’t saying much. With an operating margin of 6.7%, up 0.7 points (see Chart 2), it is still only on a par with the leading GMS chains.
• Only five firms enjoy an operating margin of more than 3% and, apart from Marui, only Isetan-Mitsukoshi is a major department store group. Isetan-Mitsukoshi also posted the biggest improvement, rising from 2.8% to 3.4%, an even more impressive number considering its margins were at almost zero five years ago. Among the other big groups, Daimaru-Matsuzakaya posted the second highest margin of 2.7%, up from 2.4% the year before. Overall just two of the top 47 businesses made a loss in FY2013.
• Profitability will improve markedly in the next few years – as long as there is no major shock – on the back of more renovations, better store profiling, more tenant income, further rationalisation, expansion into new channels like online and specialty, but above all from the rapid adoption of private brands.
• Shift to directly managed sales areas, private brands and diversification into small format retailing, will be the most important trends in the department store sector in the next five years.

Sales by department store branch (see Chart 3)

• The top 50 department store branches were up 3.7% on average, compared to 1.6% in FY2012, and the top 20 by 4.7% compared to 2.1% in FY2012.
• Total sales for the top 50 were ¥4.01 trillion, giving them a market share in department store retailing of 64%.
• Sales for the top 10 hit ¥1.55 trillion, a market share of 25%, up 2 points in just a year reflecting the focus of investment and traffic at the top stores.
• All of the top 10 saw sales up, along with 41 of the top 50 – up from only half a last year.
• The biggest improvement in sales was at Hankyu Umeda, up 33%, followed by Daimaru Tokyo, up 17%, and Mitsukoshi Ginza, up nearly 13%. All three are recently reopened branches.
• Sales densities give a clearer picture of management’s ability to squeeze more sales from the same space. Isetan Shinjuku remains the most efficient store by far with sales densities of ¥344,049 per sqm per month, a jump of 12% year on year, and ¥130,000 ahead of second ranking Takashimaya Nihonbashi.
• The lowest sales density in the top 50 was Sogo Hiroshima at ¥57,798 per sqm, partly due to major refurbishment at the store, but there were much worse numbers lower down the sales rankings.
• Average sales densities for the top 50 stores were ¥119,946 per sqm, up 4.1% year on year, compared with an average of about ¥83,000 for the entire sector.
• The main reasons for good performance were:
• Department stores were the single highest beneficiaries of the rush to buy prior to the tax hike, especially for jewellery, art and accessories but also higher end lines of apparel.
• The real and perceived increase in personal wealth and general optimism about the economy.
• The growing gap between the wealthy and the rest, with more national wealth accruing to the affluent, partly due to increases in equity values, but also due to social shifts similar to those already seen in other advanced economies. This longer-term trend bodes well for department stores and spending on luxury goods and services in general.
• Major investment in upgrading city centre stores.
• Recovery in sales of re-opened flagships like Hankyu Umeda.
• Additional new space.
• Much better profiling in renovated stores.

Apparel sales by store (Chart 4)

• The leading 30 stores performed strongly in apparel, up 2.9% compared to 2.1% the year before. For the most part, the strongest performances came from stores in major cities.
• The biggest vendor of apparel by far remains Isetan Shinjuku with double the apparel sales of second ranked Hankyu Umeda.
• Daimaru Tokyo recorded the best single performance, up 26.4% thanks to more space, new concessions and popular specialty tenants, followed by Hankyu Umeda up 21%, and Kintetsu Abeno Harukas, up 12%.
• Only four stores in the top 30 saw like for like apparel sales fall – the other two stores with negative numbers were undergoing renovation and sales space was slashed.

Accessories SALES by store (Chart 5)

• Accessories showed much stronger performance than apparel at the top 30 stores with average sales up just under 8%, up from 3.1% year on year. Again the best performances were from stores in major cities.
• Hankyu Umeda overtook Seibu Ikebukuro as the top vendor of accessories, with a huge 46% increase in sales compared to just 2.1% at Seibu – this after a 23% increase the year before. Isetan Shinjuku also jumped a healthy 21.4%, but Mitsukoshi Nagoya was second in terms of sales growth, up 34%.
• Other notable results came from Mitsukoshi Ginza, up 19% largely thanks to tourism, and Iwataya in Fukuoka, up 15%, due to new brands and the much enlarged directly managed sales areas. Matsuya also had a great year, up 11.5% on the back of tourism, the increasing focus on accessories and footwear over apparel, and ongoing improvements in the brand line up and merchandising.

