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Kmart struggles to right itself

When Charles C. Conaway strode into Troy, Mich., 18 months ago to take over the sagging Kmart Corp., he had big plans. Not only did he intend to revive Kmart, the nation's No. 2 discount chain, by attracting new customers with a wide array of useful, low-price goods, but he would do it by September 2002.

Much has changed since then, but not exactly according to plan. The company said Halloween sales fell from last year, an unusual and disturbing development in any retailing business. Kmart executives also said the prime fourth quarter, when Americans shop for the holidays, is likely to be flat at best.

And on Tuesday, Moody's Investors Service said it was reviewing Kmart's credit rating for a possible downgrade.

Conaway, however, remains confident that the turnaround is on track. "We're doing the right thing," he said. He acknowledges that the makeover, which he calls "a massive cultural as well as structural transformation," is still in progress, but says many backroom fixes consumers rarely see are already behind him.

Some problems seem beyond management's control. Nearly a year ago, the nation's economy started to shrivel and consumers stopped spending so lavishly. Then the terrorist attacks delivered a further economic blow.

But several analysts and manufacturers say Kmart still appears devoid of a strong identity that might draw consumers and is riven by problems years in the making. For one thing, while other discount merchants have picked up newly frugal customers, Kmart has been largely left out in the cold. Analysts say Conaway, despite his efforts, has not found the formula he needs to distinguish Kmart from its competition. Moreover, in a possible indication that Kmart is going out of its way to conserve cash, many manufacturers who supply products to its 2,100 stores are rumbling that they are having a hard time getting paid.

Kmart was in disarray before Conaway arrived from CVS, where he had been president and chief operating officer. His predecessor, Floyd Hall, recruited five years earlier on a similar mission, developed private brands for Kmart and introduced Super Kmart grocery stores. He stepped down partly because Martha Stewart, whose home-furnishings line brings in more than $1-billion a year for the company, had complained that he was not committed enough to her product line.

Running Kmart has long been one of the toughest jobs in retailing. Once one of the fastest-growing companies in America, it has been steadily losing ground for years to Wal-Mart, the nation's biggest and most successful retailer, while other chains, such as Kohl's, which sells discounted name-brand apparel, have picked up steam.

Many things about Kmart were "broken," as Conaway put it _ from the supply chain, which is supposed to transfer products smoothly from manufacturer to warehouse to store shelves, to the computer systems, which track sales and inventory.

And Kmart was suffering from a deep identity crisis. While its name may be embedded in the national subconscious _ with its blue-light specials and its battle cry, "Attention, Kmart shoppers!" _ many shoppers have been unclear for years about just why they should go to Kmart.

Wal-Mart became the world's biggest retailer by being more efficient at delivering the lowest-price goods in town; Target created an image as the place for the simultaneously price-conscious and fashionable. But at Kmart, shoppers complained that the products they most wanted were often out of stock. And prices, while low, were regularly undercut by Wal-Mart.

Against this backdrop, Conaway, a trim 41-year-old whom some analysts compare to George W. Bush for his malapropisms (in a conference call, he declared that "Kmart and Martha Stewart are inexplicably linked at the hip"), sought to carve out a space for Kmart. Earlier this year, he zeroed in on mothers, saying Kmart would market itself as the destination that best met their needs. Brands Kmart already handled, such as Martha Stewart and Sesame Street, fit neatly into the concept.

Conaway has signed additional exclusive agreements for apparel with Joe Boxer and Disney. The brand lineup, together with the convenience offered by the urban location of many Kmart stores, he told analysts on Sept. 10, will provide "a tremendous sweet spot for us, by being the authority for Mom."

Not everyone agrees. "Wal-Mart and Target have already perfectly divvied up the market," said George Strachan, an analyst for Goldman Sachs, noting that among the top three discounters, Wal-Mart captures a majority of shoppers who earn $50,000 a year or less, and Target attracts most of those who earn more. Conaway committed the company early on to lower prices, with his "Bluelight Always" program. The price-cutting began this year with a few thousand products, and by last month had widened to about 38,000 items, or about a third of its total, the company said. Conaway also has tried to improve customer service, tying compensation for store managers to how well their stores do on service. Conaway boasted not long ago that scores had barreled upward from 40 percent satisfaction a year ago to about 60 percent.

He also has invested in self-service cash registers that allow shoppers to scan their own purchases, all in the interest of improving their experience in the store.

But while Conaway's promises are compelling, the results have yet to appear. Kmart's sales per square foot, a typical retailing barometer, lag those of Wal-Mart and Target. J.C. Penney, also an old-line retailer attempting to turn itself around, is one of the few chains with a worse performance.

As Conaway's price-cutting got under way, Wal-Mart executives moved quickly to lower prices, which stymied Conaway's effort to stand out. While Wal-Mart's sales have risen 5 to 6 percent this fall, Kmart's have been flat.

A spokesman for Kmart, Jack Ferry, said, "To date we have made significant operational progress in transforming Kmart's business model. It takes time for the financial performance to be seen."

The disappointing sales in October, which Conaway blamed on a nationwide mood of anxiety that put a damper on trick-or-treating and other spending, were not good news. "They definitely are struggling," said Emme Kozloff, an analyst for Sanford C. Bernstein. Conaway said December would reveal much about his strategy. "You've really got to get through the holiday season to understand how long it's taking you to change consumer behavior and your own culture," he said.

Another closely watched indicator is inventory turnover, which shows how rapidly goods move from warehouse to customer. At Wal-Mart, last year's average was 7.3 times a year, and at Target, 6.3. At Kmart, it was 4.3.

Rapid turnover is essential, because the longer products sit in stores, the more they cost retailers.

Some manufacturers have said that with the deadline for Conaway's turnaround just 10 months away, the company is getting tighter with its cash, the New York Times reported, and even asked one manufacturer to contribute money back because Kmart's margins were not as high as expected.

Conaway said he knew of no such conversations. But he said he had had one meeting with a supplier who said he had not been paid on time. The problem, it turned out, was that Kmart had lengthened the period it had to pay him, "and he didn't realize it."

The conundrum for many manufacturers is that Kmart is a major account, and none want to lose its business, particularly at a time when economic conditions are deteriorating. Conaway said the company was working to improve relations with suppliers, and wanted to eliminate the $200-million worth of "chargebacks," or fines for shipping delays and the like, that it posts annually. The company stopped charging manufacturers for most of the summer and even collected an award for the effort.

But the chargebacks are in full swing once again, and among manufacturers, resentment is widening over that as well as other methods Kmart appears to be using to shore itself up.

Several manufacturers said the company had fallen behind by a week or more in payments for products already delivered. Such a delay may seem insignificant, but the amount flowing through a giant retailer quickly adds up. Kmart makes an estimated $70-million a day in payments to retailers; thus a weeklong delay amounts to a half-billion-dollar interest-free loan.

Kmart is not alone. "As the economy slows down, companies are more likely to stretch their cash by taking longer to pay their bills," said Robin Schauseil, executive vice president of the National Association of Credit Managers.

Conaway says Kmart is not short of cash, but adds that he still has plenty to do before the company is fixed. When he arrived, "Our prices were too high, our stores were too dirty, our lines were too long and we were out of stock a lot," he said. "Those are huge liabilities that we are working on."