The Reason for Ron Johnson's JC Penney Fiasco

The star CEO's flop reveals a lot about the word of retail.

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Shoppers walk into a JC Penney story in Plano, Texas, Tuesday, June 19, 2012. J.C. Penney’s shares are tumbling a day after the department store chain announced the sudden departure of Michael Francis, a former top Target executive brought in last October to help redefine Penney’s brand.

Professor Kusum Ailawadi is the Charles Jordan 1911 TU'12 Professor of Marketing at the Tuck School of Business at Dartmouth.

Under CEO Ron Johnson, JC Penney tried to change its strategy in several ways, but perhaps the biggest change was to promotion policy. The company significantly cut back on the promotions that department store consumers have been accustomed to for decades, not just at JC Penney's stores but at the stores of its competitors.

I am not usually one for making predictions, but this is one failure I can honestly say I saw coming. It sounds like 20-20 hindsight, but it's not. Here is why.

More than a decade ago, P&G tried a similar strategy – they called it "value pricing" – cutting promotions and coupons and ramping up advertising. The company believed that promotions were encouraging consumers to switch for deals and eroding loyalty to their brands. With two of my colleagues, I tracked all the major product categories in which P&G sold for a period of seven years before, during, and after value pricing was implemented. We built a model of how P&G's changes in pricing, promotion, and advertising – as well as their competitors' reactions – affected their market share.

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Market share is made up of three multiplicative components: penetration (PEN), the percentage of consumers who buy the brand at least once; share of requirements (SOR), the share of their total requirements of the category that the brand accounts for (a surrogate for brand loyalty); and category use (USE), the extent to which the brand is bought by heavier or lighter users of the category than average. We found that cutting promotions and coupons raised the effective price consumers paid for P&G products by 20 percent on average (because the reduction in everyday price was not nearly enough to offset the loss of promotions and coupons). This significantly reduced PEN and fewer promotions and coupons did nothing to improve SOR or USE.

What's more, P&G's increased advertising did not do much to increase any of the components of market share. As a result, P&G's market share dropped significantly in many of the categories in which they play, an average of five percentage points per category according to our analysis.

We published our findings in the Journal of Marketing in 2001. P&G might have argued that its goal with value pricing was to raise profitability and not market share, but in the highly competitive and mature consumer packaged goods industry, significant market share losses can quickly create a downward spiral, especially as competitors and retailers react. After much early hoopla about value pricing, P&G learned fast from the effect of its move and quietly reversed course in the early 2000s.

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JC Penny operates in a competitive landscape that is much closer to the promotion-intensive, distribution-intensive consumer packaged goods world of P&G than the heavily price-controlled and limited distribution world of Apple from which Ron Johnson came. Consumers are used to promotions in the department store world, even more so in the segment of the market that JCP operates in. These are price-sensitive, budget-constrained consumers who are willing and able to go to the store next door for better deals.

Not only did the new strategy take away a lot of "deals" that attract consumers to a store and make them feel like smart shoppers, the net price paid by consumers most likely increased because regular prices weren't reduced enough. The appeal of the redesigned JC Penney store is simply not strong enough to offset this. There is too much competition right around the corner. This is very different from Apple, which is highly differentiated and controls distribution and retail price points so that one cannot go to the store next door and find the same product at a lower price.

The lesson of the story is that, even though marketers love to hate promotions, unless you have a very highly-differentiated and premium product, they are extremely important. Promotions offer both monetary and smart-shopper appeal.

A retailer had better have a really efficient cost structure if it wants to compete head-to-head with likes of Wal-Mart, and now Amazon, on everyday low prices. And it had better be very well-differentiated on product assortment, service, in-store experience, and other dimensions if it wants to cut out promotions and survive without being truly low price. JC Penney had neither. If P&G couldn't pull it off, with a lot more brand power and consumer equity than Penney's, then Johnson's JC Penney certainly had the deck stacked against it.

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