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Bad Idea: American Eagle Turns to Outlet Malls

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Why the strategy won't work.

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I've been hearing more and more retailers say that they intend to improve profitability and sales by leaving B- and C-quality malls and locating new stores in outlet malls. I find this sort of amazing because of the simplistic outlook it assumes.

This came to mind after hearing American Eagle (NYSE:AEO) make such an announcement at a recent investor conference, though that was not the first time I had heard a retailer discuss the idea. The idea is being presented as a new direction in a tough retailing environment. To be fair to American Eagle, the other pillars of its new strategy -- putting much more emphasis on e-commerce, and cutting costs -- make good sense.

If you could wave a magic wand and optimize your store base, you would want more stores in outlet malls than in B-quality malls because your rent charges would be lower. Great. But would you have the same sales and profitability? That is indeed questionable.

Coach (NYSE:COH) did, and then overdid, the outlet mall strategy. For Coach, it worked. It was a hot brand in a sort of oligopolistic segment (upper-end "near luxury" handbags), and the prices of its handbags were high enough to make a trip to an outlet mall worthwhile. Fine.

But that is not American Eagle's situation.

Firstly, how did the issue of the rising number of B-class malls come about? Was there a huge number of malls built in the last decade? Did several dozen neighborhoods go downhill? Of course not. American consumers just became poorer, or realized that they were poorer in the wake of the 2008 recession. Therefore margins came under pressure.

So, using female apparel as an example, can American Eagle -- after it leaves some B-level malls with its tail between its legs, after having been outcompeted on price by Inditex's (MCE:ITX) Zara, H&M, Forever 21, etc. -- go to an outlet mall, pass along its lower rent costs in lower prices, and keep its previous total dollar profit? I do not see how.

Teens are still going to hang out in that B-grade mall. So American Eagle is gone -- so what? It was just one store of many and one whose prices were too high for its customers. Is it going to suddenly be cool for teens to drive 20 to 40 miles away to hang out in an outlet mall? How do you do that when it's cold, anyway? Outlet malls are not enclosed. Even if you could get teens to spend time in outlets, there would be a transition period that would involve higher marketing costs and lower sales.

This strategy is one that will not work.
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