Kmart-Sears merger of 2005.

Rahman, Noushi ; Eisner, Alan B.

"Unless this new retail giant proves that it's capable of creating stronger customer connections, there will be no real value to this merger" (William J. McEwen, Gallup Management Journal)

"As a retailer, we really have not grown at all for the last 35 years" (Alan Lacy, Vice Chairman of SHC, Ex-Chairman of Sears) "The idea is to form "one great culture" (Edward Lampert, Chairman of SHC, Ex- Chairman or Kmart)

CASE DESCRIPTION

The primary subject matter of this case is corporate strategy. The subject matter is fleshed out in the context of a merger. This case is intended for an undergraduate or graduate corporate strategy section of a business strategy course. The case is designed to be taught in one class hour and is expected to require one hour of outside preparation by students.

CASE SYNOPSIS

In November 2004, retail giants Kmart and Sears announced plans to "merge" their operations. The "merger" was finalized in March 2005 and the combined entity was named Sears Holding Company. At the completion of the "merger," Sears Holding Company had revenues of more than $55 billion (in addition to $2.8 billion in debt), making it the third largest domestic retail company following Wal-Mart and Home Depot. The new organization would face three important issues: competition, synergy, and culture. Appropriate strategies, structures, and culture-blending initiatives must be developed to integrate these historic, disparate organizations to successfully perform as one unified business firm.

THE MERGER

In late 2004, two giant U.S. retail corporations--Sears, Roebuck and Co. and Kmart Holding Corporation--announced that they would merge operations to form the Sears Holding Company (SHC). In terms of how the new entity's name was selected, the Sears name was apparently held in higher esteem by consumers than the Kmart name. Based on a survey conducted by Rivkin & Associates, Opinion Research Corp. (of 1,050 U.S. adults), 75% of Americans preferred the "Sears" name over "Kmart."

Under the terms of the merger, SHC became the third largest retailer in the U.S. with approximately $55 billion in annual revenues and 2,350 full-line and off-mall stores and 1,100 specialty retail stores in the U.S. Kmart shareholders received one share of SHC common stock for each Kmart share. Sears shareholders had the right to elect $50 in cash or 0.5 of a share of SHC for each share of Sears's common stock. At the time of the merger, it was estimated that the former shareholders of Kmart would have an approximate 63% interest in SHC and former shareholders of Sears would hold a 37% interest in SHC. On the morning of March 24, 2005, the merger approval date, Sears shares fell $6.06 (about 11%) to $50.74 (NYSE) and Kmart shares rose $1.19 (about 1%) to $126.02 (NASDAQ).

Twelve teams--comprised of members from both companies--were created to ease the merger process. According to Alan Lacy, former President and Chief Executive Officer of Sears and new Vice Chairman of SHC, one post-merger goal is that "Kmart will benefit from the planned cost sharing of several of Sears leading proprietary brands" as well as present opportunities "to capture significant revenue and cost synergies, including merchandise and non-merchandise purchasing, distribution and other SG&A expenses." Ultimately, the goal of the merger, according to Edward S. Lampert, former Chairman of Kmart and new Chairman of SHC, was to "seek to leverage the combined strengths of Sears and Kmart to obtain greater long-term value than either could have generated on a stand-alone basis. SHC plans to offer customers a new, more compelling experience with a differentiated and expanded product range" (SHC Press Release, 2005).

These changes are the first of many for these historic and somewhat disparate companies, both of which were founded in the late 1800's and are woven in American culture. The newly merged entity--SHC--will face challenges of marrying two distinct retail entities in terms of their unique cultures, in order to create requisite synergies to keep pace with (or surpass) the competition. Before looking on to the future, it is important to look at the historical evolution of Sears and Kmart to better understand the respective organizations' strategies and cultures.

BACKGROUND OF COMPANIES

Sears, Roebuck & Co.

Richard W. Sears found the R.W. Sears Watch Co. in 1886. The early days of the organization were filled with changes in structure and partnership--moving to Chicago, taking on Alvah Roebuck (an Indiana watchmaker) as a partner, and publishing the company's first mail order catalog (which comprised of 80 pages) in 1888. The watch business was sold in 1889 and by 1891 Sears had developed the nation's first mail-order business. In 1893, the company's name changed to Sears, Roebuck and Co. At that time, the company's sales had exceeded $400,000. By 1895, the 532-page Sears catalog offered a variety of merchandise, including apparel, shoes, china, saddles, musical instruments, firearms, buggies, wagons, fishing tackle, watches, jewelry, etc.

In 1911, when banks did not lend to consumers, Sears opted to offer credit services to its customers. Around this time, Sears also established a research lab to ensure product standards and conduct merchandise quality control checks. In February 1925, Sears opened its first retail store. In terms of retail history making, Richard Sears is credited with creating the modern department store; he also came up with the idea of "unconditional money back guarantee."

Like most other U.S. companies, Sears struggled during the great depression. After the depression, the company continued its growth in terms of number of retail locations, business line diversification (e.g., Sears introduced a line of tires, "Allstate," which was ultimately expanded into an automobile insurance and life insurance company), international expansion (e.g., early expansions included Cuba in 1942 and Mexico in 1947), acquisitions of several other organizations (e.g., Simpsons Ltd. of Canada, Coldwell Banker Co., etc.), and the erection of the Sears Tower in Chicago in the 1970's (i.e., at the time, the tallest building in the world). By 1963, Sears was the number-one retailer in the U.S. and one-in-five consumers shopped at Sears regularly.

