‘Sears in a Kmart Box’ Could Do Well, Chains Say of Merger

The merger would create the nation’s 3rd largest broadline retailer behind Wal-Mart and Home Depot, said Kmart and Sears executives. It would create a powerhouse sporting $55 billion in annual revenue and close to 3,500 store locations, including a significant base of “off- mall” stores that Sears savors. Levy said the merger deal was hatched last spring when Sears began negotiating the purchase of about 50 stores from Kmart to boost its “off- mall growth strategy,” through Sears Grand and other initiatives. Levy said he and Kmart Chmn. Edward Lampert had known each other for about 4 years and found a rapport. “I think we saw in those conversations the fact that there was the potential to do this on a large scale,” Levy said. As the months progressed, he said, it “just further solidified my sense that off-mall clearly is where we need to be moving very aggressively, and that doing something like this with Kmart is probably a very good thing for Sears and ultimately for Kmart.” The merger agreement reached the front burner within the past 2 weeks, Kmart and Sears executives said, and both boards approved it unanimously Tues. The deal, which awaits shareholder and regulatory approvals, is expected to be completed by late March.

“It’s pretty obvious that scale is very important to compete effectively” at retail, Lampert said in explaining the agreement’s rationale to reporters and analysts. He said Kmart’s “very significant” forte is its 1,500 off- mall locations in “high-traffic areas. At the same time, he said, “I don’t think anyone would really dispute” that Sears has the best offerings in major appliances, automotive accessories and “national brands of electronics,” Lampert said. “The issue for Sears has been with competitors opening hundreds of stores per year” to be closer to customers, while Sears has stood pat, Lampert said. Lacy said at 870 stores, Sears’ store count is about what it was when he took over several years ago. Lampert said only recently has Sears begun vying in the off-mall space through its Sears Grand format. “But the time and capital required to get there quickly is prohibitive and risky, and I think the ability to take the Kmart store base and determine whether we want to convert those Kmart stores over to the Sears nameplate and to bring Sears products into the Kmart stores is a great opportunity.” Nothing has been decided on merchandise mixes or store labels, Lampert said, “and we're going to evaluate a lot of different combinations and permutations.”

On possible efficiencies from the deal, Lampert said the 2 chains combined purchase about $40 billion worth of merchandise annually from around the world. The ability to work together “to really get best practices from both organizations and work with our supplier base” to drive down product procurement costs “is a big opportunity,” he said. Lacy said the 2 partners conservatively estimated savings opportunities at $500 million per year, including about $200 million in a “profit improvement opportunity,” such as through lower merchandise procurement costs. At least “several hundred” Kmart stores will be converted to the Sears format, Lacy said. “We've got more work to do to determine the optimal format for each location, but we see several hundred conversion opportunities, and clearly the cross-selling of proprietary brands will help both businesses by more differentiated from their competition.” Lacy didn’t deny “headcount changes” would result from the merger, “particularly as we consolidate over time some of the administrative functions. But I think it’s important to say that we've got 2 brands that both need to be very well-supported going forward.”

Responding to an analyst questioner whether the merger of 2 weak retailers would also double their challenges, Lampert didn’t deny there’s “probably a unanimity of opinion that that’s the perception of the two companies.” However, he said he sees Sears in its products and service as “every bit as good as any of its competition. The problem is they are not where the customers are, and that’s the big opportunity. It is not that the retailer per se is weak, but if you have the greatest store and it’s not near where the customers are, that’s a problem.” Lampert said he believes “Sears in a Kmart box ought to do very, very well.” As for cross- merchandising, Kmart and Sears are “going to try all different types of things, and I think that we have the ability because we have such a large store base to experiment. And we're going to get some things right and we're going to get some things wrong. But we're going to have a flexible culture, and with a flexible culture, we're going to correct our mistakes quickly and move onto something else.”

Lacy said Sears has imposed “an enormous amount of change” in its full-line stores the past several years, and “yet we've had difficulty growing the top line.” About 70% of Sears revenue is derived from product categories, including CE, that customers shop for in “an off-mall environment” because those typically are things “found more convenient to somebody’s home,” Lacy said. “So when we took Sears Grand and basically brought it out of the ground in Salt Lake City and we've now added these other 3 stores to it, we have been more than delighted with the customer response to these stores. We've exceeded our revenue expectations substantially. Customers are shopping the store more frequently. They value the fact that we offer better things than Kmart, Wal-Mart, Target, Home Depot, et cetera. And I think that we really feel like we've got a very viable place off the mall and, in fact, that’s where in many ways it’s more the sweet spot of our franchise, perhaps, than the mall.”

Sears undertook a broad revamping of its CE departments last summer. It dropped PCs, film-based cameras, cellphones and other products to make way for an expanded assortment of TVs, DVD players and movies and videogame hardware and software. More recently, Sears restructured its CE buying group, increasing divisional merchandise managers to 3 from one, while cutting the number of head and associate CE buyers to 7 of each from 8.

Sears has a checkered history with off-mall strategies. It started in 1995 with the HomeLife, a format that mixed furniture with CE goods in freestanding stores, but that was abandoned in favor the Great Outdoors 2 years later. The Great Outdoors debuted with 133,000- sq.-ft. store in Denver and at one point was expected to have 100 outlets by 2001. At the same time, Sears also tested a freestanding, 20,000-sq.-ft. CE and appliance store in 2001 in Shereville, Ill. It was a concept that, like the Great Outdoors, was later scrapped. Before landing on its plan to revamp its CE departments and drop PCs, Sears also briefly experimented with adding Dell kiosks to stores.

Kmart has less of a history outside its current retail format. In CE, it has experimented with several exclusive labels including Philips’ Philco brand for remote controls in 1994 and a revival of the Curtis Mathes moniker for 19” TVs in 2000. It recently moved to overhaul its CE assortment in hiring 2 former Sears executives -- Ray Brown and Chuck Bacon. Kmart stores range 40,000-195,000-sq.-ft. with an average of 95,000- sq.-ft. It operates 16 distribution centers and owns 135 stores, with the remaining 1,300 locations leased.