Two-For-One Sale

Shoppers Venturing into the new supersize Sears Grand concept store in Rancho Cucamonga, Calif., off the old Route 66, can be forgiven for double-checking the name on the façade. Perhaps it’s the barbecue grills on sale outside the entrance, an echo of Home Depot’s parking-lot bonanzas, or the reams of DVDs, CDs and books that make you think you’ve stumbled into Wal-Mart. Maybe it’s the colorful signs hanging from the industrial, sky-high ceiling, festooned with cheeky slogans like IT’S THE LITTLE THINGS THAT COUNT, which remind one of the king of cheap chic, Target. Then again it could be the 10-ft.-wide aisles and end-cap displays with towering boxes of bulk sodas, detergent and paper towels that look straight out of Costco, or the smarter, casual clothes that smack of Kohl’s. Sure, this Sears store still has its standard array of Kenmore appliances, Craftsman power tools and DieHard batteries, but there’s also a wine section and an eye-care shop. Most important, there isn’t a musty, aging shopping mall anywhere in sight.

If Sears’ odd amalgam of its rivals’ successful retailing strategies seems a bit disorienting, consumers may have to get used to it. Until now, the Grand store has been just a small-scale experiment to lure shoppers in more often and stop Sears from being squeezed by discounters on the low end and big-box specialty retailers on the high end. Think of it as the wider side of Sears. But in the wake of last week’s $11 billion megamerger with floundering discounter Kmart, the Sears Grand could be the foundation of an extreme and long-overdue makeover. By melding the Sears savvy in selling so-called hard goods like dishwashers, lawn mowers and flat-panel TVs with Kmart’s upmarket “soft” brands like Martha Stewart Everyday, Jaclyn Smith and Joe Boxer, the sales pitch goes, the two perennial retail losers just might create a winning formula. On the other hand, by combining two badly managed retail dinosaurs into one, wags say, the companies may simply save themselves some bankruptcy fees when they inevitably go extinct.

Notwithstanding all the talk about scale, $300 million in annual cost savings and sizable purchasing power, the merger isn’t so much an attempt to take on a behemoth like Wal-Mart as it is to survive in spite of it. Even with a combined $55 billion in annual sales, Sears and Kmart will be just one-fifth the size of Wal-Mart, which “is so overwhelming in terms of market share, logistics and efficiency that going up against them would be futile,” as Michael Appel, managing director of Quest Turnaround Advisers, puts it.

For the moment, at least, Sears and Kmart will operate as separate chains under one corporate umbrella, Sears Holdings, and each will probably offer a smattering of the other’s trademark brands. But all indications are that as time goes by, Sears, the more productive store operator and the more respected brand, will subsume Kmart and try to carve out a successful niche as a middle-market power retailer focused on fashion and the home, with more attitude and style than JCPenney could ever hope to have. “We are the trade up,” Sears CEO Alan Lacy said almost defiantly at the announcement of the deal. “We sell better things than Wal-Mart and Target. We’ve got better brands [and] better service.”

The shotgun marriage between Sears and Kmart is the brainchild of Kmart chairman and maverick investor Edward Lampert. A billionaire finance whiz who counts David Geffen and Michael Dell as clients and Warren Buffett as his idol, Lampert took control of Kmart when it came out of bankruptcy 18 months ago. Since then Lampert, 42, who also happened to be Sears’ largest single shareholder through his ESL Investments, has turned Kmart into a cash cow, albeit a shrinking one. Although critics describe his moves as short-term fixes, he reduced inventory, slashed costs, limited discounts and sold off some of Kmart’s lucrative real estate to the likes of Home Depot and, yes, even Sears.

It’s no wonder that so many skeptics think Lampert’s latest gambit is more about real estate than retail, part of a long-term liquidation plan to unload billions of dollars’ worth of property, as well as perhaps some valuable brands, to the highest bidders. But it’s a notion that the notoriously reticent Lampert took pains to reject last week. While acknowledging that some underperforming stores would continue to be disposed of, he told investors, “I don’t think any retailer should aspire to have its real estate be worth more than its operating business.”

Lampert may have no operational merchandising experience–after Yale, he worked at Goldman, Sachs under the tutelage of Robert Rubin, and went off to start his own fund at age 25 with the help of legendary Texas investor Richard Rainwater. But Lampert does have ideas about how to run a retailer, such as an unwillingness to throw money at updating stores without clear evidence of a return, and a firm refusal to play the short-term, quarterly-earnings game that Wall Street so often demands. In April, he brought in a design team led by former Gap executives to freshen up Kmart’s clothing lines. “Eddie is relentless and a harder-nosed operator than most people want to believe,” says Henry Miller, a leading business-restructuring adviser who worked with Kmart during its bankruptcy. “In point of fact, he is a retailer, in his mind. He will fight for a nickel, and mind every penny.” (If anybody doubted how good a dealmaker or student of risk Lampert was, he proved it in January of last year, when he was kidnapped. He talked his captors, who were holding him for a $1 million ransom, into letting him go with the promise he would pay them $40,000 a few days later.)

Over the past couple of decades, both Sears and Kmart have become mere shadows of themselves, plagued by aging, poorly stocked stores; management turmoil; outdated merchandise; and a lack of sophisticated IT systems–or, for that matter, a clear identity. Whereas Kmart has failed miserably to compete on price with Wal-Mart or on style with Target, Sears has found it harder and harder to stay relevant at its aging 870 mall locations, about the same number of stores it had back in 1970. It has tried everything from financial services (its “socks and stocks” period) to home improvement (the Great Indoors experiment) to returning to its catalog roots, with the purchase of the upscale Lands’ End catalog, which has proved to have less broad appeal than Sears had hoped.

In one key sense, at least, there is no denying that the merger is all about real estate. For years, Sears has claimed to be the prisoner of its once pioneering shopping-mall locations, where, in fact, Americans do less and less of their shopping, especially on big-ticket items. By transforming several hundred of Kmart’s 1,500 freestanding and strip-mall outposts into New Age Sears stores, at an estimated price of about $3 million apiece, the company hopes it can finally reach its best potential customers. That assumes, of course, that those customers want to reach Sears. For even if Sears and Kmart can assemble a compelling assortment of exclusive product lines to sell, they are still, in a sense, “going to have to transcend their own [weak store] brands,” says Kevin Keller, professor of marketing at Dartmouth’s Tuck School of Business.

Whether Sears and Kmart can do that by incorporating the best elements of much stronger brands in the industry remains unclear. “It could be more like a Bed Bath & Beyond meets Best Buy meets Target,” says Marshal Cohen, chief fashion analyst at industry researcher NPD Group. “They’ve got a second chance here.” But if Eddie Lampert can’t make it work this time, it’s likely to be their last.–With reporting by Jeffrey Ressner/Rancho Cucamonga and Jyoti Thottam and Dody Tsiantar/New York City