Arcandor has started transforming its Karstadt department stores into luxury destinations for brands in an effort to create a high-end pan-European chain.

The move is the first stage of the German group’s new business strategy of trading up and out of the tough middle market.

Arcandor – which was restructured last year when it offloaded loss-making divisions to focus on Karstadt, its mail order division Primondo and travel group Thomas Cook – will add more than 2,000 brand shop-in-shops and overhaul its category management to reverse the fortunes of loss-making Karstadt.

Arcandor chief executive Thomas Middelhoff, who gave the group’s first EBIT forecast to date for the financial year to 2009 at 850 million (£638.1 million) last week, said: “In the department store division, we are in the midst of a radical repositioning.”

The group is in talks with department stores La Rinascente in Italy and Printemps in France to forge a strategic alliance with a consortium to take advantage of synergies. The consortium includes RREEF, which is part of Deutsche Bank, as well as Pirelli and the Borletti Group.

Edward Whitefield, chairman of retail consultancy MHE Retail, said the repositioning was necessary, despite the uncertain retail climate. “The reality is that Karstadt was caught in no-man’s land. It was entrenched in the middle market and has come under threat from value operators and the designer retailers,” he said.

“It gets them out of trading at high volumes at the expense of margins. They are doing the same as Galleries Lafayette, Printemps and House of Fraser. Karstadt is in a good position to create large-scale, downtown sites as emporia of brands, as originally conceived by Selfridges, rather than traditional department stores.”

91-store Karstadt sales were 2.35 billion (£1.76 billion) for the nine months to September 30, down 1.5 per cent year on year. Operating losses were 34 million (£25.5 million) against a 36 million (£27 million) loss the previous year.