Early success ultimately made Sears complacent. By the 1970's, competition became stiff and other discounters (S. S. Kresge Co., which later became Kmart) started cutting into Sears' profits. In 1974 alone, Sears experienced a $170 million drop in profits. In an effort to continue its growth, Sears attempted to further diversify its businesses. Despite diversification in the 1980's (e.g., purchase of Coldwell Banker, then the nation's largest real estate broker; Dean Witter Reynolds, a securities firm; the launch of Prodigy, an on-line service with IBM and CBS; the launch of the Discover Card; and ultimately the transformation of Sears into a collection of specialty stores), profits continued to decline through the 1990's. In 1992, Sears slashed jobs and suffered a year-end loss of almost $2.3 billion. This outcome prompted Sears to sell off several of its businesses (e.g., Coldwell Banker, Dean Witter Reynolds, etc.).

As a strategic response to declining revenue in the 1990's, Sears made an effort to target female consumers, introducing the "softer side of Sears." To support this strategy, Sears restructured its stores (i.e., moving appliances, hardware, and furniture were moved from mall stores to their own freestanding retail outlets). By 1995, profits hit $1 billion again; and in 1997, Sears stock reached an all time high of $65.25 per share. By 1998, however, Sears again saw downturns in business and many executives, including the chief executive officer, departed. In October 2000, current President Alan Lacy took the reins and created "The Great Indoors" store concept. Another strategic move made by Lacy was to transfer Sears account holders to MasterCard as Sears had come to rely too heavily on its credit card financing operations. This move resulted in many consumer defaults because of the higher interest rates. Sears in-store sales also continued to falter. In 2003 sales were slumping and staff layoffs were instituted again. In addition, the credit card business was sold for $3 billion to Citigroup. The "softer side of Sears" was ultimately considered to be too "soft" as witnessed by the eleven consecutive months of declining sales seen in 2004 (see Exhibits 1 and 2 for Sears' revenues and net income).

[GRAPHICS OMITTED]

In general, Sears' retail business had been weak, consistent with its declining store sales. Sears' in-mall locations had been a major impediment to its sales of home-related categories because the majority of home goods are sold in off-mall locations. Indeed, Sears was able to retain some of its charisma in small-town America (i.e., where its off-mall stores were located).

Kmart Holding Corporation

Kmart was founded as S. S. Kresge Co. in 1899 by Sebastian Spering Kresge as a five-and-dime retail store in Downtown Detroit. He then expanded into chain stores, similar to that of the Woolworth stores and ultimately acquired Mount Clemens Pottery (which manufactured inexpensive, popular dinnerware sold in the stores). By 1912, Kresge stores were the second largest five-and-dime chain in the U.S. with 85 stores and annual sales of over $10 million. By 1924, there were 257 stores with annual sales of $90 million.

Similar to Sears, Kresge stores struggled through the Great Depression. Unlike Sears, Kresge stores did not offer "credit" to its customers in the early years. Although Kresge offered layaway payment plans, this approach hurt the company because customers were more attracted to credit offerings.

In the late 1950's, food grew into the single largest department in Kresge stores and in-store luncheonettes were created. Consequently, Kresge acquired various food companies (e.g., Furr's Cafeterias, Bishop Buffets, etc.), created a fast food drive-through (i.e., Kmart Chef), and ultimately entered grocery retailing in 1970's. Kmart Chef was discontinued in 1974.

In 1962, Kresge's President Harry Cunningham conducted a research study on discounters and competition. Cunningham found that discount stores were the main competition for Kresge stores. As a strategic response, "Kmart" was born in Garden City, Michigan.

After the first year in business with Kmart, sales reached $483 million and plans were made to open 32 additional Kmart locations which were geographically isolated from the competition. Through the 1960's, Kmart and Kresge continued to evolve and older Kresge stores were converted to Jupiter Discount. By 1976, Kmart became the second largest general merchandise retailer in the U.S. with annual sales of $8.4 billion. The corporation held its shares tightly (1,206 out of 1,647) and maintained 271 stores. The S.S. Kresge name was officially changed to Kmart Corp. in 1977. In mid 1970's, Kmart expanded internationally into Australia. However, Kmart sold its stake in the Australian Kmart in 1978. In the 1980's, Kmart expanded to Mexico (stores operated by a prominent Mexican retailer); the company also formed a joint venture with Japan's top retailer.

By 1981, Kmart had 2,000 stores and continued expanding through acquisitions of Penske Auto, Walden Books, and Home Centers America (renamed Builders Square). By 1987, sales were up to $25.6 billion. In order to continue its growth, from 1980 through the 1990's, Kmart Corp. acquired Sports Authority, OfficeMax, and Borders Inc.; merged with Pay Less Drug Stores, launched the Jaclyn Smith Collection, and opened Super Kmart Centers (1,200 sites by 1997). During this time, Kmart also enjoyed the growth of its apparel business (i.e., Kmart's fastest growing business).

In 1994, Kmart streamlined operations in response to shareholder displeasure. The company closed 110 stores, laying off 6,000 staff members and managers. Furthermore, Kmart sold off several of its previously acquired businesses: OfficeMax, Borders/Walden bookstores, Payless Drugs, Penske Auto, and Sports Authority.

