CryptocurrencyLeadershipInvestingClimate ChangeMost Powerful Women

Inside J.C. Penney’s “Cleanse”

March 20, 2014, 3:00 PM UTC
Fortune

By Jennifer Reingold, senior editor

THEY CALLED IT A “CLEANSE”

On Feb. 6, 2012, a clear, acrylic 10-by-10-foot cube was installed in the area between the two cafeterias in J.C. Penney’s (JCP) headquarters. It was a three-dimensional version of the retailer’s new square logo. Johnson told staffers that he didn’t want to see the old logo anywhere in the building. He thought it would be a useful ritual to have employees discard symbols of the stodgy old Penney. In ­theory, the cube was a giant time capsule, and the old Penney would be buried (exactly where, nobody said). In reality, it was a stylized, transparent dumpster.

For the next week people lined up to shed the evidence of Penney’s century-old history. Into the cube went T-shirts, mugs, stationery, pens, and tote bags. A few people even dumped the Chairman’s Award, the highest honor in the company, a glass plaque bestowed by former chairman and CEO Ullman on his most valued employees. As staffers pitched their corporate junk, they were invited to select a few replacement items with the new logo in exchange. By the time the purge was complete, 9,000 pounds of detritus had filled the cube.

The transformation had started with a single phone call a bit more than a year before. At 4 p.m. on Oct. 7, 2010, the phone rang in the office of then-CEO Ullman. The screen flashed “Vornado,” (VNO) the name of the $2.8 billion (revenues) REIT run by investor Steven Roth. Ullman, a veteran of takeover attempts at Macy’s, had noticed that Penney’s stock had jumped 10% in the 10 minutes before the call, to $32. He had a pretty good idea of what was going on. “Do you come in peace?” he asked Roth, with whom he had worked on a past deal. Responded Roth: “I’m your new best friend.” And there was a second best friend: Roth had teamed with Bill Ackman, the head of hedge fund Pershing Square Capital, to buy more than 26% of the company’s stock. They believed Penney could easily be a $60 stock — if, of course, some changes were made. Could they meet to talk?

Ullman had run Penney since 2004. He had had a fantastic start, driving the stock to an all-time high of $86 in 2007 on innovative ideas such as bringing cosmetics seller Sephora inside Penney in a “store within a store” and opening some outlets outside traditional, and declining, malls. But when the Great Recession hit, Penney’s core customer — the middle-class mom — suffered more than most. Even when competitors began to pull out of the decline, Penney lagged. One reason: Ullman’s massive deal with Ralph Lauren to launch American Living in 2008, a Polo-lite brand sold only at Penney. It failed, in part because Penney was not allowed to use Ralph Lauren’s name or the Polo logo.

MORE: Chevron seeks $32 million in fees from environmental lawyer

Penney was clearly in need of rejuvenation. Revenues had dropped from $19.9 billion in 2006 to $17.2 billion in 2011, taking the stock price along with it. Rather than resist Ackman, a brash, aggressively charming billionaire who likes to make huge bets on big companies and doesn’t hesitate to wage proxy battles against those that rebuff him, Penney invited Ackman and Roth to join the board. “I said, ‘These are two of the smartest people in their industries in America,’ ” Ullman recalls. “Why wouldn’t we want them in the boardroom?”

In February 2011, Ackman and Roth attended their first board meeting. At dinner afterward, Ackman gave an emotional speech, hailing the company’s potential. Almost ­instantly, fate intervened. As Ullman’s driver pulled out of the parking lot after the meal, his car was sideswiped. Ullman, then 64, was knocked unconscious. He had multiple fractures where his skull attaches to his spine and spent 12 weeks in a neck brace. Even before that he had battled health issues. For years Ullman had suffered from nerve damage that makes it hard for him to walk (he moves around the offices by Segway). He had endured two major surgeries during his Penney’s tenure.