Future trends for existing stores

The solid results from 2012 and 2013 have buoyed the industry. Although everyone is aware that pre-tax hike splurging was temporary, management is still more optimistic about the future than it has been for 20 years. Analysts too are positive about the sector; five years ago the expectation was that, because of population decline, ageing and an absurdly static business model/management, Japan would have capacity for only around 80-100 department stores by 2020. And indeed the sector is a shadow of its former self, accounting for just 4.5% of retail sales compared to some 20% for SCs.

The sector is still likely to shrink, but more stores are likely to survive through other means. The reality is that around a quarter of stores are already managed as SCs in every sense except name, and another third have at least partially converted to SC operations or are planning to, and all but the top flagships are progressively increasing the space for specialty tenants.

So in this sense, the forecasts are coming true – while fewer stores are closing, actual sales space used for true department store retailing is contracting. Ignore all the space now converted to SC operations, and space operating on a department store model will be similar to the total space of the top 100 department store buildings by 2020.

In other words, while true department store retailing is indeed contracting, the businesses and the buildings themselves are adapting to market need.

The optimism in the sector is clear from future investment projections; a recent survey of 33 department store firms showed that 21 planned “significant” investment in the coming year and similar numbers going forward. Notable among these are the number of regional department stores such as Tenmaya, Fukuya, Tokiwa and Izutsuya that are overhauling their stores. Indeed within the industry there is a general sense that most of the work in major cities is complete or at least started, and that the task of fixing the regions is the next priority.

Problems: WHAT STILL NEEDS TO BE CHANGED

Having said that, department stores still face significant problems, mostly the legacy of two decades of intransigence and head-in-the-sand management. These can be broadly summarised as follows:

• An overstore problem (i.e. excess department store capacity) especially in the regions, due to thoughtless expansion in the 1990s, all the more so given population decline and ageing.
• Apparel remains weak even in the boom of last year – product and value/price ratios have to improve in the face of select shop and SC competition.
• Too many stores remain diluted versions of city flagships and are thus very similar to many others and do little to meet the needs of regional populations.
• The average age of customers overall is way over 50.
• There is still not enough clear differentiation or added value compared to competitors in other formats.
• Profitability is still very low.
• Core stores cannot be relied on to deliver anything more than fractional growth over the long-term and with no capacity for new stores, new forms of growth are needed.
• Department stores have still not solved the e-commerce conundrum – although the largest are trying hard.
• Inventory management remains haphazard – although this is mostly just a function of supply chain structures rather than management weakness.

Solutions: Evidence that change is happening

The good news is that genuine solutions for all these problems have emerged and are being implemented much, much more widely:

• Private Brands: these boost operating margins, help chains and stores differentiate better and are being expanded intelligently across whole companies.
• Department store managed sales areas: these again boost profitability and store differentiation, and stores are learning, or hiring, real retail skills to make them work. They also maintain the essence of the department store format.
• SC style operations: whether a total conversion or hybrid store, SC operations mean more stable income and the chance to attract different, usually younger, customers, and also greatly help solve the overstore problem – handing over 50% of space to the likes of Yamada Denki and Uniqlo does wonders in reducing excess department store capacity in a regional city. Most firms are either converting entire buildings, making hybrids or at the least making some space available to tenants.
• Specialty and small format chain development: this is a major potential source of growth and a trend being led by Isetan-Mitsukoshi.
• Overseas expansion: another source of growth, and since most planned stores are mixed SC/department store formats, their success looks to be much more likely than in the past.
• Expansion of e-commerce: department stores are finally expanding e-commerce from just gift sales to fashion, accessories and more, and this is also forcing an overhaul of inventory management to compete with specialty chains and portals. The old ‘gaisho’ system (sales visits to wealthy customers) is also being updated for e-commerce.

Distinctive stores and distinctive strategies too

Future department store strategies can effectively be summarised by these six solutions although not all strategies will be implemented by all firms. Indeed while some strategies are common to all the top chains, what is remarkable about the new era of department stores is how distinct their future plans are. This reflects growing confidence in their own decision-making, a departure from the copycat failures of the past. Since the top four groups control close to 70% of the market, their plans provide a good indication of future trends for the sector as a whole.

Isetan-Mitsukoshi: multi-format retailing and private brands

• Isetan-Mitsukoshi’s number one priority is to continue to increase consolidated operating profit margins by:
• Having more private brands bought outright rather than sale or return. Since 2010 it has increased the ratio of apparel private brand sales to 20%, and expects to hit 30% in the next year or so.
• Investing in significant expansion of small format store chains, with a target to have 150 such stores operating within three years.
• Making positioning adjustments to regional and suburban stores along the lines of Isetan Matsudo to better meet local needs.