Facing tremendous competition from other major retailers (mainly Walmart and Target), Kmart continued to change throughout the 1990's by selling its stake in the Rite Aid Corp., partnering with Salton/Maxim Housewares (i.e., giving Kmart exclusive distribution rights Salton/Maxim's small electrical appliances, consumer electronics, kitchen housewares and personal care products and other White Westinghouse brands), introducing the highly successful Martha Stewart line (i.e., home fashion products that neared $1 billion in sales), creating BlueLight.com (i.e., an independent e-commerce company formed in 1999), and entering the food retailing segment. However, all these shuffling proved futile, as Kmart continued to lose market share (see Exhibits 1 and 2 for Kmart's revenues and net income). Kmart Corp. filed for Chapter 11 bankruptcy protection in January, 2002.

Edward Lampert, former Chairman of Kmart, turned around Kmart from bankruptcy in less than two years. By the end of 2004, Kmart reported three consecutive profitable quarters and operated 1,511 Kmart discount stores and SuperCenters. Such expedited recovery sent Kmart's stock price above $100 per share in late 2004. Despite the turnaround orchestrated by Lampert, Kmart's market share continued to shrink. Some criticized that Lampert pumped Kmart to generate cash rather than to build the business (Garbato, 2005).

THE NEW ENTITY: SEARS HOLDINGS CORPORATION

As indicated in the comparison chart (see Exhibit 3), there is common territory among the products offered by the Sears and Kmart stores--the primary overlaps being in the home goods and apparel arenas. Some major differences in product offerings exist too. On one hand, Sears sells lawn, garden, tools, large appliances, automotive, hardware and window/siding products, which are not offered by Kmart. On the other hand, Kmart's retail food line and pharmacy operations are not common to Sears. Differences in product lines need to be exploited by SHC, as the new entity "will feature a powerful home appliance franchise with strong positions in tools, lawn and garden, home electronics and auto repair and maintenance." The new company expects that these product lines, in addition to the combined strengths of the apparel lines previously offered by both Sears and Kmart, the strength of the Martha Stewart Home line and the predicted extra traffic generated by the retail food line, will result in a realization of approximately $200 million in incremental gross margin from revenue synergies capitalized by these cross-selling opportunities and by the conversion of off-mall Kmart stores to Sears. According to an SHC Press Release, "The company expects to achieve annual costs savings of $300 million principally through improved merchandising and non-merchandising purchasing scale as well as improved supply chain, administrative and other operational efficiencies" (SHC Press Release, 2004).

Lampert believes that the anticipated $200 million in additional revenue, the $300 million in cost savings, and Kmart's $3.8 billion in tax credits (which will shield profits for a number of years) would help SHC's per share price to rise. As a result, SHC should be able to accumulate cash and be in a strong market position. His vision for SHC is to build a broader customer base and to increase sales to achieve profits of 10% EBITDA-to-sales ratio (similar to successful retailers like The Gap and Home Depot). This will be accomplished by several strategies.

First, SHC will convert Kmart stores to the Sears name in "markets where existing Kmart stores better fit Sears' demographic of slightly higher-income shoppers. Second, given its huge real estate portfolio, SHC will benefit from the flexibility of switching stores between chains and selling stores as necessary (although this can be limited by mall owners, because 74% of mall owners followed by Merrill Lynch have a Sears store).

Third, SHC will expand on the Sears Grand concept (off-mall stores which carry consumables) to counter the "loss of consumers to savvier rivals." Plans are already in place to open 60 Sears Grand stores by 2006. Sears Grand expectations should benefit from Kmart's experience in the consumables and apparel markets. Consumables are viewed by the SHC as "traffic builders." Fourth, SHC will expand the Sears Essentials stores (relatively smaller convenience-driven stores) by converting approximately 400 existing Kmart locations. Sears Essentials will offer products such as appliances, lawn and garden tools, home electronics, apparel and home fashions as well as convenience goods such as health and beauty aids, a pharmacy, pantry items, household products, paper products, pet supplies, and toys. These stores will benefit from Kmart's position as one of the nation's largest pharmacy and health care retailers (i.e., 1,150 in-store pharmacies, 2,400 staff pharmacists, and significant expertise in disease management). The Kmart stores slated for conversion are located in key urban and high-density suburban markets with customer demographics and income levels matching those of the typical Sears shopper. The first 25 Sears Essential stores will open in Spring 2005.

Fifth, SHC will cross-sell products by having Kmart and Sears' carry each other's lines. For example, Kmart will carry Kenmore appliances, Craftsman tools, and diehard batteries; Sears will carry some of Kmart's brands in future.

Lastly, SHC will be able to emphasize on apparel labels that appeal to a multicultural audience. Latinos and African Americans make up a significant share of Sears' shoppers and this group also represents large share of the shoppers at Kmart's inner city locations.

Overall, management's strategy for the restructuring is aimed at better supporting existing Sears stores, although both stores will continue to operate separately under their respective names for quite some time after the merger. The new structure creates eight regions that cover 110 districts, each composed of six to nine stores. There will be a new position entitled "director of stores" to manage each district. This position will report to a regional vice president. Since SHC will operate under at least six different formats, a challenge for the new leadership will be to determine how the retail formats would fit in each market and how they should be named, e.g., Sears Grand, Sears Essentials, etc. Therefore, to avoid the inherent confusion that will result among stakeholders (e.g., consumers, SHC employees, shareholders, and analysts), it will be critical for the leadership of SHC to clearly define the organization's identity, image, and direction. This is even more important because, historically, both Sears and Kmart were accused of having an ill-defined media image, caused by frequently changing strategies. Both firms were also deficient in strategy execution and employee training. Because of this, the new SHC executive staff, in particular Aylwin Lewis--former President and CEO of Kmart, is focused on team building and staff training (Berner & Weber, 2004; Guy, 2005).

