Tuesday, July 24, 2012

Duane Reade’s Miracle Makeover

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September 29, 2011

Courtesy Business week: For the Case Analysis on this case check its under a separate blog entry
Duane Reade’s Miracle Makeover
Draft beer and sushi? Friendly clerks? The once-reviled drugstore chain’s new strategy pays off
For decades, the Duane Reade drugstore chain offered one of New York’s rawest shopping experiences, with the ambiance of a DMV, with really narrow aisles, maybe located in Times Square circa 1973. The layouts were labyrinthine and the merchandise disorganized. The staff was so famously sullen that the blog “I Hate Duane Reade: Service from Hell” used to come up first when Googling the company. In 2007, New York magazine asked the actress Martha Plimpton, a lifelong resident of the city, what she hated most about living there. “The dead-eyed pharmacy people at Duane Reade,” she said. “It’s always a journey into the heart of darkness.”
Now there’s the Duane Reade on 40 Wall St. The chain’s 254th store, just down the block from the New York Stock Exchange and across from a Tiffany’s, is like an extravagant apology to the city. It occupies a 22,000-square-foot space with 28-foot-high ceilings, graceful archways, marble columns, and a gilded air. The Rockefellers ran a bank there. Now Duane Reade offers $10 manicures where David Rockefeller’s office used to be.
The store, which opened in July, also has a hair salon, a juice bar, two sushi chefs, and a holographic greeter. There’s still aspirin and toothpaste, and now there’s a doctor, too. Beauty consultants are available, along with two different machines that provide virtual makeovers. A 20-foot-long stock market ticker flashes above the front windows. “So many men have been asking for haircuts that we decided to do those, too,” says Paul Tiberio, the executive in charge of merchandising and marketing at Duane Reade. “No shaves, though. We don’t want blood.”
Tiberio, dressed in a pinstripe suit, a crisp white shirt, and a tie in the new corporate lavender, is an enthusiastic tour guide. He walks over to the brightly lit refrigerated section and says, “We’ve got everything you would find in a grocery store, except the hanging meat.” At the sushi station, the chefs—two Korean brothers—are preparing for the lunch rush. The improbability of that image is striking. “We had been a little reserved about rolling out sushi in a drugstore,” Tiberio says. “But after we did salads and sandwiches, we thought we could do sushi, too. Now sushi and fresh juice are two of our top five sellers here.” Rounding out the list are bananas, coffee, and Marlboro cigarettes. “This is great,” he says. “You have a dream and it works.”
Duane Reade’s transformation is as noteworthy as any in modern American retail. It occurred mostly during the Great Recession. It involves private equity backers from Oak Hill Capital Partners in Stamford, Conn., and a group of Canadian executives who brought a fresh view of what an American drugstore could be.
In early 2010, Oak Hill sold Duane Reade to (WAG)Walgreens, the nation’s largest drugstore chain, for $1.18 billion, about $300 million more than it paid in 2004. The alternative—that Duane Reade would go the way of Circuit City and Borders—had been just as likely. “Duane Reade couldn’t forever ignore the consumer or it would have gone out of business,” says Bruce Cohen, a retail strategist at Kurt Salmon consultancy. “Now, for the first time, consumers have expectations about Duane Reade. Can Duane Reade live up to that?”
Duane Reade had come by its decrepitude honestly. The company was founded by three brothers, Abraham, Jack, and Eli Cohen, in 1960 and named for the two streets that bordered their first store on Broadway in Lower Manhattan. They pioneered what has come to be known as the (SBUX)Starbucks strategy, opening their second store opposite their first. The Cohens expanded slowly over the years and in 1992 sold the chain of 37 stores to Bain Capital, then run by Mitt Romney, for a reported $239 million. When Duane Reade went public in 1998, there were 67 stores. Six years later, when Oak Hill bought the chain, it had 239 stores. Now there are 256 Duane Reades in New York City, more than there are (MCD)McDonald’s.
“Duane Reade was always overly aggressive because they were the ugly girl,” says Faith Hope Consolo, chairman of the retail division at Prudential Douglas Elliman Real Estate. “They weren’t the one landlords wanted in their buildings; they had leering signage, shampoo bottles in the windows, messy stores.” Duane Reade didn’t have a retail strategy as much as it had a real estate strategy—once it secured a good location, it simply crammed in merchandise. The stores seemed to be everywhere and shopping in them became inevitable. New Yorkers rolled their eyes and complained about being mistreated but went back anyway. In the 1990s, Duane Reade’s sales per square foot were the highest of any drugstore chain in the country.
