Kmart: Fall of a Retailing Giant

Abstract:

The case details the journey of US-based retailing company Kmart from being an integral, successful part of the country's corporate history to bankruptcy in 2002. The company's origins and its evolution into a retailing giant over the decades have been traced. The reasons for its poor performance vis-à-vis rivals Wal-Mart and Target have also been explored. The case takes a look at the restructuring moves taken during CEO Conaway's tenure and examines the reasons for the failure of the same. The case also takes a look at Kmart's reorganization plans and its efforts to emerge from bankruptcy during 2002-03. Finally, the case discusses Kmart's future prospects in light of its changed strategic game plan and the various problems that still persist.

Issues:

» Understand the major causes that contributed to the failure and bankruptcy of Kmart

» Appreciate how remote and operating environments impact a company's performance over a period of time if they are not factored into the strategic framework

» Understand how competition, operational efficiencies and positioning strategies can significantly alter market shares, leadership position and financial success

"Think of Kmart as a sick uncle. He has been coughing and wheezing for years. Now he has to have major surgery. We hope he survives the knife. But he will never be what he once was."

- Tom Walsh, Free Press Columnist, January 2002.

"We will emerge as a vital enterprise, focusing on providing value to our customers and our stakeholders."

- Julian Day, Kmart CEO, in April 2003.

Kmart Goes Bust

In January 2002, leading US-based retailer Kmart filed for bankruptcy protection under Chapter 11¹ after it was unable to meet its payment obligations to suppliers due to severe financial problems.
The company's (the second-largest discount retailer and the third-largest general merchandise retailer in the US) losses amounted to $ 2.45 billion in 2001 (Refer Exhibit I for key financials). Since Kmart was the largest retailer in US history to declare bankruptcy (2114 stores at the time of the declaration), the announcement came as a major shock to industry observers, customers and employees alike. In March 2002, Kmart decided to close 284 stores throughout the US and lay off 9% of its employees (22,000) as part of its reorganization plan. The then Chairman, Chuck Conaway (Conaway) said, "The decision to close these under-performing stores, which do not meet our financial requirements, is an integral part of the company's reorganization effort."
In that year, closures were carried out in 44 US states and Puerto Rico. Over the next one year, the total number of stores closed went up from 284 to 600, while the total number of employees laid off increased from 22,000 to 67,000.
Many senior executives were also laid off - reportedly, around 25%-35% of senior level positions were eliminated. Thousands of vendors dependent on Kmart for selling their merchandise were affected badly. Kmart's share prices reflected the company's uncertain future: while the stock traded at $ 13 in August 2001, it had reached an abysmal low of 11 cents in February 2003 - a loss of $ 6.7 billion in market capitalization in less than two years. In December 2002, the stock was even delisted from the New York Stock Exchange (Refer Exhibit II for Kmart's stock chart). The downfall of the once mighty company soon came to be seen as the result of problems on a number of fronts: strategic, operational, marketing, human resources and business ethics.

Background Note

Kmart's story dates back to 1899, when Sebastian S. Kresge (Sebastian) set up the S.S. Kresge Company (Kresge) in Detroit, US. The company established a network of retail stores that sold everything for 5 and 10 cents. The low pricing strategy worked well, and by 1912 the company expanded to 85 stores, worth $ 10 million.
In 1918, Kresge was listed on the New York Stock Exchange. During the First World War and the Great Economic Depression, the company's low prices model kept it running. By the mid-1920s, Sebastian opened the forerunner of today's discount stores in the form of stores that sold items for $ 1 or less. In 1929, the company's Canadian subsidiary, S.S. Kresge Company, Ltd. was founded. By the end of the year, it ran 19 stores in Canada. In 1937, Kresge opened a store in the first suburban shopping center in the US, the Country Club Plaza in Kansas City, Missouri. As more companies entered the retailing arena and competition intensified, Kresge launched a newspaper advertising program that became highly popular and successful.
The campaign was extended to radio in due course of time. Over the next few decades, the company established many retail outlets across the country and became a name worth reckoning with in the US retailing industry.
In 1959, Harry B. Cunningham (Cunningham), a seasoned retailing expert, became the President of Kresge. Cunningham decided to launch a discount department store to help the company's stores stand apart from the rest of the players. Thus, the first Kmart store was opened in Garden City, Michigan, in 1962. In that same year, 17 more Kmart stores were opened. These stores contributed a major chunk of the company's sales of $ 483 million for that year. In 1966, Kmart recorded $ 1 billion in revenues for the first time through its 915 stores, of which 162 were Kmart stores. In 1968, Kmart (Australia) Ltd. was set up in association with G. J. Coles & Coy Ltd. of Australia, with Kresge holding 51% of the venture's equity...