Equally important in terms of strategy is retaining and building customer loyalty. A former Kmart executive, Gary Ruffing, who now serves as senior director of retail consulting for BBK, Ltd, has advice for the SHC management team: "You can fix a lot of things, but if you can't get the customer back, it doesn't matter .... My advice to the new CEO is to listen to the customer and keep the team focused on four or five critical points of the shopping experience ... the keys are the instock position, the touch points at checkout, the friendly service and keeping the pricing within the value range." Ruffing also underscored the importance of strategically placing Aylwin Lewis. "[H]is ability to understand and bring brands and positions together to drive the success of Sears Holding Co. and Kmart's ability to fit outside of discounting ... where they fit has always been an issue.... [E]ventual success could lie in the chains' combining of product lines rather than that of the retail brands. Many people say the retailers are two losers. The brand equity is not the Sears or Kmart name ... brands are brands ... you have to understand who they are and put together a marketing program and the ambient features that go with that. You need somebody who has done that." Aylwin Lewis is credited with the successful transformation of Kentucky Fried Chicken from a sleepy Southern brand touted by an aged colonel to the hip and urban KFC (Clark, 2004).

In terms of changes for stakeholders as a result of the merger, one glaring difference will be the loss of dividend payments to former Sears shareholders. Another change, which will directly affect employees, is the reduction by SHC of the number of employees eligible for stock options (Sears had already reduced the number from 17,000 to 2,000 in early 2004 and further reductions are expected) as well as the inherent management changes and organizational policy changes. According to a March 14, 2005 article in Home Textiles Today, "there will be seismic shifts among senior executives and middle managers immediately following the merger." Importantly, in April 2005 SHC announced the first of a series of staff lay-offs (which will directly affect employees and management at the Sears Chicago headquarters) as well as salary and benefits changes to take effect in 2006.

Management

The new Board of Directors consists of seven directors from the former Kmart Board and three directors from the former Sears Board. The executive team is also a blend of former Kmart and Sears staff members, as follows:

1. Edward S. Lampert, Chairman (formerly Chairman of Kmart)

2. Alan J. Lacy, Vice Chairman (formerly Chairman of Sears)

3. Aylwin B. Lewis, President of Sears Holdings and C.E.O. of Sears Retail (formerly

President and C.E.O. of Kmart)

In addition, two other previous Sears executives and five Kmart executives were appointed to SHC. Current and previous employment positions of SHC's top management team is presented in Exhibit 4.

RETAIL INDUSTRY AND COMPETITION

Retail Industry

The retail industry is the second largest industry in the U.S. when ranked by number of establishments (20% of all establishments) and number of employees (18.3% of all employment covered by unemployment insurance). The retail industry expanded at unprecedented rates from the late 1990's to 2000, before the recession resulted in a manufacturing slowdown, job losses, high consumer debt, and retail bankruptcies. The industry was further plagued by the ".com bust," uncertainty following the September 11, 2001 terrorist attacks and global unrest. The rise of Wal-Mart and other big box discount retailers (or "mass merchandisers") and the economic recovery in the mid-2000's changed the retail landscape. Retailers responded to these market pressures by restructuring stores, reorganizing internal operations, and marketing patterns and by taking advantage of technology to assist with e-commerce, inventory issues, point-of-sale systems and data analysis. In 2004 (which is considered by analysts to be the most "stable" retail year in quite some time), the top ten U.S. general merchandise retailers based on 2004 sales figures were: (1) Wal-Mart ($285 billion), (2) Sears Holding Corp. (recently merged with a combined $55 billion), (3) Target ($48 billion), (4) Federated/May (recently merged with a combined $30 billion), (5) J.C. Penney ($18 billion) (6) Gap Inc. ($16 billion), (7) TJX Cos. ($15 billion), (8) Limited Brands ($9 billion), (9) Dillard's ($8 billion) and (10) Saks ($6 billion). Home Depot, the number two retailer in the U.S., is not considered a "department store." While retail sales were strong in the luxury and discount sector in 2004, department stores and other retailers struggled to make their numbers. In early 2005, the GDP had risen 4.4% which was the fastest pace in five years and was led by consumer and capital spending (Sway & Musselman, 2005).

The architecture of the retail industry has drastically changed from the introduction of catalogs and general trading stores, to department stores, to the rise of indoor malls, to the growth of discounters and big box stores, to internet based selling, to changing demographics (more single parent households, double income households, geographic shifts and increased catalog sales due to busy lifestyles). In addition, catalogs and e-commerce have globalized the retail market.

Several other notable changes took place in the 2000's. For example, as enclosed malls fall out of favor with consumers, new open air "lifestyle centers" are becoming increasingly popular. These centers have plenty of outdoor space--fountains, plazas, and walking paths--designed to attract customers and keep them there for longer periods of time. Because retailers generally pay less rent for these open air arenas, profits are higher. In addition, consumers can park very close to the store entrance, unlike traditional mall set-ups (Kennedy, 2005).

More mega-mergers (such as the Sears/Kmart combination, Federated/May stores) will result in the closing of more stores, which in turn will propel even more mergers and acquisitions (in retail and closely related industries). Because of this activity, suppliers may be forced to merge in order to survive the huge bargaining clout created by these mega-mergers. Suppliers potentially face fewer orders, higher pressure for markdowns, discounts and promotions from the shrinkage wave following these mergers. Ultimately, smaller suppliers will be swallowed up by larger, healthier entities as they will be unable "to meet the demands and prices of the newly emerging retail behemoths" (Ostroff, 2005).

