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THE HARDER SIDE OF SEARS

Chain retools — again

BY JON SPRINGER

Nearly two years into a program of re-engineering its stores, and finally extricated from a troublesome credit card business, is Sears ready to compete on its merits as a retailer?

For shopping center developers, that’s the $36 billion question.

The storied retailer is smack in the middle of what could be the most significant reinvention in a long history of reinventing. Changes are occurring both on the store floor and at the company’s Hoffman Estates, Ill., home office. And the reaction thus far from investors, shoppers and landlords has ranged from applause to skepticism.

“Sears is an aircraft carrier that’s got its rudder turned,” said Michael P. McCarty, senior vice president of research at Simon Property Group, Sears’ largest landlord. “It’s going to take them a long time to get it pointed in the right direction.”

If McCarty seems skeptical, it’s because he believes that Sears’ troubles are neither easily solvable nor entirely unique to Sears. Yes, he acknowledges, better apparel and appliance offerings, along with improved store designs and customer service — the benchmarks of Sears’ in-store repositioning efforts — will probably help the retailer and, by extension, Simon. The landlord’s portfolio includes 131 Sears stores, nearly 11 percent of its total square footage. But apparel everywhere is suffering, and mall department stores in general are still losing business to off-mall discounters and big boxes.

And though the sale of its credit business and new attention to internal efficiency may help Sears in the earnings department, those steps by themselves won’t stop the plummeting same-store sales that plague not only Sears, but many traditional mall anchors.

“At this time I don’t think the department stores have figured out what’s wrong,” said McCarty. “There’s a disconnect between the department stores and their traditional shoppers, and they don’t seem to know what the problem is. If you look at department stores’ balance sheets, you’ll see they’re sitting on a ton of cash. They rake it in every month. The question for them shouldn’t be ‘How do I survive?’ but ‘How do I get back on comp-store-sales growth?’ I’m not convinced they know how to yet.”

Sears, for its part, is certainly trying. In October 2001 CEO Alan J. Lacy built a strategic plan around improving Sears’ 870 mall-based stores and gaining in-house efficiencies (some 4,900 workers were laid off). Lacy said the moves would not only make Sears “more competitive with off-mall competition and more differentiated from mall competition,” but also boost operating income by more than $1 billion in three years.

Alan J. Lacy

Having reached the halfway point, the plan is largely on target, Lacy said during Sears’ second-quarter earnings call in July. Beginning last year Sears units kicked up a lot of sawdust, adding new centralized checkout areas and shopping carts, as well as new signage and fixtures consistent in all the stores. At the same time, the chain’s merchandise effort improved. Sears acquired catalog retailer Lands’ End for $1.9 billion last June and launched a “better” private-label apparel line called Covington. This fall the chain will introduce a private-label clothing line aimed at Hispanic shoppers, called Lucy Pareda.

So far those changes have gotten positive reviews from observers. “It was necessary to do, because Sears was never able to get it right on apparel,” said Kurt Barnard, president of Retail Forecasting Group, Upper Montclair, N.J.

Lands’ End provides Sears with the high-end casual apparel line it never developed on its own, along with a built-in customer base accustomed to buying from catalogs. Stores that had Lands’ End departments by the early part of this year showed second-quarter apparel comp-store results 2 to 4 basis points better than those that didn’t have them, Lacy says. (The rollout was completed in August.) In the meantime, Covington exceeded $200 million in sales at the end of its first year — better than Sears executives had anticipated. Lacy says he expects Covington to grow into a $500 million brand.

Lacy outlined his strategy for turning Sears around at a Goldman Sachs conference on retail held in New York City in September. He said that the company had set apart 2001-2003 to fix such fundamentals as store management efficiency, 2003-2004 to relaunch full-line stores (involving expansion of Sears’ smaller-format stores, which he said had proved incapable of accommodating a sufficient range of merchandise) and until 2005 to return to profitable revenue growth.

Lacy also tackled Sears’ home appliance departments, seeking to fight off encroaches from discounters and home improvement retailers. Appliance departments were repositioned to conform to research showing that price perception and brand assortment were driving purchases, Lacy says. As a result, Sears added some new brands, including an assortment of low-priced merchandise. It implemented a price-match guarantee and enhanced its “Take Me Home Today” offering, which stressed that customers could take delivery of larger appliances the same day they bought them. New signage alerts shoppers to the brand and price stories. An improved focus on customer service in the appliance department (including a change of staff hours to match sales volume, and the introduction of a casual dress code for salespeople) will also help, says Lacy.

