Federated's seamless transition
James Zimmerman reflects on his first year at the helm

Sunday, May 10, 1998

The Cincinnati Enquirer

James Zimmerman, Federated chief.
(Michael E. Keating photo)
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Four seasons have passed since James M. Zimmerman ascended to the chief executive's suite at Federated Department Stores Inc., and it is spring again. But the chairman and CEO pointed out recently from his trophy-filled office about 200 feet above the potted shrubs on Seventh Street that this is not his first year in such a position. It is his 10th.

In a number of ways, 1997 shows it.

After all, Mr. Zimmerman spent nine years as the company's chief operating officer and president. As recent years have gone at Federated -- the parent of Bloomingdale's, Macy's and Lazarus -- 1997 was relatively uneventful, he said.

"I don't have any earthshaking things to tell you. After 10 years of being in basically the same job, I did not expect the last 16 months since the announcement to be different, and it really hasn't been."

federated at a glance
The point is Mr. Zimmerman, 54, had been grooming for this role long before his friend, peer and predecessor Allen Questrom delivered notice in January 1997 that he would retire four months later -- the announcement to which Mr. Zimmerman makes reference. He could have been preparing longer still, seeing that he spent every year of his professional career -- since 1965 -- at Federated.

No, he said in the spring of last year, there would be few surprises. And for the most part, there were few. Retail traditionalists who feared a sacrifice in merchandising have reported little discernable difference in the company's stores. Terry Lundgren, as president and chief merchandising officer, has proven to be a true Questrom protege -- meaning that the merchandising focus so far hasn't much changed.

Some analysts are getting restless with this -- they want theater as well as good labels -- but others support Zimmerman's priorities. "I continue to believe that Federated Department Stores will grow both in sales and in earnings," industry consultant and former Macy's executive Walter Loeb wrote. "Its management philosophy and execution is excellent."

Indeed, the retailer's performance from May 1997 to May 1998 was in many ways the execution of moves planned by the former management team, headed by "Questerman" -- the moniker put on the Questrom-Zimmerman brain trust.

But there were some developments that set the year apart. For one, 1997 marked the first year in several that Federated operated free of the distractions of bankruptcy and consolidation efforts. Since 1992, it digested the effects of a Chapter 11 reorganization, the expensive mergers with R.H. Macy & Co. and Broadway Stores Inc. and expanded Bloomingdale's into California.

So Federated had a chance to demonstrate how it can perform without those distractions -- and with pretty good marks. An anemic fourth quarter slowed sales, concerning some analysts. But earnings rose a sharp 27 percent, to $575 million, before factoring in consolidation expenses in 1996. After such expenses, 1997 earnings doubled, to $536 million.

To please stock analysts, Federated has the "high class" problem of deciding how to spend about $1 billion in excess cash -- a figure the analysts expect will multiply. To consider: acquisitions, non-store and speciality store offerings and a significant stock buyback.

"You really have to tip your hat to him; the transition was really so seamless from an investor's perspective," said Jeff Stinson, an analyst with Midwest Research Maxus Group in Cleveland.

With the absence of diversion, James Zimmerman -- JZ to some associates -- gets to fix his attention on a balancing act endemic to contemporary retailing: improving shareholder value with customer value while battling the glut of consumer spending alternatives. It means competing on value, not especially price; continuing to reduce the number of department stores; and embracing newer forms of retail, such as selling through Bloomingdale's and new Macy's catalogs and on the Internet.

It's a tall order, warring against hot tickets like Target, Banana Republic and even day spas.

"Federated is a fine department-store company," New Jersey industry expert Kurt Barnard said. "But consumers are now finding that retailers such as Sears, Penneys even, discounters (and) off-pricers, are just fine, thank you.

"The problem lies in the rather substantial and spectacular changes in the American consumer."

So it is that Mr. Zimmerman, as a leading man of American department stores, is subjected to the external forces that are reshaping retail today. Even after 10 years of preparation.

$16B balancing act

Stretched out in a chair at a conference table with a tall glass of water, Mr. Zimmerman, himself a tall man, recites the year's major goals with rehearsed cadence that reflects his operations background: Improve same-store sales with a target of breaking from 2.5-3 percent gains to 3-4 percent; increase margins on earnings before interest, taxes, depreciation and amortization to the 13 percent range from 12.3 percent; grow return on gross investment by about 1 or 2 percentage points from 15.7 percent; and raise share earnings by 15 percent on a compounded annual basis.

Lastly, he wants to reduce debt-to-capital from 45 percent to no less than 40 percent.

"You can't ever just have one subject; life's not that simple when you're a $16 billion company," he said. "And so you do have to balance these different issues."

Where is the customer in this? She is everywhere. She is the means to the end. But attracting her is a gargantuan task requiring more strategy than a generation ago.