Another recent trend is that clothing vendors are opening their own stores (e.g., Ralph Lauren, etc.), which has created somewhat of a backlash on major retailers. In retaliation, chain operators like Federated are opening series of mini stores (mini-Macys, mini-Bloomingdales and other specialty mini stores such as Charter Club and INC.) throughout the country to accommodate consumer's varied tastes (Ostroff, 2005).

In the current retail economy, consumer trends lean toward value and frugality, leading to a movement away from department stores and to the rise of discount retailers, warehouse and wholesale clubs (such as Costco and Sam's Club). Warehouse shopping outlets are currently growing at a rate of 10% per year--twice as fast as the rest of the retail industry. The long-term forecast for department stores in the U.S. suggests a continued slow growth rate into the next century as the industry continues to battle online retailing, direct marketing and home shopping networks.

Competition

Wal-Mart was established in 1962 in Arkansas and is currently the largest retailer in the U.S. and in the world. Wal-Mart is also considered to be the low-price leader. The company went public in 1970 and has 4,800 stores worldwide with 75% of those located in the U.S. Annual sales in the U.S. 2004 were $256.3 billion and their sales were higher than the combined total of the nine second largest stores (Target, Sears, Kmart, J.C. Penney, Federated, Mays, TJX, Kohl's and Dillards). Wal-Mart is planning to open 500 new stores by the end of 2005 that will result in an 8% expansion of total square footage (55 million square feet). Wal-Mart has also entered the grocery market, which has been strategic to its growth in recent years. In 2005, Wal-Mart will add 240-250 Supercenters (stores which sell both general merchandise and groceries), 30-40 Sam's Clubs (large warehouse stores) and 25-30 Neighborhood Markets (smaller grocery store formats designed to accommodate zoning in metropolitan areas).

Wal-Mart has significant power over its suppliers and has been accused of unfair labor practices for years (they maintain a strict anti-union position). It has a 44% turnover rate for their hourly workforce and, in 2001, the average Wal-Mart employee earned below the poverty level. Wal-Mart is also accused of putting many small town department stores and individual establishments out of business and has been criticized for limiting the public's choices by catering to conservative special interest groups. Wal-Mart accounts for 2.3% of the GNP. By comparison, General Motors was at 3% in 1955 and U.S. Steel was at 2.8% in 1917 at their respective peaks. In 2003, Wal-Mart was plagued by class-action employment suits (sexual discrimination against women with nearly 1.5 million potential plaintiffs, employees forced to work off the clock to avoid overtime payments) and use of illegal immigrants in cleaning companies.

Target, now the fourth largest retailer in the United States (due to the Sears/Kmart merger Target moved from third to fourth place) with 1,275 stores and 2004 annual U.S. sales of $48.16 billion. Target has its roots in the J.L. Hudson company established in 1881 in Michigan and the largest retailer of men's clothing by 1891. They opened their first Target store in 1962. Target is considered an "upscale" discounter with better brands and is very attractive to chic, hip, young consumers.

JC Penney's is ranked 5th in the retail category for 2004 with total revenues of $18 billion. JC Penney's stands to suffer from the Sears/Kmart merger because the move gives SHC an opportunity to grow off-mall at a rapid pace. Although it appears that SHC may be positioned more as a discount retailer, which would not directly compete with Penney's who are known for their value fashions for moderate consumers, the indirect result for JC Penney's could be problematic if SHC pulls their stores out of malls (the absence of Sears mall anchor stores would reduce foot traffic to malls which can ultimately hurt JC Penney's bottom line) (Howell, 2004).

Clearly, there is no shortage of retail competition between Wal-Mart, Target, Federated/May Department Stores, J.C. Penney and others. If SHC were to exclusively focus on the strength of the Sears brand lines of Kenmore, Craftsman, DieHard, and other home services, then their competitors would include Home Depot and Lowe's. At the moment, however, it appears that SHC may be aiming to become more of a mass merchandiser by cross-selling both hard and soft product lines in various formats such as Sears Grand, Sears Essentials and mall/off-mall locations. In this category, Wal-Mart is the undisputed leader. Competing head-on with Wal-Mart will prove to be a daunting task as noted by Howard Davidowitz, chairman of consulting and investment banking firm Davidowitz & Associates, "All the dead retailers had grandiose plans ... there's been more than 100 casualties. Nobody has ever taken on Wal-Mart and lived."

The Future of the Sears Holding Company

In order to be successful, SHC's business strategy must specifically address the issues of competition, culture and synergy in a very focused way. "Four out of five companies that have attempted to change business strategies have failed to meet the new strategy's objectives" (Porter, 1996) and "employees resisting change may make implementing a strategic change difficult or impossible" (Lewin, 1952). In terms of competition, the mere combination of the Sears and Kmart retail empires does not propose any significant threat to competitors (e.g., Wal-Mart, Target, Home Depot, etc.) because their consumer messages are more consistent and they continue to grow by building market share. With regards to culture, both organizations come from distinct, historic and proud pasts--and it will be a challenge to combine these disparate entities to form one unique forward-driven culture. And, finally, while there are countless opportunities to combine brands, product lines, operations, and systems, corporate history books are filled with failed mergers (e.g., AOL-Time Warner) that underscore the difficulty to create synergies at such a large scale (Sway & Musselman, 2005).

