Thursday, December 08, 2005

Off-mall idea still puzzling for Sears

Retailer says it will pull back from its Sears Essentials concept, the underperforming format that had been touted as the company's way to compete with Wal-Mart, Target and Kohl's

By Susan Chandler
Chicago Tribune staff reporter

You can take Sears away from the shopping mall, but creating a stand-alone store that works is proving harder than expected.

Sears Holdings Corp. Chairman Edward Lampert on Tuesday announced a retreat from Sears Essentials, the retail format that was supposed to combine the best of Sears and Kmart and was once touted as the company's future.

The idea was to mix Sears' Kenmore appliances and DieHard batteries with everyday items such as snack foods and laundry detergent in former Kmart locations away from crowded shopping mall parking lots. Sears has opened 50 Sears Essentials stores around the country--including three in the Chicago area and one near Rockford--and previously had promised that 400 were coming in the next two years.

But the stores have fallen far short of expectations, and Lampert dropped hints Tuesday that such lofty numbers may never be reached.

Sears Essentials' sales are tracking about 30 percent below Sears' target, according to sources close to Sears, and are down about 15 percent from those racked up by the former Kmart stores at the same sites. Sears declined to confirm those figures.

Sears had hoped the stores would generate between $15 million and $20 million in annual sales, significantly less than an average Sears store, the sources said. But the proposition was attractive because the cost to convert the former Kmarts was low, and the process was much speedier than building new stores from the ground up.

Alan Lacy, the former CEO of Sears, embraced Sears Essentials as the fastest way to move Sears away from shopping malls and better compete with off-the-mall giants such as Wal-Mart, Target and Kohl's. Lacy's plans initially were adopted by Lampert when he proposed the acquisition of Sears by Kmart last year, a transaction that closed in March.

Sears Essentials hasn't worked out for a variety of reasons, retail experts say.

Kmart shoppers can't afford--or don't want to pay--$40 for a pair of brocade pants in Sears' Apostrophe line or even $20 for a Lands' End men's flannel shirt. Kmart's apparel was much cheaper. On top of that, their favorite Kmart brands, such as Martha Stewart's popular line of housewares and linens, are missing from Sears Essentials.

Many Sears shoppers may not know that Sears Essentials exists because many are tucked away in out-the-way sites, and Sears Essentials hasn't been doing much advertising.

"When Sears Essentials came in, you had a lot of morons running around screaming this was the greatest thing. I said it was a bowling alley with no customers," said Howard Davidowitz, the outspoken chairman of Davidowitz & Associates, a national retail consulting and investment banking firm in New York. "This business of going off-the-mall is much more complex than it looks."

In his quarterly letter to shareholders, Lampert distanced himself from the Sears Essentials strategy and said it was a mistake to view Essentials as "The strategic rationale behind the merger, or at least the critical barometer of the success of the combination." Lampert acknowledged the track record to date has not been gratifying.

"We will not simply throw money behind any concept, but instead will test, evaluate, refine and `prove the math,' so that the investment is justified before we make it," Lampert wrote.

In its 10-Q filing with the Securities and Exchange Commission, Sears said it has reduced the number of Kmarts that will be converted to Sears Essentials in 2006 but provided no specific numbers.

Lampert hinted that Plan B may be to simply insert Sears' hardline brands into Kmart stores, a strategy he referred to as "Sears Inside of Kmart."

"These offerings present the possibility of achieving increased customer satisfaction and increased profit without the customer education needed to convert to a Sears Essentials format," Lampert said. "I have always believed that Kmart customers had the inclination to buy more valuable products at Kmart if presented with the right value offerings."

Still, that leaves Lampert with the dilemma of what to do with Kmart, a chain that has been losing market share over the last few years at an astonishing rate. Many retail analysts believed that Sears Essentials was basically a strategy to liquidate Kmart. But if that's not the plan, Lampert will be faced with the redundant costs of running two separate retail chains for the long-term.

Profit down sharply
Lampert's letter accompanied Sears Holdings' third-quarter financial reports, which showed a modest decline in revenue and a steep fall-off in profits for the combined company.

In the quarter ended Oct. 29, Sears reported net income of $58 million, or 35 cents per diluted share, a 61 percent decline from pro forma earnings of $150 million, or 93 cents per diluted share, in the same period a year ago. (Pro forma results treat Sears and Kmart as if they had been combined at the beginning of 2004 for apples-to-apples comparison purposes.)

Revenue declined 5 percent, to $12.20 billion from $12.84 billion.

For the first nine months, Sears reported a profit of $141 million, or 87 cents per diluted share, down 52 percent from $295 million, or $1.84 per diluted share, in the year-earlier period. Revenue declined 2 percent, to $38.18 billion from $39.12 billion.

Sears and Kmart no longer issue the monthly sales reports that are forthcoming from other major retailers, but they do provide numbers on a quarterly basis. In the third quarter, sales at Sears domestic stores open at least a year declined 11 percent, led by disappointing apparel sales. Kmart same-store sales fell 2.8 percent, hurt by lackluster sales of home goods.

It was hardly an encouraging lead-in to the important holiday selling season, but Wall Street found reason to cheer anyway.

Investors bid up Sears shares $6.26, or more than 5 percent, to $122.97. They were encouraged because Sears easily surpassed analysts' earnings estimates of 28 cents per share and because its gross margin widened because of fewer price-oriented promotions.

``Expectations for them are very low,'' Arun Daniel, an analyst at ING Investment Management, told Bloomberg News. ING's $40 billion assets included about 293,000 Sears shares as of September. ``Any improvement they can show on the merchandising side without compromising margins is a positive.''

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