"There's a natural assumption within retail today, and not just in department stores, that the customer continues to be the primary focus," said Bruce Van Kleeck, vice president of member services at the National Retail Federation. "And if you focus on the customer with the right merchandise and value, the sales will come, and everything will fall into place."

It isn't so easy nowadays, what with 19 square feet of retail space for every American -- about the size of a walk-in closet -- and with consumers increasingly opting for experiences and adventure over "things."

Loyalty to stores is fading. These days, she's more likely to go for the pedicure than the pullover. Or even shop at Wal-Mart. Some analysts think that this is reflected in Federated's 1997 sales, which eked ahead by 2.9 percent over 1996, to almost $15.7 billion, largely because of the woeful fourth quarter.

"You can run a business so long by driving your expenses down," said analyst Joseph Ronning, with Brown Brothers Harriman in New York. "But at some point, you've got to improve at the top line."

Which is why Messrs. Zimmerman and Lundgren have made sales growth a top goal, to the applause of their vendors.

"In Jim, we have a partner who is exceedingly sensitive to the new realities of retailing and the different roles we must all play in order to be successful," said Denise Seegal, president of Liz Claiborne Inc.

Behind the scenes, Federated is responding with programs to enhance customer service and point-of-sales. On the floor, it continues to diversify presentation and expand and market its major private brands -- of which it offers seven.

The goal is to grow private brands, such as I.N.C. and Charter Club, to represent as much as 20 percent of all sales; those brands command 15 percent now, generating $1 billion in 1997 sales. Those efforts help differentiate Federated stores from its rivals, but many competitors are doing the same thing, analysts point out. Labels, schmabels, one industry insider complained. What about theater? What about store magnetism?

The fight against complacency among department-store retailers such as Federated should be broad and constant.

Federated will battle the two ways it knows how: on the floor and in the boardroom. Having absorbed R.H. Macy and Broadway, and having built a cash war chest, Federated is positioning itself to again take on some of its competitors.

"I'll be surprised if, in the next several years, there is not at least one or two more department store-type acquisitions by us with the free cash flow," Mr. Zimmerman said.

But which retailers? Mr. Zimmerman declines to name names, but Mr. Barnard, the retail specialist, said just a few can be targeted without raising antitrust issues. May Department Stores Co. is too big, and so is Proffitt's Inc. Mercantile Stores Co. Inc., based in Fairfield, is plausible, he said. So much so that it could be a target of Federated and Proffitt's, he surmised.

The rumors have existed for years.

But acquisition is a necessity of growth in retail. There are already too many stores, Mr. Zimmerman said, and competition is so sophisticated that "a lot of the old rules of the game have been thrown out." In his words, retailers must execute the business with more precision, while pursuing "multiple gods" -- sales, profit and return on investment.

"Unfortunately, I guess I'd have to say this is not always a romantic, daylong experience of joy. This is, "I need to get it and still get there in time to pick up the kid in the car-pool line and then get home for my night meeting.' "

Beyond price competition

It's a far cry from the retail world that a young James Zimmerman entered in 1965, clutching a degree in business administration from Rice University.

In the decades that followed, department stores metamorphosed from the primary shopping venue to a slipping attraction on the list of retail offerings that include speciality and superstores. Federated itself survived a hostile takeover and bankruptcy reorganization. Now approaching his 35th year in retail, Mr. Zimmerman is not willing to spar solely by price tag.

"If you compete on price only, nobody makes any money," he said.

"The easiest thing in the world to do if there's pressure on comps (same-store sales) is go out and have another damned sale. But you undermine your relationship with your customer, and that's not the only way to provide value."

As such, the company will pull back on promotions. It might not be noticeable to the untrained eye, but the frequency of coupons at some divisions will lessen. The reduction signs will apply to classifications of goods rather than whole departments.

These are some of the practices that Federated will fine-tune as it operates without the distractions of acquisitions and consolidations. Patrick McCormack, an analyst at BT Alex. Brown, estimates that Federated will generate about $4 billion in free cash flow in the next five years. Expected uses of the cash include growth -- acquisitions, specialty stores and non-store retailing -- and stock repurchases and dividends.

Mr. Zimmerman doesn't argue.

"Most of the analyst community has speculated that we will soon be buying back significant amounts of stock, and I am comfortable with that speculation. How is that for waffle?"

He also is comfortable saying that, yes, Federated has and is considering Europe and Asia for overseas retailing beyond the catalog. The names to make the voyage would be Bloomingdale's and Macy's, the latter of which will make a catalog debut in August. Still, he admitted, Federated has "better fish to fry."

Most analysts agree. While stopping short of issuing James Zimmerman a report card, some said Federated suffers the aches symptomatic of the industry -- the competition, the distracted shoppers, the public's appetite for excitement.

The need to grow shareholder value through customer value.

"I am very optimistic about Federated Department Stores," consultant Walter Loeb said. "It's in a leadership position.

"I think Jim is the whole key to it."

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