Kmart Under Conaway

In May 2000, Conaway replaced Floyd as the CEO of Kmart - and things were never the same again. In addition to Wal-Mart, the company was struggling hard to compete with another discount retailer Target.
Competition from these two companies led to a fall in Kmart's market share (Refer Table I) and financial performance (for 2000, Kmart posted a loss of $ 244 million). Kmart had become infamous for not keeping its stores clean and for not stocking enough goods. Customers had to wait in long queues for shopping at its stores. Even Martha complained of distribution problems and the difficulty customers had locating her products. For such customers, she said, "If you are frustrated, keep looking." Conaway identified the following as Kmart's major problems: poor inventory management (resulting in empty store shelves); lack of customer focus; and a poor, undifferentiated marketing strategy...

Towards Bankruptcy

Under the above circumstances, Conaway's and Schwartz's (who joined in September 2002) 'obsession' to beat Wal-Mart and Target was untimely. Conaway and Schwartz wanted to leave no stone unturned in their quest to beat the competition.
In 2001, while Kmart posted a loss of $ 1.3 billion on sales of $ 36 billion, Wal-Mart posted a profit of $ 6.7 billion on sales of $ 217 billion (Refer Exhibit III for a brief note on the industry environment for these companies). In fiscal 2001-02, Kmart reduced its prices significantly, hoping to beat Wal-Mart and Target. Under this initiative, named the BlueLight Always campaign, the company planned to sell over 50,000 items at everyday low prices. Reportedly, the directors of the company including Adamson expressed their displeasure with regard to the BlueLight Always program. In fact, Adamson recommended a trial-run of the program. However, Conaway went ahead with a full-fledged implementation of the program...

The Reorganization Initiatives

After almost a year of arranging funds, streamlining operations, organizing store closures and laying off employees, Kmart filed its plan of reorganization with the bankruptcy court in January 2003.
As per the plan, ESL Investments (ESL) and Third Avenue Value Fund were to be the two main investors. ESL converted claims worth $ 2 billion into stock and put up $ 109 million in cash for running the business. These two were to invest around $ 140 million in exchange for shares in the reorganized Kmart (with a combined stake of 54%).

And subject to certain conditions, ESL was to provide additional $ 60 million of convertible unsecured note financing. ESL also agreed to use the cash received by it (as a holder of Kmart's bank debt of approximately $ 152 million) to purchase more equity. Other holders of Kmart's debt were to be given 40 cents for each dollar of debt held...

Reorganization Roadblocks

In February 2003, Kmart reported a $ 54 million net loss on revenues of $ 2.7 billion. In the same month, the bankruptcy court approved Kmart's plan of reorganization with minor modifications. The confirmation hearing for the plan was scheduled to be finished on April 14 and 15, 2003.
The company revealed that as per preliminary projections, it foresaw earnings before interest, taxes, depreciation and amortization of $ 51 million for the three months ending March 26, 2003. From the beginning of 2003, sales were $ 4.06 billion, a little higher than the $ 4.01 billion mentioned in the plan submitted to the court.

The first obstacle to the reorganization came in the form of a dispute with a company called Capital Factors (CF). Kmart owed $ 20 million to CF, a company which bought Kmart's accounts receivables at a discount and assumed the risk of collecting the money. CF had appealed against a court decision (in 2002) which approved Kmart's plans to make payments to critical vendors...

Life Goes On - Kmart's Future Plans

Liquidation sales had begun at 317 Kmart stores across the US in January 2003. Heavy discounts were offered and sales off take was quite impressive. To lure back customers to the stores that continued to remain in business, Kmart launched the 'Savings Are Here To Stay' promotion in February 2003. The campaign included in-store events, lucky draws and money saving offers in the form of coupon books (worth over $ 150 in savings on major brands and exclusive Kmart merchandise)...