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The Science of Hitting
The Science of Hitting
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J.C. Penney's Ron Johnson at Brainstorm Tech - Notes

July 23, 2012 | About:

While I continue to pound the table on J.C. Penney (JCP), I feel the need to keep my readers informed on any new developments; with CEO Ron Johnson appearing at a recent Fortune conference (link to the video and full transcript here), I thought I would post my notes for the GuruFocus community (the bold is added by me for emphasis):


I’m continually amazed by the short-sighted focus of analysts and talking heads when it comes to JCP; here is what Ron had to say about the timing of the transformation:“Like any business thing, a transformation is a marathon, it's not a sprint. It's been interesting for me watching all these analysts: They think this is going to change overnight. As you recall, when we were in New York in January, we said this could take four years… You know, if people want to know what the vision is, and we tried to lie that out quite clearly, but it doesn't mean it's going to be easy; you know it's going to take time.”


“Right now, we have 3,415 unique stores under construction. So next week, we'll open up a lot of new stores, because we're creating all these specialty stores; we'll be the best place in America to buy a pair of jeans… Buying a pair of jeans is actually quite hard for people. There are a lot of fits, a lot of finishes. We're putting in what's called the Denim Bar with Levis that will launch next week. We're opening in about 700 of our stores, so most Penney stores.”


I find it fascinating that people point to the threat from e-commerce (where price is readily available), yet question JCP’s shift away from non-differentiated commodity products (which, by definition, compete on price alone) when the company cannot win against the likes of Amazon (AMZN) or Wal-Mart (WMT) on price; here was Ron’s take on the threat of e-commerce:

My take is that the physical store will have a permanent place, and it will vary by category. When I came out of Harvard Business School in the 80's, stores weren't going to work because the catalogue was going to take over. What woman who's working, who could sit there and read a catalogue and call 1-800 and have it delivered to the door, would ever go to a store? The catalogues went through in many ways a small version of what the Internet did. After six or seven years, catalogue had 7% of general merchandise retailing, [and] stayed there. There were certain things that happened for that category that required you go to the store… If I had to pick today, would I rather be an online only retailer and try to compete ten years from now, or a physical retailer trying to complete ten years from now? Knowing that the digital and physical worlds come together, I'd take a physical retailer in a heartbeat because it can do everything an online person can do and more, because it has that physical presence. You know, when you offer pickup, as many as 40 percent of the people choose to select online, pick up in store, right? That's a relatively new thing surprisingly for retail. But then when we enhance that pickup experience, you know, so if you order clothes and you come and they're in the fitting room to try on, and you can pick several items, and you don't have to worry about a return if you don't like it, we're now solving problems that exist for an online-only retailer.”


“Fundamentally, we're changing our pricing strategy, because we want every day to be a great day to shop, and if you're designing a new interface designed by its nature, whether it's a product or an experience, what's the most important thing it has to have? It has to have integrity. If you're going to build a relationship, you've got to have integrity to that. So it's hard to have integrity when you artificially mark up products just to mark them down… Every business has its own pricing strategy. We've chosen to go to every day. The reason we've done that, though, is because every brand has its own DNA… If you go back to J.C. Penney, the first ten years of our store it was called the Golden Rule. It was founded on the principle of do unto others as they do unto you. In 1920, Mr. Penney wrote a letter to shareholders or to customers saying you know, we do not believe in marking up goods beyond a fair profit. We will not mark things off 10, 20 or 50% off. We do not do that type of business… That's a business model choice, and we're going to honor that as part of everything we do. It takes time. When Wal-Mart changed its pricing back in the 80's, and went back to everyday low, after about seven months, [CEO] David Glass and Sam [Walton] looked at each other and said "Can we do this? It's really hard.”

They had a huge drop [in sales], and everyone's going to, because you're basically taking an unsustainable business model and you're depromoting… But you get through one year and you're onto a new future. It's a one year depromote, and then we've got a business based on integrity.

The other thing about retail stores, it's all about the friends you keep, the company you keep, the brands you carry. In a discount promotional model, no great brand wants to be put into that environment, because you're devaluing the brand. So the only way to sustain a promotional model was with your own private label. So if you look at Penney's or Kohl's today, 60% of the products are designed by the in-house teams. They're not designed by other partners who have real great design skill. So this is going to -- fundamentally, the pricing strategy enables everything we want to do. It transforms everything.”


“There's a great theory when you go to business school about good profits, bad profits. Good profits come from really treating that customer well. You know, bad profits to me are artificially inflating the price, trying to deceive the customer through a fake sale. It's not sustainable. Good profits are competing on earning loyalty through service and products and presentation, and honoring a customer in the store.”


The interviewer asked if the near term has been tougher than anticipated, which Ron agreed with; afterwards, he said the following:So we plan to go backwards. We'll go back a little more. So the real fundamental question is when we end this first year, and I said that we're going to transform this company, not improve it.” I only note this because Ackman’s presentation showed Penney’s sort-of leveling off at Q1 levels. Personally, I do not think they will be able to hit those levels and that Mr. Johnson’s choice of words reflects that; not that I’m particularly concerned either way (I’m still loading up because it is simply a short-term guess and of little importance in the long term), but I wouldn’t be surprised if Q2 was even worse than anticipated.