It should be noted that 70% of mergers fall short when it comes to achieving their targets for revenue synergies, while 40% lead to cost-synergy disappointment. Other mergers are "dis-synergy disasters" such as the aforementioned AOL-Time Warner merger, which resulted in $99 billion in write-downs by January 2003. Miscalculations of revenue synergies can be attributed to unexpectedly high consumer defection levels, poor assumptions about market growth and competitive realities, and overly optimistic prospects for cross-selling opportunities in a deal's wake. It is also important to make efforts to retain employees from both companies. Bad assumptions (e.g., overly optimistic projections, simplistic predictions and assumptions, and poor time projections) "will lead to substantial over-estimates of synergy net present value by making cash flow accretion and other deal metrics look unrealistically positive" (Frieswick, 2005).

The question looming over the top management of Sears Holding Company is whether they can create a distinct brand image and identity to outperform fierce competitors like Walmart and Target. To take on the competition successfully, key obstacles would be to create a culture of success among the disparate organizations of Sears and Kmart, to generate consumer loyalty, and to appropriately position SHC, based on its identity, in the general merchandise market.

ANALYST REVIEWS

Analysts' reviews of the merger are mixed, ranging from optimism and faith in the leadership and vision of Lampert to ultimate failure of SHC (see Exhibit 5). There is, however, much speculation among analysts as to whether Lampert can successfully accomplish the stated goals without the selling off of real estate. Hailed by Business Week as the next Warren Buffet, Lampert closely mirrors Buffet's strategy of investing in cash rich old line companies and he stands to benefit enormously from the merger via his private investment fund, ESL Investments, which held 52.6% of Kmart and 14.6% of Sears (pre-merger). As of March 2005, many industry analysts and insiders remained skeptical as to Lampert's motives--whether they would build a successful retail empire or merely generate cash.

REFERENCES

Berner, R. & Weber, J. (2004). Eddie's master stroke. Business Week, November 29, 34-36.

Clark, K. (2004). Kmart orders out. Chain Store Age, 80(12), 39-40.

Frieswick, K. (2005). Fool's gold. CFO Magazine, February 1. Retrieved from: <http://www.cfo.com>.

Garbato, D. (2005). Team grit, Retail Merchandiser, 45(2), 4.

Guy, S. (2005). Brands a key in success of merger. Chicago Sun-Times, March 22, 49.

Howell, D. (2004). New no. 3 on paper, but can Sears/Kmart deliver? DSN Retailing Today, 43(23), 3, 85.

Kennedy, K. (2005). Retailing changes create opportunities. FDM, 77(3), 18.

Lewin, K. (1952). Group decision and social change. In G. E. Swanson, T. M. Newcombe, & E. L. Harley (Eds.), Readings in Social Psychology (2nd ed.), 459-473. New York: Holt.

Ostroff, J. (2005). Store mergers to roil suppliers. Kiplinger Business Forecasts, March 8.

Porter, M. E. (1996). What is strategy? Harvard Business Review, 74(6), 61-78.

SHC Press Release. (2004). Kmart Holding Corporation and Sears, Roebuck and Co. agree to m erge. November 17. Retrieved from: <www.searsholdings.com>.

SHC Press Release. (2005). Kmart and Sears complete merger to form Sears Holdings Corporation. March 24. Retrieved from: <www.searsholdings.com>.

Sway, R., & Musselman, F. (2005). 2004: A very good year. Display & Design Ideas, 17(3), 34-50.

Exhibit 3: Pre-Merger Operations and Financial Comparisons of Sears and
Kmart

(data as of 1/1/05)

Item Sears Kmart

1/1/05 Revenue $36,099,000,000 $17,072,000,000
Full-time employees 247,000 158,000
# Shares outstanding 253,824 89,629
Dividends per share $0.92 $0
Earnings per share $1.53 $2.52
Price per share 52 Week High: $50.49 52 Week High: $99.64
 52 Week Low: $49.81 52 Week Low: $97.35
Stockholder's equity $6,092,000,000 $2,192,000,000
Long term debt $3,473,000,000 $477,000,000
Total assets $22,474,000,000 $6,084,000,000
Total liabilities 16,382,000,000 $3,892,000,000
Return on equity 5.45% 11.31%
Return on assets 1.48% 4.08%
Return on investment (1.36) 106.77
Net profit margin (1.40%) 1.45
Total debt to equity 0.57 0.22
ratio
Fortune 2005 Overall score: 6.67, Overall score: 4.22,
"America's Most ranked third behind ranked tenth
Admired Wal-Mart (7.86) and following Wal-Mart,
Companies"--General Kohl's (6.71) and Kohl's, Sears, J.C.
Merchandisers moved from fourth to Penney, Federated
 third place over last Dept. Stores, Target,
 year Dollar General, May
 Dept. Stores and
 Dillard's and moved
 from eleventh to
 tenth place over last
 year
Number of stores in 873 full-line 1,511 (includes
U.S. department stores, Puerto Rico, Guam and
 1,307 specialty the U.S. Virgin
 format stores (auto, Islands) and 60 Kmart
 neighborhood Supercenters.
 hardware) and 15
 Lands' End retail
 stores.
Fortune 500 Ranked 32 in 2004, Ranked 67 in 2004,
 was 30 in 2003. was 39 in 2003.
Analysis In 2004, total In 2004, Kmart did
 revenue decreased not have a 10K
 12.2% from 2003 filing. In 2003,
 (attributable to the Kmart was in the
 decline in credit and midst of reorganizing
 financial products from its 2002 Chapter
 revenues as a result 11 filing, which
 of the sale of the resulted in the
 domestic Credit and closing of 284 stores
 Financial Products and the elimination
 business). of 22,000 jobs and a
 charge of more than
 $1 billion.

