Kmart-Sears merger of 2005.

Rahman, Noushi ; Eisner, Alan B.

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.

INSTRUCTORS' NOTES

Teaching Objective

This case is intended for use in a business policy and strategy class. In terms of its length, writing style and content, the case should be relatively facile for any undergraduate senior to read and comprehend. The authors wrote the case in a style that overviews the situation but intentionally avoids guiding students through specific application questions or any analytical framework. Subject style enables the instructor to adjust class discussion to accommodate students with a broad range of abilities. Specifically, instructors can invite more experienced students, including graduate students, to reason through a situation where uncertainty exists and speculation may be required.

Case Use

Course: Business Policy and Strategy (Undergraduate or Graduate)

Suggested Position in Course: Corporate Strategy Case

The case can be targeted as a corporate strategy case; helping students to understand the various issues associated with strategic change. After completing this case, students should recognize an impetus for changing a corporate strategy--including why firms choose to find partners for mergers and other strategic moves to adapt to changes in the industry environment, how firms identify the necessity to change their corporate strategy, and how they implement change.

The case of the Kmart/Sears merger illustrates two retail giants "merging" to reposition themselves in response to competition in the retail environment (Textbook Chapter: Corporate Strategy), declining profits related to lack of internal growth issues at each respective organization (Exhibits 1 and 2), and historical problems with brand identity. Kmart and Sears have joined forces to create a global retail giant to better compete with market discount leader Wal-Mart and other leading mass merchandisers such as Target. The fate of the individual brands that made both Sears and Kmart popular--Martha Stewart, Jaclyn Smith, Lands End, Kenmore, Die Hard, Craftsman, etc.--are still to be determined. However, the Sears name will live on and the Kmart name will likely fade away. This will be important in terms of brand identity and customer loyalty.

Of interest, opinion polls and analysts clearly point to a more positive connotation with the Sears name than the Kmart name, justifying the new entity's name: Sears Holding Company (SHC). It should be noted that the Sears name is more popular with male consumers than female consumers based on the strength of their tools, equipment, automotive and home improvement lines. Both Sears and Kmart have never been viewed as fashion-forward entities by female shoppers. Of greater interest, however, is that while Kmart was more financially stable than Sears pre-merger (i.e., Kmart had less shares outstanding, higher earnings-per-share, higher stock prices, lower long term debt, less liabilities, higher return on equity, higher return on assets, higher return on investments, higher net profit margins, and lower debt-to-capital ratios), Kmart continued to be viewed as a "damaged" brand name in consumer polls. The question remains whether the Sears name will exist in the traditional, familiar way (i.e., well stocked inventories and trained quality sales staff with "in-department" expertise) or as something else, such as a hybrid appliance/home center giant combined with a discounter, pharmacy, grocery, and retail components (Textbook Chapter/Section: Corporate Parenting and Restructuring). In order for the new entity to be successful, the following critical issues need to be addressed:

1. What is the Sears Holding Company and what does it want to become?

2. What is its brand identity?

3. Who are its customers?

4. What are its competition: (a) Home Depot, the second largest U.S. retailer, based on the strength of Sears tools and outdoor equipment sales?; (b) Wal-Mart, the largest U.S. retailer, best known as a discount retailer offering conventional apparel and the market leader in grocery/food sales?; or (c) Target, now the fourth largest U.S. retailer following SHC, that is popular among younger consumers and known for discount hip apparel and home furnishing brands?

5. How does it plan to combine two disparate cultures with strong ties to American history, into one uniform culture that looks to the future, not to the past?

6. What are its specific plans to create synergy among the former Sears and Kmart operations and systems? For example, the disparity ranging from the product lines and staff expertise of the exclusive Sears appliance, tool, automotive, equipment, and home improvement lines to the Kmart pharmacy expertise and grocery retail experience?

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.

SHC's Long-Term Business Strategy

The new entity has announced its long-term strategy as:

1. Expanding upon the Sears Grand concept (off-mall stores which carry consumables) to counter the "loss of consumers to savvier rivals" by benefiting from Kmart's experience in the consumables and apparel markets. Consumables are viewed by the SHC as "traffic builders";

2. Expanding the Sears Essentials model stores (smaller--80,000 square feet--convenience-driven stores which can be developed off-mall rapidly by converting existing Kmart locations that are located in key urban and high-density suburban markets with customer demographics and income levels matching those of the typical Sears shopper). These stores are on a single level, offer a variety of products and feature exit cashiering, a centralized customer service center (similar to the layout of Sears Grand stores) and generate foot traffic through the sales of consumables and pharmacy/health and beauty aides;

3. Converting Kmart stores to the Sears name in "markets where existing Kmart stores better fit Sears' demographic of slightly higher-income shopper's;

4. Cross selling by having Kmart carry Sears' lines such as Kenmore appliances, Craftsman tools, and diehard batteries;

5. Switching stores between chains and selling stores due to the huge real estate portfolio of SHC (although this can be limited by mall owners--74% of mall owners followed by Merrill Lynch contain a Sears store); and

6. "Emphasizing apparel labels that appeal to a multicultural audience (Latinos and African Americans make up a significant share of Sears' shoppers and comprise a natural audience at Kmart's many inner city locations)."

