Lessons from Mervyn's

The most recent issue of Business Week features a story of how private equity companies supposedly ruined Mervyn's , a mid-range department store located primarily in the western U.S. I think there are a number of interesting aspects to the Mervyn's story.

• First, it's a prime example of the effects of competition. As this commentary argues, Mervyn's did quite well as a mid-range retailer until other stores started piling into the space and Mervyn's failed to adapt.
• Second, although the main Business Week story casts the private equity companies as villains in the downfall of the company, I'm not sure the case is made very well. The main objection regarding the actions of the private equity companies seems to be focused on Mervyn's real estate holdings. The PE companies split the company into real estate and retail, and then sold off many of the operating leases. The new lease holders increased the rents to market rates, which caused lease payments to double in many cases. So, essentially, the company had previously been subsidizing poor retail operations with below-market lease rates. By moving lease rates to market rates, the PE companies were helping ensure that the real estate was being allocated to its highest and best use. Apparently that was not a Mervyn's department store, as the company could not survive and is filing for liquidation. Yes, I imagine the story is probably more complicated that this, but the Business Week story certainly doesn't give the PE companies any credit for moving these real estate assets to a better use.