“They’ve made some significant strides,” said George Whalin, CEO of Retail Management Consultants, San Mateo, Calif. “The move toward centralized checkout was the right thing to do. Putting shopping baskets in stores was the right thing to do. Adding Lands’ End to the mix was the right thing to do. I think Alan Lacy has made the most significant changes to Sears’ retail operations [of] any CEO they’ve had in 10 or 15 years.”

Barnard agrees. “What Lacy has done,” he said, “has changed the look and functioning of the stores to create the impression of a discount store — the mall-based counterpart to the discount store. And it’s working. I am very much impressed.”

Perhaps the clearest sign of Lacy’s faith in the changes he made came this year, when Sears unloaded its lucrative credit card business. Although credit accounted for some 60 percent of Sears’ earnings and helped it ride out lulls in the retail business, Lacy said the $6 billion sale to Citigroup would give the retailer badly needed financial flexibility and help it focus on retail. When questions arose last fall over bad accounts in the credit division, investors punished the stock. But their reaction to the sale of the division was to send the shares climbing again. Sears was trading at over $44 in September, up from a low of $18.50 in March.

“Where [the credit card unit sale] impacts us is that Sears has a healthier balance sheet now, and we know they’re no longer diverted,” said McCarty. “The attention at the highest levels of that company was devoted to solving the credit card problem. If there’s one positive, it’s that their attention is back on solving the retail problems they have.”

Lacy’s plan, it should be noted, differs in some ways from that of his predecessor, Arthur C. Martinez, whose retail strategy involved developing such off-mall concept stores as The Great Indoors, National Tire & Battery and Sears Hardware, as well as a home furnishings superstore. In comments to analysts during the second-quarter earnings call, Lacy said the company is investing only modestly in many of those concepts today. Further, Sears says the Great Indoors stores may be modified or shut (it closed three in late August). Though there is much to admire about the performance of the Great Indoors, Lacy said, “we still haven’t gotten the profit model right.”

Sears does have plans for another off-mall concept, Sears Grand, but that one is merely in the pilot phase, Lacy says. At press time the first of these freestanding, 200,000-square-foot stores was set to open this fall in West Jordan, Utah. The single-story store will expand on merchandise available in Sears stores, but also add some “convenience” items, such as CDs, DVDs and hardware. Sears has plans to open four additional Sears Grand locations, with the next one set to open in the spring in Gurnee, Ill. “We’ve been too mall-dependent,” Lacy said.

Sears’ Great Indoors has proved to be not so great, the retailer says.

And vice versa, some might argue. According to McCarty, malls need to evolve along with changing retail concepts. “If you look at the old model, where department stores drove traffic to malls, we think that’s changing,” he said. “It has changed. … We’re a landlord, not a landlord to department stores only. We shouldn’t care to whom we lease our stores as long as it’s what the customer wants.”

Sears, McCarty believes, suffered along with other mall anchors blindsided by such emerging concepts as Kohl’s, Target and Wal-Mart. Those retailers don’t share anchor space in more malls, he said, because “traditional department store anchors were given surprisingly strong approval rights over who comes into malls in the anchor positions,” and because malls “kept treating [discounters] like they were second-class citizens and charging them higher rents than they’d be willing to pay.”

But that’s changing, which could return Sears to fighting for shoppers within malls rather than losing them to retailers outside. “Once we decided Kohl’s was an anchor, their cost of entry dropped dramatically,” McCarty said.

Lacy says he expects comp-store sales to be flat for the second half, which would in fact be an improvement after months of declines. He’s targeted 2004 as the beginning of results to the bottom line. As for this year, he said, that “is all about improving top-line growth.”

Success would be another high in a long line of peaks and valleys. Beginning in the late 19th century, Sears has been in a constant state of evolution and reinvention. At first a mail-order company that sold and repaired watches, it expanded into farmers’ goods. Then it became a huge cataloger before ever opening the doors of any store. Later it entered the mall development, financial services and life insurance fields, only to exit them again.

Sears is surely acquainted with difficult times. The chain nearly hit bottom in the late 1980s and early 1990s before then-CEO Martinez spearheaded a renaissance behind the “Softer Side of Sears” campaign. But that momentum wasn’t to last.

“Arthur Martinez did save Sears to a point,” said Barnard. “He saved it from extinction. But he did not save it from changes in the retail marketplace and the competitive arena that would develop in the years afterward. That was something he could not foresee.”

In a speech at ICSC’s Spring Convention in 1997, Martinez spoke about Sears’ comeback, noting that the chain’s problems stemmed from its losing focus on customers and competition, which culminated in a “massive identity crisis.” Those were criticisms Lacy faced anew when he took over in 2000. Martinez acknowledged, however, that the process of evolution can never stop. “Frankly,” he said, “it’s a journey without end.”

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