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Off Price Is The New Black For Retailers

The promise of a prestige name at a sweet price — minus the clearance-bin rummaging — has become a fixture in post-recession retail, prompting more department stores to mimic the off-price model as they adjust to an ongoing shift in spending habits.

Macy's (NYSE:M) is the latest — and largest — department store chain to explore the lower-price space, with the first Macy's Backstage locations opening last week in the New York tri-state area. Then on Tuesday, it announced the closing of 35-40 mainline stores in early 2016.

Along with Nordstrom (JWN) Rack, Backstage joins Neiman Marcus' Last Call, Bloomingdale Outlet (also owned by Macy's), J. Crew Mercantile and Saks Off 5th in the discount world.

4 Mil New Shoppers

High-end chain Nordstrom has made a successful play for the off-price customer. The first discount offshoot opened in 1973, and by the end of 2012 there were as many Nordstrom Racks as Nordstroms. As of Aug. 1, Nordstrom Racks outnumbered full-line stores 178 to 118.

Rack is showing "really good momentum," said Cowen & Co. analyst Oliver Chen, who believes that it will continue to produce attractive comps and square footage growth.

The off-pricer is Nordstrom's "biggest source of new customers," Co-President Blake Nordstrom said during the company's Q2 earnings call, bringing in 4 million new shoppers in 2014 and outpacing the rest of the business.

Rack's sales rose 13% in Q2 on 1.7% same-store sales growth, compared to 1.1% net sales growth at Nordstrom's full-line business and combined full-line and online comps of 0.8%.

In theory, off-price shops stock clearance products from the main stores, but it has become common for them to carry lower-cost, made-for-outlet merchandise. Only about 20% of Rack merchandise comes from Nordstrom, according to fashion news site Racked.

Going On Treasure Hunt

Shoppers seeking out a specific dress will have to head to the mainline store, but off-price channels are for those who want a whiff of the main brand's offerings and have a flexible shopping list.

As with many things, technology and the Great Recession can be blamed for the new normal in consumer spending habits.

"The treasure-hunt environment is universally appealing," said Chen, adding that even higher-income shoppers who adjusted their buying habits after 2008 aren't likely to want to go back to paying high sticker prices.

"No one's saying, 'Oh, now I want to pay $1,000 (again),'" he said. "It's fashionable to look for values.

While Macy's is now joining the off-price trend, it has been one of the best operators in the department store space, Macquarie analyst Laurent Vasilescu told IBD. But "it is a shrinking universe.

The overall department store space has tumbled as retailers struggle to woo back customers from one-stop e-shops like Amazon (AMZN), he said. Department store sales peaked at a seasonally adjusted $19.9 billion in January 2001, falling to $13.8 billion as of July, according to census figures.

Department stores are well aware of the amount of turf that they've lost to off-pricers, Retail Metrics' Ken Perkins told IBD, with TJX (TJX), Ross Stores (ROST) and others gobbling up precious retail market share at an accelerated pace since 2008.

Stores like Nordstrom and Macy's "are looking at the post-2008 crisis landscape and seeing a very different consumer that's looking for brand names for discount prices and isn't as willing to shop in their main stores," he said. "It's a growth vehicle. There are very few of those avenues left.

But as department stores chase those shoppers, one question they face is whether adding lower-priced stores will tarnish the prestige factor associated with a company's main brand.

Case in point: outlet-heavy Coach (COH), which several analysts name-checked when talking brand dilution. The purse maker's image took a hit after the brand's discounting activity and abundant factory outlets turned off would-be buyers.

But department stores, which carry a suite of brands in different segments, aren't as vulnerable to dilution, said Chen.

If anything, off-pricers like Rack could draw both higher-income shoppers looking for deals as well as middle-income shoppers looking for an accessible entry to coveted brand names.

"The aspirational consumer that wants to be able to shop at Nordstrom — maybe it's a real stretch for them to shop at the mainline department store, but they'll get a few things at (Rack)," Perkins said.

An Alexander McQueen dress, for example, runs from $1,500 to $6,400 on Nordstrom.com. But on NordstromRack.com, deal seekers can get a McQueen frock for $500 to $650 (though there are only two from which to choose).

For Macy's, which already often discounts its mainline merchandise, brand dilution "would definitely be a bigger concern," said Perkins. And a recent sneak peek into Macy's Backstage made Credit Suisse analysts wonder if the prevalence of private-label brands could create "pricing confusion.

"Most off-price retailers sell little to no private label items, but Backstage had a significant amount of Macy's private label merchandise, especially in the juniors and women's apparel areas," wrote Credit Suisse analyst Mic-hael Exstein.

Best-case scenario? Off-pricers draw in new shoppers, who make the leap to the brand's full-price channels. Nordstrom has already seen it happen.

"Last year, we had 1 million Rack customers start to shop at our full-line stores or Nordstrom.com for the first time," said Nordstrom during the call.