C. Gopinath

While the recent announcement of the Kmart and Sears combine has raised speculation as to whether the store would be an effective challenge to Wal-Mart, the more relevant question is whether it should even try and challenge the retail giant. The answer is, `no'. Instead, the new combine should carefully segment the retail market and find attractive niches that it can exploit.

THE November 17 announcement that Kmart and Sears, two household names in the retail industry, are going to combine has given rise to a lot of speculation about how the sector is going to shape up in the near future.

Sears, Roebuck & Co, which began in 1893, and Kmart, which began in 1899, have held iconic reputations for many years. Sears had built its name as department stores nationally selling a range of clothing, accessories, tools and home equipment. Its catalogue was a pioneering effort that, for many years, was the main access for many rural communities to the products that were available to urban consumers. It gradually shifted its focus from retailing when it added the real estate and stock brokerage businesses, which it then exited. The firm began to do poorly and, as part of the attempt to restructure a few years ago, it also gave up its catalogue division.

Kmart, also with a national reputation as a discount store, made a success serving largely urban consumers. In the 1970s, when Kmart had over 1,000 stores, Wal-Mart had barely 150 and with just about 5 per cent of Kmart's sales. Both Kmart and Sears have been performing poorly for some years now. They lost their way through bad strategy, worse execution, and were rapidly overtaken by Wal-Mart. Kmart emerged from bankruptcy only in 2003 and Sears is currently reporting losses.

The deal was brought together largely by one man, Mr Eddie Lampert. At 42, he runs a private hedge fund, ESL Holdings, and is recognised as a financial wizard generating a return of almost 29 per cent. He had acquired 53 per cent of Kmart stock when it was in bankruptcy court and also held 14.6 per cent of Sears. He also held the post of Chairman of Kmart and was able to act as a catalyst in bringing about the deal.

The markets have given a vote of confidence to the combination by bidding up the price of both stocks. Technically, Kmart is acquiring Sears, but the combined company will be called Sears Holding Co and Mr Lampert will hold about 40 per cent of the new company. Although the deal will be investigated by the Federal Trades Commission for its effects on the competitiveness of the retail industry, it is not expected to face antitrust opposition given the dominance of Wal-Mart.

Several analysts are asking whether this combining of Sears and Kmart will be an effective challenge to the retail giant, Wal-Mart. The more relevant question is whether they should even try and challenge Wal-Mart. The answer has to be a resounding `no'; they will be more successful trying to be different.

Wal-Mart, with sales of $256 billion (Rs 11,77,600 crore) is the largest retailer in the world. It has over 3,033 stores, and generates sales of about $433 (Rs 19, 918) per sq ft. In comparison, the combined Sears-Kmart combination accounts for about $64 billion (Rs 3,03,600 crore) in sales revenues, from about 2,370 stores. Its average sales per sq ft of about $220 (Rs 10, 120) tells you how far they have to go to even begin to challenge Wal-Mart.

Over the years, Wal-Mart has grown to dominate the sector with its ability to offer a wide selection of goods at very low prices and at great locations. There are many reasons for their low cost structure. Their very size gives them enormous bargaining power, which they have used to keep cost of supplies low. They are able to dictate terms to large manufacturers including FMCG giants such as Proctor & Gamble. They have eliminated middlemen in their dealings. China has become their major low cost source for goods. Wal-Mart, by itself, is said to account for more than 10 per cent of US imports from China. They have invested enormous sums on computers and information technology that they have used to keep inventories and costs low, and studied purchasing patterns to make sure they do not run out of items on their shelves. In the process of becoming large, they have also attracted negative attention.

Many local communities are upset that their presence and aggressive pricing strategies has caused a lot of small local traders to close shop. Suits by employees have highlighted discriminatory pay and promotion practices. Wal-Mart's aggressive tactics with its suppliers is causing considerable heartburn. In a recent move, some toy manufacturers are offering the retail chain Toys R Us some exclusive models so as to help that chain survive and be an alternative meaningful outlet for toys, thereby reducing the power of Wal-Mart as the primary outlet.

Rather than try to challenge Wal-Mart head on, the new Sears-Kmart combine should carefully segment the market and find attractive niches that it can exploit. They still have some excellent locations, which is an important advantage in the retail business. The consumers see them as underdogs in the competition against Wal-Mart and that is a feeling that can be exploited to draw the crowds in. There needs to be a careful study of the changes in demographics, and some rearranging of the goods and services they provide. For example, Sears is largely located in large shopping malls but much of the sales in their kind of merchandise now takes place in large retailing box stores that stand alone. The stores need to carefully identify segments of the market, rather than cater to the general customer.

Early indications are that several of the Kmart stores would be converted into Sears stores and would be part of a new chain called Sears Grand. (Sears has a better reputation than Kmart and it is likely that the Sears name will dominate the combination into the future.)

If there is one lesson they can learn from Wal-Mart, it must be in how important it is to execute strategy. Many years ago, Kmart introduced groceries in their discount stores. But the shopping carts designed to carry clothes were insufficient to carry the large packages of groceries, the aisles were too close for comfort with carts bumping into each other, and few sales counters would be open resulting in long lines for frustrated shoppers. If the level of execution does not improve, the best strategy would fall flat.

What is yet to be known is whether the new owner of the combined company, Mr Lampert, is interested in making the combination a retail success. Published reports of how he has shown a turnaround in Kmart are not very encouraging. Same store sales continue to fall, which is very troublesome indication for a retailer. Stores continue to look dowdy. The black ink on the Kmart balance-sheet comes from smart real-estate moves, slashing costs, and cutting back on inventory. This is good financial management, which is very different from showing retail expertise. Sears, on its part, has been in the red.

The stores have several strengths they can exploit. Sears has reputable in-house brands such as Craftsman (tools and implements), Kenmore (white goods), and the recently acquired line of clothing, Lands End. These are not strong points for Wal-Mart and can be leveraged with success. Whether the Sears-Kmart combine will emerge as a successful retailer in its own right will depend on whether its new boss thinks the nitty-gritty detail of retailing can be made to generate the kind of returns that he has been able to get out of his financial wizardry.

(The author is a professor of international business and strategic management at Suffolk University, Boston, US. He can be contacted at cgopinat@suffolk.edu)

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