In the past year, Sears Holdings Corp. has been moving its best Sears brands into Kmart in an effort to reach more shoppers and jump-start years of declining sales.
First Craftsman tools and DieHard car batteries appeared on Kmart shelves. Then roughly one out of every 10 Kmarts began selling Kenmore appliances.
Now, in the boldest move yet, the retailer is experimenting with putting free-standing Sears stores inside of Kmart.
The discount chain is renting about 7,000 square feet inside existing Kmarts to Sears dealers in four towns — Claremont, N.H.; Freedom, Calif.; Pell City, Ala.; and Zephyrhills, Fla. — carving out a separate entrance and hanging a Sears sign over the door. The dealers sell hardware, appliances, lawn equipment and some consumer electronics.
The combination comes closer than any effort to date in merging Sears and Kmart into one entity, a process many investors were skeptical would happen after hedge-fund investor Edward Lampert engineered Kmart Holding Corp.’s acquisition of Hoffman Estates-based Sears, Roebuck and Co. more than two years ago.
“We thought it was going to be more of a land bank story than an operating story, but the operating story has been surprisingly strong,” said William Dreher Jr., a Deutsche Bank Securities analyst in New York who rates the stock a “buy” and who owns Sears shares.
Sears has a network of 822 so-called dealer stores, run by entrepreneurial-minded business owners. They are well-versed in selling big-ticket items such as refrigerators and lawn tractors, products foreign to Kmart. And they have incentive to generate sales.
The dealers have invested their own money into the Sears business. Although Sears owns the merchandise and sets the prices, the dealers pay operating expenses and receive sales commissions.
Inside of Kmart, the dealers continue to operate as they always have, but rent payments go to Kmart instead of the landlord, lowering the Kmart store’s overhead costs and in turn helping profits. And, if all goes as planned, the higher-income customers that go into Sears to buy a lawn mower or dishwasher will wander into Kmart and do some shopping.
Putting dealer stores inside of Kmart also is a way to boost sales without investing a lot of money in the stores, a textbook Lampert strategy.
Sears calls the move a test and plans to expand it, CEO and President Aylwin Lewis told shareholders at the company’s annual meeting in May.
“All indications are that it’s something we will take a look at,” Steve Titus, vice president and general manager of dealer stores for Sears, said in an interview last week.
If successful, the experiment could go a long way in helping Lampert’s efforts to fix the two troubled retailers.
When Lampert took control of Kmart in bankruptcy court, he turned the retailer around by selling real estate and cutting costs. As Sears’ chairman and its largest shareholder, with a 43 percent stake, Lampert has not sold much Sears real estate but has still managed to improve profits by cutting overhead costs and trimming capital spending.
But without the asset sales, Lampert’s strategy is starting to reveal limitations.
Slipping sales eat at profit
After holding steady for two years, sales at Kmart stores open at least a year fell 4.4 percent in the first quarter of fiscal 2007, as the company reported in May, hurting overhead expenses and cutting into total profits. Same-store sales at the Sears chain fell 3.4 percent, dragged down by a what Sears called “a notable decline” in home appliance sales, which are facing increased competition from Home Depot, Lowe’s and Best Buy. Home appliances accounted for about 15 percent of Sears Holdings’ revenue in fiscal 2006, or about $8 billion.
“Recent missteps have left investors wondering if this is a temporary stumble or a sign that cost savings are drying up,” wrote Goldman Sachs Group Inc. analyst Adrianne Shapira, who rates the stock a “neutral” in a June 13 report. Shapira predicts profit improvement will return but warns it “could be somewhat choppy given that success increasingly hinges on top-line results.”
Sears Holdings’ net income came within its predicted range for the first quarter, but after removing one-time gains and charges, Dreher estimates profits from continuing operations fell slightly.
On Thursday, shares closed at $168.53, up 46 cents, but that’s a 12.6 percent decline from its record close of $193 on April 17. Still, shares of the merged company have increased 28.5 percent since closing at $131.11 on March 28, 2005, the first day of trading as Sears Holdings.
A chance to minimize rivalries
Sears established the dealer stores in 1993 after shutting down its legendary Big Book catalog. The stores, many of them former catalog outlets, gave Sears a way to reach rural Americans who lived far from a traditional Sears store. But since Kmart bought Sears in March 2005, scores of Sears dealers compete directly with Kmart. Craftsman tools and DieHard batteries, products once exclusive to Sears, now are available at the more than 1,300 Kmart stores. About 180 Kmarts sell Kenmore appliances, and more stores are on the way.
“You need to have a 3 to 4 percent sales increase each year just to keep up with the overhead,” said Thomas A. Redington, a former Washington, Mo., Sears dealer. “If Kmart sells the same products where you had an exclusive, you lose volume.”
About 200 dealers banded together in June 2005, shortly after the merger, and sued Sears for infringing on their territory. A federal judge dismissed the lawsuit, saying in essence that Sears had individual contracts with each dealer, not the group as a whole.
By sharing customer traffic, both stores could benefit.
“If you want a tractor, Kmart walks the customer over to the Sears dealer store,” Titus said. “If someone wants a smaller microwave than the built-in microwaves the dealer sells, the customer walks over to Kmart.”
Sears undertook a similar strategy at its department stores with Lands’ End. Sears bought the preppy direct-mail business in 2002 with the hope that selling the upscale clothing inside of Sears department stores would attract higher-income consumers.
But the initial execution faltered. Lands’ End, a higher-priced line that rarely went on sale, hung on racks next to Sears’ promotional in-house brands. The presentation confused the traditional Sears shopper and lacked cachet for Lands’ End fans.
Lands’ End fared better after Sears carved out a separate “store” for the brand. The company tested the in-store shops in a handful of Sears stores before rolling them out to 100 stores last year and plans to have Lands’ End shops in 200 stores this year.
“It’s like what they did with Lands’ End to drive traffic into Sears,” said Love Goel, chairman and CEO of Growth Ventures Group, a Minnetonka, Minn.-based retail investment firm. “They’re trying to use appliances to drive traffic to Kmart.”
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smjones@tribune.com
Graphic: FISCAL 2006 U.S. FINANCIALS %% KMART SEARS Sales $18.65 $29.18 billion billion Operating $948 $1.32 income million billion Stores 1,388 2,030 %% Source: Sears Holdings Corp.