 In 2003, total In 2003, total
 revenue decreased revenue decreased
 0.6% from 2002. 15.4% from 2002.
Business Description: Home group: Includes Home group: Includes
 appliances, appliances,
 electronics, home electronics, home
 fashions, home fashions, fitness and
 improvement products sports equipment and
 (e.g., tools, fitness includes the Martha
 equipment, lawn and Stewart Everyday
 garden equipment) and brand.
 includes the Kenmore,
 Craftsman and
 WeatherBeater brands.

 Apparel/Accessories: Apparel/Accessories:
 Includes apparel and Includes apparel and
 footwear, jewelry and footwear, jewelry and
 accessories and accessories and
 includes the Land's includes the Disney,
 End, Covington, Jaclyn Smith, Joe
 Canyon River Blues, Boxer, Route 66,
 Apostrophe and TKS Thalia Sodi, Sesame
 Basics brands. Street and Kathy
 Ireland brands.

 Sears Auto Centers:
 includes automotive
 services and sales of
 tires and batteries
 including the DieHard
 brand.

 Sears has 1,000 Kmart Supercenters:
 specialty stores in 60 stores that
 off-the-mall combine a grocery,
 locations, an deli and bakery along
 internet retail site with general
 (sears.com), 792 merchandise.
 dealer stores (which
 are primarily
 independently owned),
 245 hardware stores
 (Sears Hardware and
 Orchard Supply
 Hardware), 18 The
 Great Indoors stores
 (specializing in home
 decorating and
 remodeling
 interiors), and 45
 Sears Outlet stores
 (carrying overstocks
 and discount
 merchandise).
Significant Sears Canada: Similar No significant
International to U.S. operations presence outside of
Presence with 122 department the U.S.
 stores, 42 furniture
 and appliance stores,
 144 dealer stores,
 14 outlet stores, 53
 floor covering
 stores, 49 automotive
 centers, 110 travel
 offices and 2,200
 catalog pick-up
 locations. Sells
 brands similar to
 those sold in the
 U.S.
Motto and Business Motto: "Satisfaction Motto: Unclear. No
Model guaranteed or your reference of a formal
 money back." Their motto can be traced.
 vision is to be the
 preferred and most
 trusted resource for
 products and services
 that enhances its
 customers' home and
 family life.

 Business Model: To Business Model: The
 offer a compelling historical core
 customer value competency of Kmart
 proposition through is in designing and
 the combination of sourcing apparel and
 high quality products in its merchandising
 and services at and marketing
 competitive prices. approach on quality
 This is affected by brand names.
 low pricing and
 promotional
 activities, and
 minimization of
 product and service
 costs. This is
 achieved through
 economies of scale,
 centralized overhead
 expense structure,
 reinvestment of
 operating cash flows
 into capital
 projects, and quality
 improvements in
 proprietary brands.
 To return profits to
 shareholders, issue
 dividends, repurchase
 shares, and increase
 share price.

 Differentiation: By Differentiation: By
 offering high quality designing and
 national brands as sourcing its apparel.
 well as Sears
 proprietary brands
 which enjoy high
 levels of consumer
 awareness, trust and
 integrity (Kenmore,
 Craftsman, DieHard
 and Land's End brands
 are offered
 exclusively at
 Sears stores) and
 retail-related
 services such as
 delivery,
 installation, product
 repair, product
 warranty, and
 protection services.

 Pre-merger Pre-merger
 challenges: Retail challenges: Kmart has
 stores within a been challenged by
 mall-based format are competitors like
 not preferred by Wal-Mart and Target
 consumers. Sears has and was forced to
 been challenged by close stores,
 competitors that eliminate jobs and
 specialize in certain declare Chapter 11
 types of consumer Bankruptcy in 2002
 goods and Sears was due to a rapid
 focused on being the decline in liquidity
 lowest cost provider which resulted from
 in those categories. below-plan sales and
 earnings performance
 in the 4th quarter of
 fiscal 2001, the
 evaporation of the
 surety bond market,
 erosion of supplier
 confidence, intense
 competition,
 unsuccessful sales
 and marketing
 initiative, and the
 continuing recession
 and capital market
 volatility. After
 emerging as Kmart
 Holding Corp., the
 focus was to generate
 profitable sales,
 control costs,
 streamline overhead,
 increase asset
 productivity, and
 improve customer
 service.

