J.C. Penney’s secret comeback sauce? Its own brands by Phil Wahba @FortuneMagazine 12:29 PM EST E-mail Tweet Facebook Google Plus Linkedin Share icons J.C. Penney JCP is taking its destiny into its own hands: the retailer has put its own brands at the heart of its comeback plan. The department store has a long history with in-house brands: a century ago, James Cash Penney was frustrated by vendors who would not sell him their products, so the retailer’s founder started making his own merchandise in 1914, starting with Marathon Hats for men. That marked the beginning of what has become one of retail’s longest standing and biggest private brand operations: Penney today has a portfolio of more than two dozen names, the billion-dollar St. John’s Bay clothing brand and Arizona jeans chief among them, which have long generated about half of Penney’s sales, with the other half coming from national brands that are widely available at other retailers. Penney’s private brands were instrumental in arresting the 30% sales drop caused by Penney’s disastrous attempt in 2012 to become hipper: in fact, one of the first things CEO Mike Ullman did when he returned in 2013 to save the company was to quickly bring back the private brands former CEO Ron Johnson had dumped as he tried to update Penney, arguing they had little distinctiveness or pricing power or ability to draw in anyone but longtime Penney shoppers. Now, with its business stabilized, Penney has to prove it can actually thrive again, and not just muddle along with modest sales gains or worse yet, revert to the stagnating J.C. Penney of 2011, which had these private brands and that Johnson was brought in to shake up in the first place. The jury is still out: at its analyst day in October, Penney gave a long-term forecast that suggested it would take at least six years for annual sales to get back up to pre-Johnson levels of $17 billion. And last month, Penney reported unchanged comparable sales for the third quarter, ending a streak of three quarters of growth and casting doubt on claims that Penney’s customers have come back. Penney’s shares have fallen 20% since the analyst day. What’s more, Penney’s push seems to be going against the industry tide. Macy’s M gets about 25% of sales from exclusive merchandise and successful in-house brands like INC International Concepts. Kohl’s KSS gets about 52% (up from 30% a decade ago) but plans to scale that back to re-emphasize national brands such as Levi’s and Nike NKE . Turns out that exclusive and private brands are only of value if customers really want them. Still, Ullman, CEO from 2004 until 2011 when he was replaced by the one-time Apple AAPL retail whiz Johnson, is adamant that private brands are one of Penney’s biggest advantages over the competition, and should remain at some 50% of sales. Private brands do indeed play to Penney’s strengths, with its big operation and offer much higher profits, control over pricing, the timing of markdowns, and distribution of the inventory. “It’s been part of our DNA, part of our culture for years,” said Ken Mangone, the executive who heads Penney’s private brands, told Fortune in an exclusive interview at Penney’s campus in Plano, Texas. “It’s just part of who we are.” Re-hiring Mangone, a 37-year Penney veteran whom Johnson had ousted, was one of Ullman’s first moves when he came back. With Mangone’s help, Penney had St. John’s Bay women’s clothing back in stores within months. Soon after that, its Cooks kitchenware and JCPenney Home goods were back, and earlier this year, so was Ambrielle lingerie. Penney eventually dropped most of the outside brands Johnson brought in to replace the 14 Penney brands Johnson had shed, and it has changed the layout in stores to give better spots for its own brands like a.n.a. women’s clothing. (Ullman is stepping down in August and will be replaced by former Home Depot executive Marvin Ellison, but will stay on for another year as executive chairman.) Those efforts have led to a big jump in Penney’s profitability, with such brands offering a gross profit rate 4 to 5 percentage points higher than national brands: last quarter, Penney’s gross profit margin was 36.6% of sales, compared to 29.5% a year earlier—almost back up to its historical levels. By and large, experts say Penney’s focus on its own brands is sound. Mortimer Singer, CEO of retail business development firm Marvin Traub Associates, said successful in-house brand development is in fact essential at a time new national brands are popping up all over the place and gives a retailer, even a department store, a stronger identity. “Brands are becoming retailers, and now retailers are becoming brands. I’m very bullish on any business with private brands,” he said. So, with the business stabilized, albeit at a lower watermark, how does Penney get more punch out of its private brands? Not just labels, but brands Penney has come a long way since 1929 when its founder would test how quickly textiles and fabrics would fade by washing them in his New York hotel room. Penney opened its first overseas sourcing office in 1959 and now has eight. By the 1990’s, Penney had centralized its design and sourcing functions to set itself up as a vertically integrated manufacturer, to better compete with emerging rival brands opening their own stores and not just selling wholesale. The private business now employs 1,000 people in all, both in the Dallas area and abroad, and has a team that creates designs for about 8,000 different products. Last year, Penney opened an apparel design center in New York and its products routinely get high customer scores. That structure has given Penney the ability to develop new brands when an opening in the market presents itself. A case in point is Xersion activewear, a brand launched in 2008 that taps the “athleisure” craze and woos customers not willing to spend a fortune at Lululemon Athletica LULU or even Gap Inc’s GPS more affordable Athleta. Yet for all of the strengths of its private brands, the question remains: how does Penney make the broader public, including people who never set foot in a store, aware of all these labels, let alone get them to buy them? Mangone (whose full title is executive vice-president, product development, supply chain, design and sourcing) says some brands can be expanded. He is also open to creating a few new brands in the coming years, market conditions warranting it. But a big part of his approach will simply be to better market the brands and let word-of-mouth do its magic. “We have a very big base of customers, so a lot of it is just getting them to buy more,” said Mangone. While Penney could build some new brands, and its better financial situation gives it the wherewithal to do so, that can be risky, especially in apparel. “For anybody to launch a brand new brand, unless they want to spend hundreds of millions of dollars and wait for years to make a mark, I’d say ‘forget it’,” said Robin Lewis, an industry expert and the author of the Robin Report. Another idea would be to also sell its brands beyond its 1,060 stores or web site, through licenses and possibly other retailers, and turn them into de facto national brands. But Mangone argued that would undercut one of the main reasons for private brands: giving shoppers a reason to shop at Penney specifically. “Our priority is really driving the J.C. Penney destination. Right now, we’ve made the decision that this is an advantage for us, to have the exclusive, to traffic our stores,” Mangone said. Despite its efforts, shopper traffic has continued to be weak at Penney (as it has broadly in retail) and is expected to decline this holiday season quarter. Indeed, at this juncture, venturing outside Penney stores or its web site could be interpreted as a lack of faith in its business, said Howard Feller, a partner at MMG Advisors, an investment bank focused on retail. “That could be looked at unfavorably. It could be seen as Penney giving up on its big boxes,” he said. Instead, Feller said Penney could opt to broaden its brand of portfolios through an acquisition, like in 2011 when it bought Liz Claiborne for $267.5 million, taking on a brand with instant national recognition and one it has already expanded into categories like home goods. Claiborne will add window treatments to the assortment in 2015. But Mangone said Penney won’t develop new brands just for the sake of it. A new brand would have to be something Penney can really develop an identity around, otherwise it just amounts to what he calls “label-slapping.” For now, Mangone still sees enormous potential left in Penney’s existing brands. “We know we have the opportunity to build more brands to a larger scale,” he said. “Our customers are really attached to our brands. They really see them as brands.” Take a trip down memory lane with this list of classic J.C. Penney house brands.