By the early 2000s, though, Duane Reade was in trouble. Its most profitable store, at the World Trade Center, was destroyed in the 9/11 attacks. During the recession that followed, its tight profit margins got even tighter. Duane Reade’s sales increased slightly from $1.14 billion in 2001 to $1.38 billion in 2003, but its profits fell 80 percent, to $5 million. National drugstore chains such as Walgreens, (CVS)CVS, and (RAD)Rite Aid realized Duane Reade was vulnerable and began moving into the city. Oak Hill, which was founded by Texas billionaire Robert M. Bass, bought the company for $702 million, including debt, in 2004.
It didn’t take long for the executives at Oak Hill to start rolling their eyes and complaining, too. “The operational opportunities were greater than we expected and the challenges were greater, too,” says Tyler J. Wolfram, the Oak Hill partner who oversaw the investment. He’s sitting in a conference room in the firm’s office in Stamford. Wolfram, 45, looks like a more scrubbed version of Matthew McConaughey. He attended Brown University, received his MBA from Wharton, calls colleagues by their initials, and can speak perfect corporatese when necessary. Two public-relations specialists listen in via conference call. Recalling his first months overseeing Duane Reade, he says: “We had to do everything better.”
Among the challenges was the chief executive officer, Anthony J. Cuti, who had been recruited from Pathmark Stores back in 1996. Cuti was fired in late 2005, but that wasn’t the end of Oak Hill’s problems with him. According to his 2008 indictment, a forensic review of Duane Reade’s accounting revealed fraudulent real estate transactions that had inflated the company’s income by as much as 15 percent from 2000 to 2004. At the time of the acquisition, which he helped broker, Cuti received a bonus of some $25 million. The former CEO was charged with securities fraud and misleading investors. He was found guilty last year and this summer was given a three-year prison sentence. Cuti is appealing his conviction. Wolfram declined to comment about the fraud, citing the ongoing litigation.
In 2006, all Wolfram knew was that Duane Reade’s trajectory was downward. It was also involved in an expensive confrontation with its unions, which had taken to calling the chain “Dwayne Greed.” The company was highly indebted because of Oak Hill’s leveraged buyout. Its credit rating had been downgraded four times by (MHP)Standard & Poor’s. “And BusinessWeek called us a zombie,” Wolfram notes genially.
Wolfram hired Richard W. Dreiling as chief executive. Dreiling had been in charge of operations at Longs Drugs in California and quickly improved Duane Reade’s cleanliness and basic organization. As rudimentary as that was, it helped. Duane Reade’s earnings (measured by adjusted EBITDA) went from $42 million in 2005 to $64 million the first year under Dreiling, and to $79 million the second. In 2008, though, Dreiling was lured to (DG)Dollar General as CEO.
Wolfram’s next pick to run the company was John A. Lederer, who had been an executive at the $30 billion Canadian supermarket chain Loblaws for three decades and president from 2001 to 2006. Lederer had resigned as part of a management shake-up; when Wolfram called him in February 2008, he was living on his tomato farm in Ontario. “I told John, ‘Here’s my vision, it’s pretty simple: Duane Reade has to do something different. Duane Reade doesn’t have a soul. We have to figure out who we are and where we are going.’”
Lederer took a look at the hate blogs—“Duane Reade Sucks” had become popular, too—and took a trip to New York, where he saw how traditional even the best drugstores were. After that, he invited Wolfram up to Canada to talk. “I had to stay in his house, in his daughter’s bedroom. He wouldn’t let me stay in a hotel,” Wolfram recounts. “John told me: ‘We’re going to create something that people in the U.S. have never seen before.’”
Lederer took Wolfram to visit Loblaws as well as Canada’s largest drugstore chain, Shoppers Drug Mart, both of which aim to be one-stop shopping destinations. Loblaws’ private label, President’s Choice, was a revelation: It had been modeled on those of European stores such Marks & Spencer’s and offered everything from fudge cookies to mobile-phone service and pet insurance, all of good quality.
Lederer brought in two executives he had worked with at Loblaws: Joseph Magnacca, who took over the merchandising, and Joe Jackman, who ran the marketing. Among their discoveries was that the pharmacy had been run by the guy in charge of construction. “We told the other executives and store managers that without bold and immediate action, we are history,” says Jackman.
Magnacca first decluttered the stores. “We found that if we reduced the number of items by about 10 percent, customers credited us with more variety,” he says. “They could see it, shop it.” Duane Reade used to be more focused on buying merchandise than actually selling it. “Now it’s how much we sell, not how cheaply we can buy,” Magnacca says.