Exhibit 4: SHC's Top Management Team

Sears Holding Corp. (SHC)

Board Size: 11 (Chair, Vice Chair, CEO, CFO, and 7 Directors)

Top Management Team

Name Age SHC Position Background

Edward S. Lampert 43 Chairman Chairman, Kmart
Alan J. Lacy 51 Vice Chairman Chair/CEO, Sears
Aylwin B. Lewis 50 Pres/CEO CEO, Kmart
William C. Crowley 47 EVP/CFO CFO, Sears
Maureen McGuire N/A EVP/Chief Marketing VP-Strategy/
 Officer Marketing, IBM
Corwin Yulinsky N/A EVP-Customer Consultant,
 Strategy McKinsey SVP-
 Customer Strategy,
 Chase
Lisa Schultz 50 EVP-Apparel Design SVP/Chief Creative
 Officer, Kmart
Karen A. Austin 43 SVP/CIO SVP/CIO, Kmart
Julie Younglove-Webb 35 SVP/GM-Sears VP-Space Planning,
 Essentials and Kmart
 Sears Grand
Teresa Byrd 56 SVP/GM-The Great VP/General
 Indoors Merchandise
 Manager-Sears
 Grand, Sears
Chris Shimojima N/A VP-Merchandising VP/GM-Sears
 and Marketing, Customer Direct,
 Customer Direct Sears
Andrea L. Zopp 48 SVP/General Counsel General Counsel,
 Sears Logistics
Edgar (Ted) McDougal N/A VP, Public SVP-Public
 Relations Relations and
 Government
 Affairs, Sears

Exhibit 5: Analysts' Reviews

Date Positive Reviews Negative Reviews Source

November 18, There are "two Ascribe
2004 threats Newswire, "Iowa
 immediately for State Sources
 the merged Offer Expertise,
 firms: debt will Perspective on
 be more Sears/Kmart
 expensive Merger
 because bond-
 rating firms are
 downgrading
 Sears' credit-
 worthiness, and
 the power and
 growth of Web
 shopping are
 weak areas for
 both firms ...
 neither Sears
 nor Kmart have
 strong Internet
 sales....
 Walmart.com and
 Target.com have
 seen significant
 growth in sales
 but this merger
 is not likely to
 improve the
 internet
 presence for
 Kmart or Sears"
 (Cynthia
 Jeffrey,
 Associate
 Professor, Iowa
 State College of
 Business).

November 22, They will Retail
2004 provide a Merchandiser,
 compelling power "Consultants
 brand statement Question Success
 in both fashion of Sears/Kmart
 and home Merger
 categories that
 will drive
 shoppers to the
 stores. If they
 pool their war
 chest of brand
 names and become
 one, they may
 solve the "brand
 image" problem
 that has eluded
 both Sears Grand
 expectations
 should benefit
 from Kmart's
 experience in
 the consumables
 market.

November 22, Sears has long Retail
2004 offered ethnic- Merchandiser,
 specific Consultants
 programs.... Question Success
 Kmart has just of Sears/Kmart
 begun to Merger
 "officially"
 target
 Hispanics....
 Perhaps bringing
 the benefits of
 big box
 retailing
 combined with
 these power
 brands to inner
 city, lower
 income, ethnic
 shoppers will
 provide the
 right niche for
 a still under
 served audience.

November 22, "Long-term, the Business and
2004 combined Industry, HFN,
 entity's success "The Big Deal:
 will hinge on S-Mart?", by
 execution, where Barbara Thau,
 neither company pg. 1, ISSN:
 had a 1082-3010
 particularly
 good track
 record.... In
 our view,
 neither
 management team
 brings a
 significant
 track record of
 operating
 success to the
 transaction....
 Still, better
 real estate
 locations will
 give them access
 to greater
 customer
 traffic, so we
 think it would
 be rash to
 discount the
 deal entirely"
 (Danielle Fox,
 Merrill Lynch
 analyst).

November 22, "We do not Business and
2004 believe that Industry, HFN,
 adding Sears "The Big Deal:
 appliances to S-Mart?", by
 Kmarts or Joe Barbara Thau,
 Boxer apparel to pg. 1, ISSN:
 Sears will turn 1082-3010
 either company
 around" (George
 Strachan,
 Goldman Sachs
 analyst).

November 29, Overall, Kmart Business and
2004 brings stronger Industry, HFN,
 soft home goods "Battle of the
 to the Brands for Kmart
 merger ... the and Sears," pg.
 Martha Stewart 4, ISSN:
 brand will be 1082-0310
 re-energized and
 become the focus
 private-label
 brand for the
 merged chain.

November 30, Most analysts Retail
2004 are skeptical Merchandiser,
 the combination "How Kmart-Sears
 of two Merger Affects
 struggling Suppliers"
 retail brands
 that will
 continue to
 operate
 separately will
 thrive in a
 sector dominated
 by Wal-Mart.

February 10, "You have two Gallup
2005 retailers who Management
 are doing badly Journal, "Merger
 right now ... Myopia: Two
 It's hard to retail giants
 fathom how join forces. But
 combining them how will the
 is suddenly customer
 going to produce benefit?" by
 a new entity William J.
 that will do McEwen
 better" (Stephen
 Hoch, The
 Wharton School).

March 24, "It's about The Associated
2005 profitability, Press, "Kmart
 not about sales. Buyout of Sears
 It may get Gets Final
 smaller, but ... Approval;
 it's going to be Changes Loom,"
 more profitable, by Dave
 more stable, Carpenter
 with a better
 strategy. And
 it'll be more
 competitive with
 Wal-Mart and
 Target" (Richard
 Hastings,
 independent
 retail analyst).

March 24, "For the short The Associated
2005 term, it's very Press, "Kmart
 exciting. But Buyout of Sears
 for the long Gets Final
 term, watch Approval;
 out." Davidoff Changes Loom,"
 forecasts a by Dave
 "bleak outlook" Carpenter
 for Sears unless
 the move away
 from malls is
 successful
 (Howard
 Davidoff,
 Davidoff and
 Associates).

Noushi Rahman, Pace University Alan B. Eisner, Pace University