Big deal: Why Kmart-Sears is tough sell

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kmart stands to make a financial killing with its $11 billion purchase of Sears. But the absence of a clear brand strategy for either chain throws the survival of both into doubt.

Eddie Lampert's planned merger of Kmart Holding and Sears, Roebuck & Co. makes financial and strategic sense-as it did last December when Advertising Age ran a column proposing the marriage to Mr. Lampert, the top shareholder in both retailers.

But Sears and Kmart are fuzzy brands, irrelevant to many consumers who have moved on, and Mr. Lampert's investment priorities could be an impediment to fixing the problem.

Mr. Lampert, 42, is committed to providing the best financial return, and that might not come from reinvigorating the stores. The chairman of Kmart and chairman-to-be of Sears Holdings puts customers first. But that means his investment-fund clients-Michael Dell, David Geffen and the Tisch and Ziff families-not necessarily the consumers, who are the relentless focus of arch rival Wal-Mart.

"The financial metrics of the deal look very good and the retail metrics look terrible," said Howard Davidowitz, chairman of Davidowitz & Co., a retail consultancy. "In three years, there will be no more Kmart, and in six years no more Sears."

Mr. Lampert's record since he took Kmart out of bankruptcy offers little evidence he wants to build a retailer. Kmart has had four consecutive profitable quarters, payoff for his strategy of slashing expenses (including marketing), cutting inventory, selling real estate, raising cash and holding a cache of old Kmart losses that can be applied against taxes on future profits. The stock's up. Business is down-with comparable sales at remaining stores plummeting 14% year to date. Sears also is shrinking, with comparable-store sales down each year after Alan Lacy became chairman-CEO in late 2000.

The merger premise is simple. Sears is stuck with 870 aging mall stores; consumers prefer big-box chains. Kmart has underleveraged real estate (1,482 off-mall stores). Solution: Put strong brands (Sears' Craftsman and Lands' End, Kmart's Martha Stewart) in Kmart boxes; cut overhead; create the No. 3 retailer behind Wal-Mart and Home Depot.

The obvious solution is to rebrand everything Sears and eliminate costs of running two national chains. "The way to make this work is to focus on one [name]," said Kelly O'Keefe, chairman-CEO of retail consultant Emergence Brand Labs.

Sears could remodel all Kmarts into pristine Sears stores for about $4.5 billion. Mr. Lampert could more cheaply slap Sears' name on Kmart's gritty shops and run new Sears like old Kmart (cut costs, pile up cash). But Burt Flickinger, managing director, Strategic Resource Group, said some Sears suppliers wouldn't trade down to Kmart class.

For now, the company will keep two chains and convert "several hundred" Kmarts to Sears. It will employ one key marketing partner, WPP Group. Sears' $640 million account is split between Ogilvy & Mather and Y&R; WPP is buying Grey Global Group, which handles Kmart's $175 million account.

Sears and Kmart stores will be run by an executive in the retail-merchant trade for one month: Aylwin Lewis, a veteran of the fast-food industry who was COO of $8 billion Yum Brands. Mr. Lewis, 48, joined Kmart as president-CEO on Oct. 18, learned about the Sears deal two weeks later and now is in line to be president of Sears Holdings and CEO of the $55 billion Sears/Kmart chains. Mr. Lewis said of the deal: "My headline on this is one plus one equals two."

Unless Sears makes a remarkable turn, Mr. Lampert's best option may be to milk the chains, sell real estate and invest the money elsewhere. It's his store: His fund owns about 53% of Kmart, 15% of Sears and will own more than 40% of Sears Holdings.

"We're going to have very strict return on capital requirements. ... to allocate the capital to where it's best used," he said. Added Mr. Lacy: "The strategy is to operate a significantly more profitable retailer, and the size of the retailer will be based on opportunities." In this case, one plus one may equal zero.

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