DSW Milestone: Q&A With Michael MacDonald

Michael MacDonald has big plans for DSW, and he thinks he’s got the right team in place to pull it off. “We’ve got a lot of talented people here, and people who have been here for a number of years,” said the executive when Footwear News sat down with him at the company’s Columbus, Ohio, headquarters last month.

MacDonald joined the company as president and CEO in April 2009 at a particularly precarious time, when the recession was in full force and consumer confidence was at rock bottom.

Still, he pushed ahead with a strategic 10-point plan to grow the business. Among his goals: Use the company’s rewards program database to better gauge buying patterns; optimize the size and location of each store; implement a stock locator system; and utilize e-commerce to generate more sales in regions not served by brick-and-mortar stores.

And that plan quickly paid off.

The firm rapidly began growing its sales and income, and its share price also steadily rose, going from about $10 in April 2009 to roughly $45 at press time.

Yet MacDonald believes there is much to do.

For starters, he said, the firm is still on the lookout for new accounts in its leased business segment. He also wants to increase its international operations; grow the company’s store base to 450 doors; enter smaller markets; increase the men’s and accessories businesses; and improve systems to increase the productivity of stores.

“We’ve got all those plates spinning,” said the CEO.

The end goal, MacDonald added, is to become the largest shareholder in the adult footwear market.

According to data from The NPD Group, DSW is currently No. 2, with 3.9 percent market share, just behind Macy’s Inc., which holds 4.4 percent.

And industry insiders think that the firm’s business model just might have the legs to carry it to the front of the line.

“DSW identifies the voids caused by swings in the market better than anyone in the industry,” said Amelia Varela, EVP of wholesale at Steven Madden Ltd. “Their success is in providing their customer a balanced assortment of designer footwear at value price points.”

Given the company’s previous track record, analysts said DSW could hit its many aggressive targets.

Between 2004 — a year before it went public on the New York Stock Exchange — and 2010, DSW’s top line had a compound annual growth rate of 11 percent. Its bottom line grew even faster, by 20 percent.

“That’s impressive,” said Steven Marotta, analyst at CL King & Associates, noting that the firm’s operating margin of 9.5 percent is on the high side for the industry.

MacDonald now wants to double the firm’s profit to $215 million by 2015, from $108 million in fiscal 2010. And he is confident his merchant teams, retail formats and product assortment will help DSW hit that number.

“Our stores average about 22,500 square feet. We’re carrying 25,000 to 30,000 pairs of shoes, which means that versus most of the competition, we cover more fashion points of view, more price points and more brands, all under one roof. We become a one-stop shop for all footwear for men and women. You just can’t compete with us when we’re offering [that many] pairs,” he said. “We’ve become a category killer.”

Here, MacDonald opens up about the company’s critical relationships with its vendors, the challenges ahead and what a potential acquisition might look like for the growing company.

What do you think makes DSW a standout retailer in the marketplace?
We addressed a question the customer had about their everyday shopping experience. I don’t think customers like to be bounced up and down, [thinking] today it’s 20 percent off, tomorrow it’s regular price, the next day it’s 30 percent off. So what we did was offer an experience that we really felt they were asking for but that no retailer was addressing: to offer current, on-trend, in-season product at a fair, everyday value. [Customers] don’t have to worry about walking out the door [with a purchase only to find] five minutes later it’s going to be discounted by another 20 percent.

What do you consider to be the most important elements of the company’s business model?
We have four different elements to our value proposition: [First] is our everyday discount [at] the front of the house, [where shoes are] 20 percent to 25 percent off the manufacturers’ suggested retail price. Then, about 10 percent to 12 percent of our regular-priced footwear has a “Big Deal” sticker attached to it. Those are what we call “screaming values” that are 30 percent or more off the MSRP. And then one of the essential elements of our value proposition is our clearance merchandise. Once a shoe gets to the end of its [shelf] life, we move it into clearance status. All our clearance racks are organized by size [and each shoe has a] color-coded clearance sticker on it [indicating how many percent off it is]. Then, every few weeks we rotate: The 30 percent [ones] go to 40 percent, the 40s go to 50, and the 50s go to 70. The stuff evaporates. We turn merchandise in clearance twice as fast as the front of house does.

How have you developed your vendor relationships in a way that leads to lasting partnerships?
We don’t ask for the manufacturer to pay for marketing and, unlike our competitors, we don’t ask them to give us money back because we generated a [smaller] gross margin [than what] we wanted. [Because] we pay the lowest possible price, we can put those goods out at a price that’s fair every single day. Plus, the supplier knows how much they’re going to make on each sale to us the minute we walk out their door. That’s another reason they love us. And our merchandise team is more committed to every single shoe they buy because they’ve got to make sure it’s going to [sell]. Those are the reasons our [vendor] relationships are really strong. They’re one of the biggest assets of DSW, and it doesn’t appear on any financial statements.

