Macy's in-store Backstage off-price unit risks harming margins

Macy's year-old strategy of opening its Backstage off-price chain within its existing department stores drives traffic into the main store, the retailer said on Thursday, but analysts said the move confuses customers and could hurt Macy's longer-term results.

Macy's reported a bigger-than-expected fall in quarterly profit and sales, hurt by sluggish demand for discretionary items like apparel and an inability to retain shoppers who are moving online.

Despite the poor performance, the retailer doubled down on its in-store discounting plans and said it will open 19 more Backstage stores within existing Macy's stores to drive traffic and sales. Macy's has so far combined 26 such stores.

Backstage discount stores sell excess and off-season inventory at steep discounts and compete with the likes of Nordstrom Inc's Nordstrom Rack and TJX Cos.

Macy's said 70 percent of millennial and two-thirds of their best customers shop off-price items on a monthly basis. These core customers like the opportunity to find merchandise that offers a "deep value" within existing locations, it said.

"We are encouraged by the performance of these combined stores, where the total store sales are being lifted," Chief Financial Officer Karen Hoguet said on the company's conference call.

Macy's also assured investors it is careful not to add merchandise in the discount format that would hurt sales in the full-price section.

Despite the assurances, analysts said the strategy risks undercutting full-price sales in the longer term, a development that puts Macy’s higher-margin sales at risk.

"As much as we can see the logic for this from the perspective of trying to make space more productive, we believe the strategy will ultimately fall short," said Neil Saunders, managing director of research firm GlobalData.

Saunders said customer data shows evidence that such moves send confusing messages to shoppers about the Macy's brand. Ken Perkins, founder of research firm Retail Metrics, said he is skeptical the move will make consumers buy full-price at such locations, especially as they get used to finding bargains.

"Traffic is obviously going to come at lower average unit retail and smaller transaction prices and those consumers are unlikely to gravitate to the other part of the store."

Steep discounts have hurt margins of department store operators, resulting in weaker quarterly results and bleaker forecasts.

But Macy's is confident the move will offer it the distinct competitive advantage of tapping into shopping mall foot traffic.

"Most of our ferocious off-price competitors are off mall right now," Chief Executive Jeff Gennette said. "We do hope that we will have a viable off-price concept that is on mall... that millions of American consumers come to each and every day."