The accident intensified the board’s concern over Ullman’s health — as well as the undercurrent of dissatisfaction that the new directors felt with his leadership. As director Geraldine Laybourne told me in 2012, “You know you’ve done something wrong when you wake up and someone has bought 26.8% of your stock.”

There were no obvious successors at Penney. Ullman says he thought instantly of Ron Johnson, the Minneapolis native who had helped bring great design to Target (TGT) before he was recruited by Apple (AAPL) to create its retail stores. Under Johnson they became the most profitable stores in the country, making him a star at what was then the hottest company on the planet. Ullman had called Johnson about a director position a few years back, but Johnson had rebuffed him. Now, however, with Steve Jobs ailing, a recruiter told Ullman that Johnson might be more amenable.

Beginning in March 2011, Johnson met with Ackman and Roth and separately with Ullman. Soon the conversation moved from a role as a director to the possibility of becoming the next CEO. Johnson, who started his career at Mervyn’s and had always loved the retail business, had been pondering the lack of innovation in department stores. He had a vision of a new type of store—a destination rather than simply a repository for product. Well-liked and relentlessly positive, Johnson, then 53, seemed to offer the kind of ­can-do Silicon Valley spirit that hadn’t been seen in the retail world since, well, Apple. “I just believed in the guy,” Ackman told me at the time. “I had a man crush on him.”

With Ackman as head cheerleader, Penney’s board offered Johnson the CEO position. When the announcement was made, on June 14, 2011, the retail world was astounded — and thrilled. Although Johnson wouldn’t start as CEO until Nov. 1—he said the cancer-stricken Steve Jobs had asked him to stay longer — Penney’s stock rose 17% on the news. It was as if a triple-A team had just signed Babe Ruth.

MORE: The Fed doesn’t care about the unemployment rate anymore

When Johnson eventually unveiled his strategy, it centered on a few points. The biggest, perhaps, concerned Penney’s incessant price-slashing promotions — 590 in 2011 alone. The new JCP would have virtually none. There would be three prices for an item: the original price, which was far below the typical marked-up price; a month-long value price for certain items; and a twice-monthly “best” price for things that needed to move. No more clearance racks, no more mess, just an honest—or as a later slogan put it, “fair and square” — relationship between the customer and the store. In a retail world full of illusory market-share gains based on which retailer offered the lowest clearance prices, it felt like a welcome way to stop the madness.

The second component of his strategy was equally radical. Johnson wanted to remove the “department” from the department store, recasting each store as a collection of 100 separate boutiques, with a kind of town square in the center. The product mix would change too. The new JCP would feature a much higher percentage of branded merchandise — modern, higher-end, youth-oriented — compared with house brands. This was a very big move for Penney, which got 50% of its sales from its own brands and tended to display most of its products by classification (such as bath mats) rather than by collection (such as Martha Stewart).

The new strategy made sense if Penney could attract many top brands, which would lure consumers without the catnip of frequent sales. Clearly, the approach worked for iPhones. Would it work for mattress pads and pantyhose?

Johnson wasn’t going to wait around for an answer. When a director asked when he planned to test the notion, Johnson scoffed. Never mind that other retailers had tried such pricing only to see customers vanish. He had made his decision. After all, his hero, Jobs, disdained tests and instead relied on his gut. At the same time, Johnson didn’t seem particularly interested in how Penney operated, according to Ullman. The outgoing CEO noted in a regular update to the board that the new CEO had not asked a single question about how the business was currently running.

Meanwhile, there were hints that the board was not as focused as it could be. Ackman had consistently complained about the chocolate-chip cookies served at Penney’s board meetings. Rather than soft, gooey orbs, Ackman grumbled, these were rock hard. To assuage him, say three people involved, Penney began ordering fresh-baked cookies delivered from local bakery Tiff’s Treats. Other Penney directors also expressed concern about the caliber of cuisine served at their meetings—so much so that on at least one occasion a senior executive personally sampled the food before it was served. (Ackman declined to comment on the company’s baked goods; Penney denies that an executive served as a food taster.)

To read the full story, visit How To Fail in Business While Really, Really Trying.