How did the recession change the behavior of the typical customer?
[After the] big economic shakeup [in 2009], a new normal was established [where] our customers came back, but also other customers came to us for the first time because everybody became more value-oriented, whether or not you had money. We benefited from a lot of channel shifting that was taking place. We created a lot more DSW loyalists.

Has the customer’s concept of value changed?
You’ve got to define value broadly. Value is the price you pay and the quality you get for the shoe. Value is also time, and we provide time efficiency to our customers because we have so many shoes under one roof that satisfy so many different interests. Value is also enjoyment. Coming into our [stores], having a sea of shoes [at] great values [accompanied by] hip music…creates a situation where you can move easily throughout the store. That’s part of the value equation, too.

How worried are you about rising sourcing costs and the impact on your own pricing strategy?
The uncertainty around [sourcing] costs and being so reliant on one country [is worrisome] — and that’s industrywide. I never like to have all my eggs in one basket, but we all do. [However], I’m not at all uncertain about our business model. I’m not at all uncertain about the value we add to customers’ lives. Could someone come in here and try to replicate what we do? Many have tried; none have succeeded. We need to make sure that continues to happen. The most important thing we can do is get better at executing our model so we can increase the distance between us and the competition.

DSW has leased businesses with four retailers: Gordmans, Frugal Fannie’s, Filene’s Basement and Stein Mart. What is it you like about the leased department business model?
It makes us money. It also increases our importance to some of our key vendors because it adds to our purchased volume. And it’s important to the [stores] because we can put our shoes in their stores and they’ll start making money from day one. We own the inventory and we take the risk. They just get a percentage of every sales dollar recorded. So it’s low-risk [and] immediately pays off for them.

How many more partners would you like?
Taking on one per year would be as fast as we’d want it because it’s a big deal and we want to do it with quality. I suppose if there was another store that catered to exactly the same market that Stein Mart caters to in a similar geography, we should be careful about that because we wouldn’t want to hurt our existing clients.

Given the success of your brick-and-mortar stores, and the increased competition that comes with selling online, why invest as heavily as you are in e-commerce?
It’s the fastest-growing part of our business. Customers who shop on both channels are twice as productive as those who only shop in the store. We just started selling kids’ online, from Aug. 1, and it’s off to a really nice start. We fired up a mobile website a few weeks ago, which caters to customers who like to use their smartphones. Later this year, we’ll implement the ability to sell internationally. We’re also working on a capability that will allow us to drop-ship, which is essentially selling out of our suppliers’ warehouses so we don’t actually have to own shoes in our fulfillment center.

Why are you investing so much in new systems, and how will that translate into sales?
The objective of assortment planning is to understand fashion, brand and price-point preference by market and by location, so you can orient the assortment to cater to those natural demand patterns. [Systems] allow us to be more precise and predictive. We’ve got some catch-up work to do, and we don’t have a lack of funds [or] a lack of ideas, and we’ve proven an ability to get a return on our systems investment. The only thing that is limiting our ability to spend more is the ability for the organization internally to implement those system changes with quality, and without disrupting our day-to-day operations.

DSW has $400 million in cash and investments. What kind of acquisition opportunities are attractive to the company?
[Because] the footwear market is extremely fragmented, we could acquire other footwear retailers to put us into categories, geographies or price points that we don’t currently operate in. We could go into other e-commerce retailers that perhaps give us new capabilities. We could go into complementary businesses: There are a lot of category extensions within [the accessories business] that might be opportunistic for us. We’re looking at all those things. Our filtering mechanism is we want things that are within our area of expertise; are healthy and have managements that want to stay engaged; can be immediately accretive to our earnings and add value to our shareholders; and that aren’t going to take up so much of our time that we get distracted from our base business.

What size deals are you interested in?
I would say medium-sized [is] enough to garner attention but not so much that you’re betting your ranch. We wouldn’t do anything more than $1 billion, that’s for sure.

What will DSW look like in another 20 years?
We’ll have the No. 1 market share in footwear. Everybody will realize that it’s cool to shop at DSW. We’ll probably own other companies, some of which will have our name on the door and others won’t. We’ll probably have other categories we don’t carry today in brick-and-mortar stores. We’ll have international brick-and-mortar stores. We will have a powerful list of our own private brands — maybe so powerful that [manufacturers] will want to buy them from us. You never know.

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