April 2002

The Demise of an Icon: Lessons to be Learned By Stan Pohmer

Kmart, the $37 billion, 40-year-old mass-marketing company that has roots going back over 100 years (S.S. Kresge), files the single-largest retail bankruptcy protection petition in the history of business. The same company that started its checkered discount store history in 1962 — the year that both Wal-Mart and Target began. The same company that first introduced the horticulture category into the mass market and, for many years, was the largest retailer of lawn and garden products in America (they're still in the top five). The same company, that because of its sheer size and the uncertainty about its reorganization plans, is having a significant impact on L&G growers' and manufacturers' P&L's, balance sheets and concerns for their own financial futures.

The recent actions at Kmart pose a whole litany of questions that beg to be answered. Can or will Kmart survive? What event(s) precipitated their financial collapse? What impact will their problems have on existing suppliers, short-term and long-term? And, most importantly, what lessons can we learn from Kmart's problems that can be applied to our own businesses to prevent this from happening to us?

Kmart's problems aren't recent; they are the culmination of decisions made or not made over the past 40 years that are finally coming to roost. Let's look at some of the key factors that led them to this precipice.

The many-headed monster

Store Locations.During the early years, Kmart was the fastest-growing of the "big three" discounters (Kmart, Wal-Mart and Target), easily outpacing their key competition. They located their stores where the population was — in the cities and the first-tier suburbs. Unfortunately for them, the population densities shifted from urban to suburban, leaving them with a lower demographic consumer base. This was unlike Wal-Mart, which started in rural areas and followed the population growth into the suburbs, or Target, who started off slow in the suburbs and successfully nurtured this higher demographic consumer segment. Kmart either didn't see the shifts coming or didn't have the cash to build new stores in the more desirable areas. The net result is that Kmart is strapped with stagnant locations that limit their mature store growth potential.

Positioning. Kmart is trapped between Wal-Mart and Target, becoming the merchandiser in the middle — and ultimately, the discounter in the muddle. Wal-Mart has successfully built an organization on price leadership. Target took an up-market position focused on trend and fashion — mass with class. Kmart hasn't demonstrated that it can effectively compete with either end of the spectrum — price or upscale — though they've repeatedly attempted to and failed.

Kmart's consumer image or perception in the marketplace hasn't changed from that of the 1970s or '80s: They're still thought of as the "polyester palace," though not for lack of trying to change. To compete against Target, Kmart embraced the Martha Stewart Everyday marketing initiative. Kmart's hope was that Martha's higher-end image could be used to upscale their total store image, but that's like the tail trying to wag the dog. The concept was sound, but they didn't do enough to change the core merchandise assortments in the rest of the store, so this created a high-end/low-end image disconnect in consumers' minds.

At the same time, they also tried to compete on price against Wal-Mart, most recently in fall 2001 with their "Blue Light Always" everyday low price campaign. I learned at a young age that I shouldn't pick a fight with someone bigger than me or I would reap the obvious results. Unfortunately, Kmart tried to pick the price fight with the 800-pound price leader, Wal-Mart, who was not about to relinquish their market leadership position. When they lost this marketing and positioning battle, they were forced back into that unenviable middle ground — again.

With these constantly changing, mixed-image messages being sent — low price vs. trend and fashion — the consumer ended up confused.

Quick Fixes. As in the case of many companies, when your core strategies aren't working, you look for the quick fixes. Sales and profits weren't materializing in the Kmart stores, so they decided to grow non-core businesses: Builder's Square (home improvement), The Sports Authority (sporting goods) and Borders (bookstores). But ultimately, they weren't able to sustain or grow these chains profitably, and they were sold off at losses. Kmart ended up holding the real estate leases as these chains shrunk or went bankrupt, putting additional pressure on Kmart's hard-pressed core of stores to generate profit.

Technology. Unlike its major competitors, Kmart failed to make the technology investments into their business that facilitated efficient supply-chain management, allowing for good inventory control and in-stock items. This set up major opportunities for disappointing customers, especially on ad goods, and led to poor shopping experiences. From a supplier's standpoint, the lack of good data capture inhibited inventory forecasting and flow and prevented the implementation of good practices such as efficient consumer response and category management. This lack of technology investment cost Kmart severely from a maximization of sales and achieving freight flow savings perspective, putting further pressure on their ability to effectively compete against Wal-Mart and Target.

Demographics. Kmart has not defined who their customer truly is, making it difficult for them to develop clear marketing and assortment direction. With a large number of their stores located in urban and urban edge locations, they could define a niche in serving lower-income and ethnic demographics; however, they have not addressed this opportunity. They continue to attempt to differentiate based on their upper-end programs such as Martha Stewart, which is not necessarily consistent with their core customer needs.

Profitability.Though the cause for filing for bankruptcy protection was cited as a "liquidity" problem, the reality is that Kmart has not achieved sustained profitability for many years. Declining same-store sales, a high operating structure due to a lack of technology, and a high overhead structure caused by carrying leases on "dark" or unoccupied stores related to bad past business decisions are key factors in the poor profit performance. The net result is that decisions were made not for the good of the future of the business but to stave off further financial deterioration, sacrificing long-term goals to put out immediate fires and avert imminent disaster.

Management Chaos. Kmart has been a revolving door for senior management, having seen three CEOs in the past seven years, each with their own strategy for turning the company around. This management burn and churn and changing direction not only confuses customers and employees, but rocks the cultural foundation on which a successful company is built.

The Future

The bankruptcy filing allows Kmart to void the leases on the "dark" stores, saving an estimated $250-350 million annually in unproductive operating expenses. It also gives them the ability to close down their unprofitable stores, vacating their leases and other obligations; Kmart announced early last month that it intends to close 284 of their current 2,115-store base. With the infusion of $1.5 billion in Debtor in Possession asset or equity-based financing in place, they have effectively solved their immediate liquidity problems.

Will Kmart make it long term? I'm confident that they will successfully exit from under bankruptcy protection within 18-24 months, albeit as a significantly smaller company. I also believe that their operating cost structure will be much lower, primarily due to losing the lease liability and the closing of unprofitable stores. But this alone will not ensure Kmart's long-term success. Until we see a detailed reorganization plan that addresses fixing their core positioning issue, identifying a customer niche and a reason for being that differentiates them from Wal-Mart and Target, as well as the implementation of improved operating efficiencies and processes, this bankruptcy protection only buys them a little more time. For the sake of our industry, I hope they make the right long-term decisions.

Lessons

Many of the challenges that Kmart has faced could impact your own businesses if you let them. Understanding your customers and their changing needs; positioning your programs to meet their needs and expectations; investing in the technology that provides efficiency and efficacy; and communicating a clear and consistent message to employees and customers alike will help you stay growing and profitable. Study the reasons for Kmart's demise and learn from them — you'll be the better for it!