Lessons from JC Penney.

Corporate Transformations promise much but rarely succeed in reality, and in any event, the transition is always likely to result in a sharp fall in near term revenues and earnings. Finally, the risk that the transformation will simply fail is not accurately calculated by investors.

All of these elements were present in the JCP situation. A transformation strategy seduced Wall Street, but failed to take into account that customers, employees and the brand’s core identification were all anchored in the past. All of these have to be jettisoned as the transformation process begins. Old customers exit immediately, but the influx of new customers, even if successful, will take time. In the interregnum, the Company’s balance sheet and financial resources will be stressed.

Probably Ron Johnson was mistaken in communicating his strategy so bluntly immediately upon being hired. This simply accelerated the loss of customers before he was ready to begin the implementation of the new strategy.

Meanwhile, the new strategy takes time to develop as the Company must hire new employees, change the fashion direction of the Company and remodel stores. This is a time consuming process fraught with risk. Until this process is complete new customers are not going to be induced into the stores –until they can touch, see, and feel the new strategy in real time.

What happens after Mr. Johnson’s departure is unlikely to be good for shareholders or employees. The interim CEO, Mr. Ullman, while a seasoned expert in retail at JCP, cannot be enthused about the strategy that was the brainchild of Mr. Johnson. On the other hand, JCP cannot go backwards; the old JCP is dead.

The best outcome would be to continue the transformation as a private company. A PE firm might be induced to bid for the company given its undervalued real estate assets, estimated at $11 per share. However, the buyout price is likely to be a discount to the current price level near $14.

A interesting question is whether the Board engaged in a thorough planning exercise to understand the enormity of the transformational strategy, or whether they simply relied on the instinct of one “genius”. Rumors suggest that the latter was the case.