Although the management of SHC has created twelve separate merger teams to assist in the transition ("employees resisting change may make implementing a strategic change difficult or impossible" [Levin, 1952]), the following issues remain unclear:

a. how the new entity plans to manage and communicate change to employees, managers, independent operators affiliated with Sears and Kmart, suppliers, etc. and manage any resistance to change;

b. what corporate identity or "image" will be associated with SHC (both Sears and Kmart have been historically accused of having a lack of vision and in delivering inconsistent messages which culminated in the frequent changing of business strategies--"four out of five companies that have attempted to change business strategies have failed to meet the new strategy's objectives" [Porter, 1996]);

c. how SHC plans to build its customer base and consumer loyalty (this relates back to (b) above and in knowing what kind of a company it is, what it wants to be, what its competition is, what its strengths and weaknesses are; these problems have plagued both Sears and Kmart in recent decades);

d. whether the long term strategy proposed by SHC is specific and consistent enough to marry the distinct retail entities and their unique cultures to create the synergy to successfully compete in the retail sector.

TEACHING PLANS

Given the decision to "merge" Sears and Kmart and create new store formats to compete with Wal-Mart and other big box retailers, ask students to discuss the strategic issues outlined by the new Sears Holding Company. Does the strategy proposed--the Sears Grand and Sears Essential stores, and conversion of Kmart stores to Sears in certain demographic locations--adequately address the real competitive edge currently enjoyed by world leader Wal-Mart and by hip, chic Target (Textbook Chapter: Organizational Structure)? Does the SHC corporate strategy adequately address the strengths and weaknesses of the individual brands and product lines of the former Sears and Kmart and go far enough to specifically address the issue of product complementarity and staff training? Does the corporate strategy specifically outline the human resource impact and plans to manage change and synergize operations, systems and staff (Textbook Chapter: Organizational Control)?

We believe that this case provides a rich context to discuss Environmental Analysis and Internal Analysis of the former Sears and Kmart organizations, and Corporate-level strategic analysis for the new Sears Holding Company. In terms of Environmental Analysis (Textbook Chapter: External Analysis), aspects of this case analysis relate directly to Porter's Five Forces as regards the strategy selected to pursue an advantage over rivals (geographic expansion and store format changes), and in terms of the exploitation of relationships with suppliers (big box control over suppliers). Also key is what generic strategies (cost leadership, differentiation, and focus) SHC plans to use to counter the Five Forces (Textbook Chapter: Competitive Strategy). As regards Internal Analysis, this case presents an interesting example of the complementarity of the individual store brands and product lines, suppliers and business lines and the importance of creating a new, single culture that is forward-driven (Textbook Chapter: Internal Analysis). With respect to corporate-level strategic analysis, the merger move was a vehicle to pursue quick horizontal integration (Textbook Chapter: Corporate Strategy). Both firms were motivated to merge because both were losing market share. However, gaining market share through a merger is clearly not the solution to losing market share. The merged firm must take advantages of synergies of combining various products, economies of scale for producing more of the same thing, and economies of scope for producing more of different things. Also, a great deal of learning curve benefits can occur if Sears and Kmart actively learn the best practices of each other. Nevertheless, mergers tend to face one huge obstacle of blending disparate corporate cultures and corporate strategy analysis ought to address this issue as well.

ASSIGNMENT QUESTIONS

As noted in the "teaching objectives" section, the opportunity exists in this case to engage in speculation. The authors of this case believe that better students will respond to this uncertainty and see an opportunity to exercise their ability to reason logically in the face of uncertainty and fierce competition. The questions presented below cannot be fully answered without some degree of speculation. For each question below, we offer an average response by a student. Each instructor using this case is encouraged to do the analysis as well.

1. Was the decision to merge K-mart and Sears a good strategic move in order to compete with discount retailer and cost/market leader Wal-Mart and to increase market share?

