Diversification Is the Key to the Nordstrom, Inc. Story

By Markets Fool.com

A little more than 50 years ago, a chain of shoe stores in the Pacific Northwest decided to add clothing to its merchandise mix. Since then, Nordstrom has grown to become one of the largest department store companies in the U.S. (the company formally refers to itself as a fashion specialty store).

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Operating upscale department stores has been a highly successful enterprise for Nordstrom for the past several decades. But to drive its next phase of growth, the company is looking well beyond its traditional business. Here is how it is branching out in order to reach its full potential.

Beyond the four walls
As recently as 2009, Nordstrom derived 73% of its sales from its 112 full-line stores. However, mall traffic has stagnated in the U.S. lately, due to various factors including the growth of e-commerce. This trend has forced many department stores to retrench, including industry leader Macy's.

Nordstrom has managed to continue growing sales in its full-line stores -- slowly. It added five full-line stores (net of store closings) between 2009 and 2014, and grew sales in full-line stores from $6.4 billion to $7.7 billion during that period.

Sales in Nordstrom's full-line stores are growing but slowly.

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However, Nordstrom has increasingly been cannibalizing its in-store sales through its website. It has invested heavily in e-commerce, and the payoff has been huge. Online sales have surged from less than $600 million in fiscal year 2009 to $2 billion last year.

Nordstrom.com now accounts for 15% of total revenue, and it is still growing quickly. Sales increased 23% last year, and Nordstrom has set a goal of increasing online sales by more than $1 billion by 2017.

Lastly, Nordstrom bought fast-growing fashion start-up Trunk Club last year. Trunk Club allows men to get personal style advice either online or at a showroom and then receive a "trunk" of handpicked items to try on. Customers can keep what they like and return the rest. Trunk Club more than doubled its revenue last year to around $100 million, and Nordstrom expects it to double its revenue again in 2015.

Growing off-price sales
Nordstrom is also branching out beyond its upscale roots by investing heavily in its off-price business. Nordstrom roughly doubled the number of Rack outlets between 2008 and 2012. By the end of 2012, Rack stores outnumbered full-line Nordstrom stores. In August 2012, it laid out a goal of doubling its Rack store base again by 2016, reaching 230 locations.

The company ended fiscal year 2014 with 167 Rack stores, and it has firm plans to open 27 more locations this year. While Nordstrom will probably fall short of hitting its 230th Rack store next year, it recently provided a new target of operating 300 Racks by 2020.

Nordstrom plans to continue growing the Rack chain quickly for the next few years.

This rapid store growth has already boosted Nordstrom Rack sales from $1.4 billion in fiscal 2009 to $3.2 billion last year. The additional planned store growth and the maturing of recently opened stores should allow Nordstrom Rack to more than double its revenue again by 2020.

Other department stores have taken notice of this success and are moving to enter the off-price business themselves. Most recently, Macy's announced plans to test an off-price concept starting this year(it already operates a handful of Bloomingdale's Outlet stores).

However, Macy's is light years behind Nordstrom in the off-price business. Having already built up a solid physical presence, Nordstrom Rack is now moving on to building its online operations. Online off-price sales already account for 3% of total revenue.

Putting it all together
Online sales growth -- primarily full-price but also off-price -- and the expansion of the Nordstrom Rack chain are rapidly changing Nordstrom's revenue mix. Whereas 73% of revenue came from full-line Nordstrom stores in 2009, the full-line stores only accounted for 58% of revenue last year.

Nordstrom has laid out a target of reaching $20 billion in revenue by 2020. Most of this growth will come from online and off-price sales, but Nordstrom's entry into Canada and the opening of its first full-line store in Manhattan do provide some growth potential for the full-line stores as well.

As a result, Nordstrom's growth will lead to better diversification of its business. Full-line stores will probably represent significantly less than half of total revenue five years from now. This will ensure that the company remains well-positioned to continue adapting to the evolving retail environment.

The article Diversification Is the Key to the Nordstrom, Inc. Story originally appeared on Fool.com.

Adam Levine-Weinberg owns shares of Nordstrom. The Motley Fool recommends Nordstrom. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.