Sogo Seibu: a seamless cog in the Seven & I wheel

• Seven & I’s approach with Sogo Seibu is very different. The retail giant’s new found passion for ominchannel retailing, following a study of Macy’s in the US, means that the department store part of the group is increasingly being bent to the wider corporate mission:
• Co-development of private brands with Seven & I group companies. Last year for example it purchased 25 tonnes of cashmere yarn with Ito-Yokado for private brands.
• Sogo Seibu will use the 17,000 Seven-Eleven stores to allow customers to pick up items ordered through e-commerce or even in stores.
• Group member stores are showing up in more and more Sogo and Seibu department stores, notably Loft and Akachan Honpo.
• New formats bearing the Seibu name are showing up in group stores.

Takashimaya: Tamagawa SC the model for all future investment

• Takashimaya too is focusing on its strengths. It knows that the jewel in its crown is not head office management but the team over at Toshin Kaihatsu, which runs the perennially successful Takashimaya Tamagawa SC, as well as most of the group’s overseas properties. The Tamagawa SC is a Takashimaya department store wrapped in an community hub SC made up of a smart selection of specialty tenancies, services and restaurants. Takashimaya says that this community hub model will be used for almost all future investment both at home and overseas:
• The Nihonbashi redevelopment, which will complete in 2019, will consist of the main department store combined with SC operations.
• Other stores with little space to expand are being converted to this model within; Takashimaya Omiya for example now has Junkudo and other specialty stores, and as a result just 30% of the store now consists of department store operations.
• Both the Shinjuku and Tachikawa stores will be remodelled by Toshin Kaihatsu.

Daimaru-Matsuzakaya: multi-format

• J Front’s aim is to become a multi-format retailer. It now owns Parco and a growing small format division that includes Plaza, meaning that just 70% of sales come from department stores – and it is remodelling these too. Its Ginza location will reopen as a major new SC in 2016 with top end tenants, and the South Tower at its Ueno store will open in 2017 with Parco as the anchor.
• In addition, J Front has three strategies for future growth:
• ‘Gaisho’ sales: Gaisho means non-store sales and usually means person to person selling. Gaisho sales climbed 8% last year to ¥130 billion.
• Private brands: Last year outright purchasing of in-house developed brands in womenswear and menswear reached 6% of sales and will hit 8% this year, but through 2016 will jump to 30%.
• Tourism: While all department stores are focused on this for specific stores, J Front is implementing new service areas, tax-free counters and marketing across the chain. Tax-free sales doubled from ¥3.4 billion to ¥6.4 billion last year, but still account for just 1% of turnover.

A solid future – for overseas brands too

This is just a brief summary of changes and trends in the department store sector. That this is brief is itself testament to the level of innovation – a decade ago, new developments would have taken up less than a paragraph. The key question is a) whether these changes will work, and b) what this means for overseas brands and suppliers.

More private brands and contraction of department store space effectively mean a narrower channel for supplier brands, even if concession areas for major brands remain as before. This raises concerns among many overseas brands that the department store channel is becoming much more restrictive, even more so because of store closures.

However, the reality is that these changes are for the most part at the expense of local manufacturer-wholesalers, not overseas firms.

Paradoxically, the increase in specialty tenants and private brands should actually improve the department store market for big and small overseas brands alike. As department stores become more appealing through better merchandising, more dynamic layouts, and improved product in terms of both design and value, footfall should improve – and this means younger footfall especially.

At the same time, expansion of directly managed areas is being done for a reason: not just to improve margins but to make stores distinct from competitors and more interesting. This benefits overseas brands and designers, especially those not yet sold commonly in other department stores.

Equally, the creation of small format stores, especially those Isetan branded formats, opens up a promising new sales opportunity for overseas brands – and given the plethora of product categories in these stores, this means not just apparel and accessories but cosmetics, lifestyle goods and food. There is every possibility that some firms may take the acquisition route to add new specialty store capacity. The same can be said for the growth of e-commerce beyond the staple gift ranges.

Problems of course remain. These include the many regional stores largely unchanged for decades, the merger of inventory management systems for e-commerce and stores, the uncomfortable mashing together of SC tenants and luxury concessions in some stores, and the ongoing evolution of competing formats from the specialty sector. However, the momentum and new levels of confidence among department store management teams, not to mention an improvement in handling relationships with brands (all things are relative), suggest solutions can be found.

All in all, the outlook for department stores in Japan is promising – something not seen since the 1980s. Add in the growing wealth of the wealthy, which should underpin sales of premium sales of apparel, accessories, jewellery, art, furniture and services over the medium-term, and there is every reason for overseas firms to keep close to department stores in the years ahead.