The Retail Trick That Has J.C. Penney Company, Inc. in Hot Water

By Markets Fool.com

Continue Reading Below

A lawsuit claims that when everything is always on sale, nothing is really on sale. Photo: Chris Chan, Flickr.

The doorbuster sale alone isn't responsible for the ongoing turnaround at J.C. Penney . Nevertheless, it has had an undeniable role in bringing back customers who fled following the disastrous pricing policies of former CEO Ron Johnson.

But now the department store chain is facing a class action lawsuit because it followed this standard retail industry playbook, and this could derail its recovery.

An emotional appeal
Johnson thought customers were logical enough to understand that sales in the industry were illusory, offering what he called "fake prices" in which retailers marked up prices just so they could discount them later. Instead, he instituted what he called "fair and square" no-coupon pricing, or prices that were consistently low -- in many cases 40% lower than J.C. Penney's previous price -- while only offering a monthly sale on select merchandise.

But Johnson was wrong. The low-price-everyday policy that has served Wal-Mart so well over the years didn't resonate at all with J.C. Penney shoppers. In what will likely be a Marketing 101 case study for many years, shoppers fled the department store chain in droves, driving down revenue by 25% in 2012. Macy's , on the other hand, kept standard industry practices in place and was rewarded with a 5% spike in sales that year.

Continue Reading Below

The return of sales and coupons has helped J.C. Penney bounce back sharply since its near-demise. Data: J.C. Penney quarterly SEC filings.

The psychology of pricing means you'll sell more of something priced at $9.95 instead of $10. Shoppers also want to believe they're getting something special, and few things convey they're getting a deal more than merchandise that is "on sale."

Breaking down the doors
After ousting Johnson in favor of his predecessor, Myron Ullman, J.C. Penney moved fast to scrap most of the reforms that had been put in place, including everyday low pricing. The doorbuster sale made its reappearance and sales began to recover.

In fact, J.C. Penney might even be reclaiming those customers who fled. Since late 2013, its same-store sales growth has far exceeded those of Kohl's and Macy's. Macy's has even seen its comparable sales turn negative.

But not everyone is happy with the promotions. As Johnson said, the prices are fake, and a class action lawsuit filed against the retailer says they amount to consumer fraud. J.C. Penney is accused of faking prices on almost all of its sales.

An anchor around its neck
The problem is what's called "price anchoring," or comparing a sale price to an original price that is never really available. Anchoring itself is OK, so long as the original price is real. But when the retailer doesn't ever sell merchandise at that higher "original" price, offering a discount to that price is misleading to consumers.

According to the market researchers at Checkbook.org, many retailers engage in what amounts to a never-ending sale. It tracked a basket of goods from retailers including Kohl's, Macy's, and Sears Holdings over a 44-week period and found that much of the merchandise was rarely or never sold at the full price.

Sears was the worst offender, only putting items at the full price during times when customers weren't visiting its stores anyway. It also listed the items as being "on sale" even when it was charging the full price, but just neglected to put the original price on the sale tag.

Kohl's and Macy's were also found to engage in "egregious and deceptive" pricing, while others includingBest Buy, Home Depot, and Target didn't rely as much on perpetual discounts. Costco rarely offers any sales.

J.C. Penney isn't the only retailer running a never-ending sale, but its reliance on the practice to save itself might have made it a higher-profile case.

Everybody's doing it
The lawsuit says that J.C. Penney has operated a "massive, years-long, pervasive campaign" of deceptive advertising. While it's obvious that many retailers are playing the game Johnson tried to end -- and Kohl'sand Jos. A. Bank have previously been hit with similar suits -- J.C. Penney's still-precarious financial position means that it has the most to lose if it's forced to alter the way it prices goods.

J.C. Penney has relied on its doorbuster sale strategy to stage its recovery. Sales rose 3.4% last year on a 4.4% jump in comparable sales. Those metrics were up 2% and 3.4%, respectively, in the first quarter of 2015.

The retailer has initiated other plans that have contributed to the recovery, including partnering with beauty supplies retailer Sephora and bringing back popular private-label brands. Still, if consumers can't get a deal on J.C. Penney's products -- or worse, perceive that they're not getting a great deal on them, they might flee its stores once more.

Yet the plaintiffs in the case face an uphill battle. For example, the Jos. A. Bank lawsuit was tossed out for failing to demonstrate the harm the pricing caused consumers. But the case could pressure J.C. Penney to modify its policies to ensure it doesn't run afoul of consumer protection laws. And in the end, that could run its recovery off the rails.

The article The Retail Trick That Has J.C. Penney Company, Inc. in Hot Water originally appeared on Fool.com.

Follow Rich Duprey's coverage of all the retailing industry's most important news and developments. Heowns shares of J.C. Penney Company. The Motley Fool recommends Apple, Costco Wholesale, and Home Depot. The Motley Fool owns shares of Apple and Costco Wholesale. 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.