Ron reaffirmed the board’s total support for management and the plan, and had this to say about the rampant speculation:“Yeah, most people -- you know, what happens, what's been interesting to me is in the absence of information, there's a lot of misinformation, and as you know, we've chosen not to address everything that comes up in the press. So when you don't react, it kind of runs with it, and there are a lot of people who love to do that. But you've got to ignore all that.

Mickey Drexler said run; ignore it all, put your head down, do what you know how to do…

Apple went through much tougher years then we're going through this year at Penney's. I joined in 2000. In 2002, Apple's revenues dropped 38% from 2001. In 2004, the stock was below where I joined in 2000. We all forget these things… We're in a marathon here. It's going to be four years, and we've got a very precise vision of how we're going to get there, and we're going to stick to our plan, you know, because that's what it's going to take. You know, that's what I learned at Apple; that's what it's going to take here.”


On the day of the event, Oracle announced that JCP had transformed their entire retail platform to Oracle Retail Systems; here’s what Ron had to say about the switch: “Like many large companies, we had all these systems and then built up for the year, and 90% customized [of] 490 unique applications, when you should run a company of our size with fewer than 100. So we made the decision we're going to transfer everything to Oracle, you know, the core-based platform, and we can do that spending less money than we spent last year, and begin to invest in all of these customer-facing technologies, and it's going to be real exciting. So we're trying to simplify internally, and transform externally, and you'll see massive change over the next six months and year in-store with technology… We're also doing something that no retailer has done completely: we are going 100% RFID with ticketing this fall… We're going to jump right to the customer, and my goal in 2013, by the end of 2013 is to eliminate the cash route… About 10% of all the money we spend, $500 million a year, goes to transactions; well, that can be done through technology.”

About the author:

The Science of Hitting
I'm a value investor with a long-term focus. As it relates to portfolio construction, my goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach to investing is "patience followed by pretty aggressive conduct". I run a concentrated portfolio, with a handful of equities accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

Rating: 4.5/5 (19 votes)


Josh Zachariah
Josh Zachariah - 5 years ago    Report SPAM
The interview is thoroughly elucidating, thanks for sharing!
The Science of Hitting
The Science of Hitting - 5 years ago    Report SPAM

Sure thing! Hope the extra insight on the JCP plan helps with any analysis!
Stevenramsey - 5 years ago    Report SPAM
One of the keys I see in successful retail companies is that the guy at the top has to be a superstar (think Sam Walton, James Sinegal, Apple, etc). Ron Johnson is one of these. One of the other qualitative aspects I like about this investment is how it really seems to fit the framework of "Good to Great", by Jim Collins. After reading the Q1'12 transcript, I felt as if I was seeing the dynamics of that book play out in real-time. The right people are on the bus, they are in the right place, and they are changing the culture and the business model completely.

Another point to remember is that this is not a turnaround of a company in a ditch. They are not on the brink of bankruptcy. While I don't think it's worth trying to put investments into buckets all of the time, I do not believe it would be fair to call this a "distressed value play". Is it contrarian and out of favor? A resounding yes. But as the price gets lower, the downside for an investor does too. At these prices, with solid management, an established footprint, and a business that is changing its trajectory from a commodity to a business with better pricing and lower costs, I am willing to buy now, buy lower, and wait.

Remember, the tortoise beats the hare.

Cogitator99 - 5 years ago    Report SPAM
Thanks for this man
The Science of Hitting
The Science of Hitting - 5 years ago    Report SPAM

Interesting commentary; thanks for that!


You're welcome!
Equitynovice - 5 years ago    Report SPAM
Very informative. If this approach is successful, what would stop other competitors from copying? Will such copying have any impact on JCP as a business?
The Science of Hitting
The Science of Hitting - 5 years ago    Report SPAM

That's a good question; I would point to a couple of things that may deter competition: the capital investment that needs to be made, the near term pain of the shift (most mangers don't want to step away from the herd, particularly to be slaughtered for months on end like JCP has been), the time to complete the change (3-5 years), the inability to attract great vendors (JCP has the pick of the litter), etc. I think those things will cause a serious lag or even outright discourage copycats from attempting to replicate this model if it turns out to be successful (have to get that part done first!).

Thanks for your question!
Cogitator99 - 5 years ago    Report SPAM
Science, I think if JCP is successful it probably won't take 3-5 years to copy the model. Nothing takes that long to copy anymore.

What do you think of Ackman's 15x comment? Seems high to me.
The Science of Hitting
The Science of Hitting - 5 years ago    Report SPAM

Maybe you're right; I'm simply using their time frame as guidance. I think the important part is not the timing to actually implement the strategy, but rather management's willingness to accept short term pain; regardless, they will not have the pick of the litter for branded partners like JCP does.

In regards to the 15x comment, I guess it all depends on how low the stock can go; I continue to believe that the company is worth $8-10B in it's current status (based on earnings power post-cost cuts and the asset valuation), and has the potential to be worth $20-25B in the next 5 years (See Ackman's base case for EPS of $6, which suggests the stock could easily hit $90-100/share).

While that's not 15x, I certainly wouldn't be unhappy if this jumps 5x through 2016...

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