A Case Study on Sears versus Target and Divergent Responses – Blame the Market Environment or Command Your Performance

Charting a winning corporate strategy is rarely an easy task, and 2012 has been particularly difficult for executive decision-making.  Yet difficult times do not get executives off the hook for poor performance.  A case in point:  Sears (SHLD) is floundering while Target (TGT) is advancing.  What is driving the significant divergence in performance between these two competitors?  Is a role reversal possible in the next 18 months?

Target (red) and Sears (blue) 5 Year Stock Performance

Bad Market Environment

2012 has offered continued economic malaise, stretching from the Unites States to Europe, China, and much of the rest of the world.  Growth is slow and uneven with many sectors still retreating.

Politically, the waters have been murky, with a few outright failures of governance, leaving a wide wake of doubt.  The US promises an uncertain election followed by a potential self-imposed self-destructive fiscal cliff.  Europe has proven indecisive in failing to curb excessive government structural spending, ensure reliable banking oversight, change policies which discourage entrepreneurship, and balance austerity with sound investments.  Even China is going through its own leadership succession with the expected rise of Xi Jinping to the presidency, with all the uncertainty and restraint which this momentous occasion brings.

These huge uncertainties are set against a backdrop of continued growth of mobile internet access that threatens to disintermediate long-reliable distribution channels through showrooming and cultural shifts that threaten the historic strengths of well-known brands and demand patterns.

Any executive could cite any of the above plus a number of other exogenous factors as reasons to delay investments, delay hiring, or explain poor performance.  And yet, despite this challenging environment, we see some executives making investments, hiring, and driving growth.  Hence, there is evidence that hiding behind the cover of a bad market environment is an insufficient excuse for avoiding difficult decisions, especially when peer competitors are able to address these challenges and thrive.

In other words:  Life it tough.  Get over it.  Now go do something positive.

Target

In 2011, Target Corp. earned revenue of $69.9 billion and averaged retail sales of $280 per square foot-year across their stores.  In the first quarter of 2012, same-store sales were up 4.4%.  In the second quarter of 2012, same-store sales were up 3.1%.  These are decent results considering that the US economy grew only by 1.85% in the first half of 2012.

Target is investing in new stores and new store formats on top of opening 21 new stores in 2011 and along with plans to enter Canada in 2013.  A new urban twist on their brand, CityTarget, opened in Chicago, Los Angeles, and Seattle this summer with promising results, and talks with several other major cities are underway.  With new stores come new hires.

What is driving this growth at Target?  A strong customer acquisition and retention strategy.

• For over a decade, Target has delivered affordable fashion in a strategy they currently describe as “Expect More. Pay Less.”
• In the past few years, Target has expanded its offerings to include household essentials, food, and pet supplies – giving customers more reasons to shop at Target.
• Target has worked with branded-good manufacturers to deliver exclusive items to reduce showrooming.
• It has joined other department stores in adopting the store-within-a-store format in a few areas to improve the customer experience.
• Target’s reward program offers 5% discounts on all purchases to encourage customer loyalty.

This strategy dovetails with the business philosophy that states that a firm exists to serve customer needs profitably.  From this philosophy flows the executives’ mandate to understand customer needs, develop approaches to meet their needs, and invest in those that it can meet profitably.

Sears

In 2011, Sears Holdings earned revenue of 41.5 billion and averaged retail sales of $148 per square foot-year across Sears outlets, and $118 per square foot-year across Kmart outlets.   With roughly similar revenue to Target but half the revenue per square foot of retail space, Sears Holdings requires roughly twice as much property to earn equivalent revenue.  In the first quarter of 2012, same-store sales were down 1.0% at Sears and 1.6% at Kmart.  In the second quarter of 2012, same-store sales were down 2.9% at Sears and 4.7% at Kmart.  These results are anemic in comparison with the national economic growth over the same period, and simply paltry relative to Target’s returns.

What is driving this decline at Sears?  ­­­­

Edward S. Lampert, Chairman and controlling shareholder of Sears Holdings, describes his five pillar strategy for Sears as:

1. Creating lasting relationships with our customers by empowering them to manage their lives
2. Attaining best in class productivity and efficiency
3. Building our brands
4. Reinventing the company continuously through technology and innovation
5. Reinforcing “The [Sears Holding Corporation] Way” by living our values every day

We have seen some action on each of these points, but the efforts have been woefully underperforming, as Mr. Lampert himself appears to acknowledge.

Of these five points, Lampert claims that technological investments occupy most of his time but it appears that cost cutting is the real driving force of change.  Past headlines have focused on Sears’ planned discharge of 1,200 stores.  Recent financial reports have highlighted a $544 million inventory reduction.  September’s headlines regard Sears’ decision to have employees select medical insurance from an online marketplace.  Each of these is more closely related to efficiency improvements than any of the other identified strategic pillars.  Operational efficiency improvements are a necessary part of business, but they alone will not drive growth.

Customers need a reason to shop at Sears again. The Shop Your Way Rewards program of Sears is a good move, but it is not unique nor will it suffice.  Similarly, relying on the sales of Kenmore and Craftsman won’t improve the utilization of retail space considering the category-level sales of these items are lackluster.  As for the aforementioned technological investments, these may take a few years to prove effective in creating and capturing customers.  Hence, on the customer-facing aspects of Sears’ strategy, there is nothing compelling.

Potential for Role Reversal

The analysis above highlights the current success of Target and the current shortcomings at Sears, but must it stay that way?  18 months should be sufficient time for Lampert’s current turn-around strategy for Sears to deliver results considering he has run the company for several years now.  Is it possible for a Sears to match or even out-compete Target in the next 18 months?

Everything is possible, but such a reversal is highly improbable.  Sears’ strategy is simply not compelling and their current performance reflects their strategic deficit.  In contrast, Target’s strategy is sound—fraught with risk, but sound.  Target’s performance reflects its ability to execute its strategy.  With Sears, we see a leadership blaming the bad market environment.  By contrast Target’s leadership has accepted the challenge and risen to the occasion.

To improve the chance of positive results from Sears, a radical change in strategy is required.  This new strategy must involve investing in efforts which will increase customer engagement and assume the risks associated with these investments.  In absence of a major strategic shift, bankruptcy becomes the more likely long-term outcome.  Many have speculated that Mr. Lampert is secretly pursuing a strategy of extracting value along the path of decline, which involves slowly selling off parts of the combined firm.  From Mr. Lampert’s actions and statements, this does not appear to be his desired strategy.

Assuming the slow path to dissolution is undesired, we are left with one question:  Mr. Lampert, are you able to formulate, finance, and execute such a shift; or is it time to swallow your pride, cut your losses, and let others run the firm?