Both Sears and Kmart had experienced growth and revenue problems in the years immediately preceding the merger. The decision to merge creates additional retail locations for "quick" growth by virtue of store conversions to the Sears name format, which SHC's management believe will result in an increase in market share. Through the cross-selling of previously successful brands and product lines in the new store formats, and coupled with the creation of new selling regions and districts, and the entry of Kmart into inner city neighborhoods, SHC hopes to capitalize on the successful brands of the former Sears and Kmart entities, e.g., Kenmore, Craftsman, DieHard, Martha Stewart, etc. and gain a better footing in the minority market.

However, the current lack of a clear management plan and focus on the cross-training of Kmart employees and management on specialized lines (e.g., Sears automotive, tools, outdoor equipment, house windows/siding, appliances, etc.), a forte of the Sears floor selling model, can only lead to a further erosion of customer loyalty and consumer dissatisfaction with in-store selling experiences and in service. The SHC corporate strategy focuses intensely on plant and expansion issues (increased geographic locations, changes in store formats, conversion to the Sears nameplate, plans to increase store foot traffic and growth in off-mall locations) but does not adequately address human capital and management issues.

2. According to analysts, building a brand image is key to the success of the Sears Holding Company. Why is it important for the Sears Holding Company to establish brand identity sufficient to create a distinct retail experience?

Identifying a brand image is critical to positioning the Sears Holding Company in the market and to consumers. In other words, it needs to be very clear as to whether SHC is a retail discounter like Kmart and Wal-Mart or more like Home Depot with strengths in tools, appliances, outdoor equipment, and home repair. Or, does it aspire to be both or neither? If SHC plans to stick to its mass merchandising, it is important to decide what kind of products will SHC stores carry (i.e., generic, super-value items like Wal-Mart does or chic, premium items like Target does). An ill-defined brand image will hinder the success of the Sears Holding Company, creating confusion among shareholders (as exemplified by the former Kmart in the 1990s), employees, managers, and consumers. Particularly with regards to consumers, when they do not know whether the store will sell expensive premium items or discounted generic items, they will most likely start avoiding the store altogether. Ultimately, this would result in a loss of existing customers loyal to the former Sears and/or Kmart, and prevent SHC from gaining much-needed market share (it may even cause a loss of overall market share).

3. Is the corporate-level strategic move to create geographic regions and districts with Sears Grand and Sears Essential stores, through the conversion of existing real estate, enough to build market share and customer loyalty? Are the strategic plans outlined by management immediately post-merger sufficiently specific and targeted to accomplish this goal?

The strategic moves outlined by the Sears Holding Company address some of these issues, but are not specific or focused enough to attack the major challenges of growth by expansion, geographic territory, minority appeal, and store formats. This kind of grouping is common among smaller retailers (since they often operate in a narrow market). As a large retailer, SHC would be able to compete with these specialized retail stores through its various geographic regions and districts (and with different store formats). Also, the Sears name, which is near and dear to the hearts of small town America and popular with males based on recent opinion polls, could represent a significant positioning opportunity (regarding home improvement and auto related products) if properly exploited and executed. Moreover, distinct store formats would allow SHC to deliberately group its product offerings. Consequently, Sears Grand stores could opt to develop a brand image that is very different from Sears Essential stores.

4. How are cultures of the two companies different? How can SHC blend the two corporate cultures to positively influence the synergy creation process?

Sears' culture is more innovative than Kmart's. Sears stores also offer a more sophisticated environment than Kmart stores. Within a unified culture, employees who are used to any one type of culture will feel out of place. Customers who valued the sophisticate environments of Sears would expect the same in SHC, any less will not do. Conversely, customers who did not care for the shopping environment of the stores (as long as the bargains were the best in town), would care little for the extra effort SHC might put in to offer its customers an improved shopping experience. Bringing these seemingly different cultures would require extra efforts by dedicated taskforce at the corporate level and managerial staff at the store level to orchestrate a seamless integration. Hence, as problems would arise, these staff would be able to address them on the spot and sketch out long-term solutions at the corporate level. Moreover, a culture of one-ness could be fostered by storewide events, and celebration of successful integration and milestone achievements at newly merged stores.

A two pronged marketing campaign might be necessary too. First, in areas where more Kmart shoppers live, SHC needs to convince the customers that there is a lot more in life than bargain basement prices. Second, in areas where more Sears shoppers live, SHC needs to advertise its added features in its merged stores and the probability of potential bargains in its products. SHC needs to also send the message that the newly merged stores will not compromise with the sophisticated culture of the "old Sears" stores.

EPILOGUE

Only by creating a distinct and clearly communicated brand image, and by implementing a successful change management strategy focused on the education and development of human resource capital, can the Sears Holding Company hope to successfully unite the Sears and Kmart cultures and become forward-thinking. Due to the "newness" of the merger, there is insufficient data to further develop this.

REFERENCES

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.

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

Noushi Rahman, Pace University

Alan B. Eisner, Pace University