In the fall of 2008, with the recession looming, Lederer and his team began to renovate the highest-profile stores: They widened the aisles, lowered the height of the shelves, installed better lighting, and removed the posters and displays from windows to admit more natural light. They changed the queuing system to one line and added cashiers: some 300,000 people shopped at Duane Reade every day, about 5 percent of the adult population of New York City, and it used to seem that half of them were waiting in line. The executives also reorganized the store into three categories: how I look, how I feel, what I need. “We heard that almost word for word in our focus groups,” says Jackman. “After that, our mantra became ‘New York living made easy.’” They also redesigned the logo and added the hopeful tagline, “Your City. Your Drugstore.”
By the winter of 2008, “People were saying the stores were unbelievable, but we felt like we were just getting warmed up,” says Magnacca, who’s now president of Duane Reade. “We were a 3 out of 10. Then we realized we hadn’t started at zero. We had started at –3.”
The name for Duane Reade’s new private-label food, Delish, came from a focus group, too. When it came to thinking about the products themselves, “we were following the Canadian and European experience,” says Magnacca. “We wanted to create food that people will come here for.” Duane Reade now sells its own brownie bites, gummy bears, steel-cut oats, and tomato basil soup.
As for beauty products, Magnacca introduced the kinds of expensive lines once found only in department stores. In this regard, too, “we mostly get inspiration from Europe, where they are so progressive,” says Magnacca.
Sales of Duane Reade’s private-label products doubled between 2008 and 2010. Its Look Boutiques generated 25 percent more sales among its most loyal shoppers. And overall sales in the remodeled stores usually increased by percentages in the high teens.
Still, the financial situation remained tenuous. Duane Reade could afford to remodel only 23 of its stores by the end of 2009. Oak Hill Capital had originally invested $244 million to buy Duane Reade, borrowing the other $458 million. In 2007, the firm put in $40 million more and two years later it had to raise an additional $125 million to fund the redesign and buy back some debt at a discount. “Everything we did had to make a return because the clock was ticking,” says Wolfram. “This business was negative free cash flow for every year that we owned it up until the last year.” It had also become one of Oak Hill’s biggest and most scrutinized investments.
In the winter of 2009, Gregory D. Wasson, the chief executive officer of Walgreens, went undercover in Manhattan. “I wore a baseball cap and sweatshirt and went into some old and new stores,” he says by phone from Deerfield, Ill. “The moment I decided we should get serious about buying Duane Reade was after seeing their new Herald Square store. After that, I went with three of my executives to a competitor’s location, and it was a traditional urban drugstore—frankly, like we run—with narrow aisles and merchandise stacked high. I said, ‘Duane Reade is creating something new.’ That’s what we were looking to do.”
Walgreens had opened a new store every 16 hours in 2008 and boasts that 75 percent of Americans live within five miles of one of its stores. “By the fall of that year, we had to slow down, step back, and shift our strategy,” says Wasson. “We’re still opening 200 stores a year, more than all our competitors combined. But we’re moving from ‘location, location, location’ to ‘experience, experience, experience.’”
Among Duane Reade’s recently opened stores is one in Williamsburg, the hipster neighborhood in Brooklyn. After Duane Reade leased the space, “we realized they didn’t want us there because we’re a chain,” says Magnacca. “So we asked them what they needed. They said food and beer.” The executives planned a “beer cave” with local brews. “Then one of our merchandise directors said, ‘What about a growler?’ I said, ‘What’s a growler?’” A growler is a half-gallon jug used to transport draft beer, and Magnacca liked the idea. The growler bar has been so popular that he’s put in two others in Manhattan so far.
When Magnacca, Tiberio, and Jackman (now a consultant) began designing the Wall Street store in late 2010 they were ready to see how far they could push Duane Reade, and they thought a revitalized Lower Manhattan was just the place to try. The 40 Wall St. store is doing well, but it’s not something that Walgreens expects to replicate. Wasson says it’s a learning lab. “We could move bits and parts into select locations,” he says. “We’re selling sushi in a lot of drugstores already, but not with the chef. The smoothies might be an opportunity. Who knows? The ability to get a 20-minute manicure or blow dry may be something we can do in certain locations.” Walgreens is going to bring some of what Duane Reade has figured out in terms of food and cosmetics to its 7,760 stores across the country. It’s already offering 10 DR Delish products.
Duane Reade still has some transforming to do. This year it again ranked last among pharmacies in customer service, as measured by J.D. Power. Its score did improve, though, something that’s never happened in the five years the survey has been taken. Duane Reade executives prefer another ranking, which measures how likely it is that a customer will refer someone to the chain; on that score, Duane Reade says it has improved 150 percent since 2008.
Then there’s the informal score: The I Hate Duane Reade blog went quiet after Walgreens bought the chain. These days, if you Google Duane Reade, the blog comes up sixth.
Berfield is an associate editor for Bloomberg Businessweek.

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