Case Analysis

Kmart
Marie Janz & Kris Ruth

Introduction

Historical Overview

In 1987 Sebastian S. Kresge, the founder of Kmart opened his first five-and-
dime store. In 1962 Kresge had opened the first Kmart discount department,
followed by 17 other Kmart stores that same year. (4)

In 1966, Kresge died, leaving 735 Kresge variety stores and 162 Kmart
stores with combined annual sales greater than $1 billion. Management
replaced all Kresge stores with Kmarts and continued to build more Kmarts.
(4)

In 1977 Kmart Corporation was established with 95% of sales coming from
Kmart department stores. In 1981, the 2,000th Kmart was opened.(4) (For
other significant historical facts see Appendix 1.)

Kmart Corporation began diversifying their business strategy in the early

1980’s by acquiring many different companies. (For a complete listing of
Kmarts History of Diversification see Appendix 2.)

Beginning with Antonini’s stay as CEO, president, & Chairman of the Board
and continuing into this year, Kmart has been divesting these businesses.
This divestiture strategy has left Kmart with only % shares of the shoe store
that currently stocks their shoes (Kmart does not own the shoes it sells).
Kmart after several years of negative income have chosen to concentrate on
their core business.

Currently Kmart is undergoing a reconstruction strategy. This strategy

includes constructing Super Kmarts to compete with Wal-mart’s Super-
Centers and grocery stores. Super Kmarts are open 24 hours. For their
current stores, they are closing down the smaller ones and remodeling the
larger ones into Big Kmarts. The Big Kmart is designed with a "pantry", which
is like a convenient store set-up, near the registers. The "pantry" is the
central point with other items radiating out in terms of frequency of
purchase. Kmart is opening Big Kmarts at the rate of 600 stores per year. Big
Kmarts will include Kcafes which will carry Little Ceasars, Tyson, Coca Cola
and Sara Lee items on the menu. (1, 2) "The Big Kmart format [ has] received
the 1997 SPARC/3M (Supply Performance Award by Retail Category Program)
award."(1)

As of November 12, 1998, Kmart has 2,160 retail outlets. (1)

Mission Statement and strategic goals

  "Kmart will become the discount store of choice for middle-

income families with children by satisfying their routine and
seasonal shopping needs as well as or better than the
competition."

Floyd Hall was appointed as CEO/President/Chairman of Board in March

1995. Under Hall’s direction Kmart has undergone a restructuring strategy.

The goals of this strategy include: increasing the frequency of Customer

visits, improving image and appearance, eliminate stock-outs, improve their
inventory management, improve customer service, promoting of Private-
Label Merchandise, eliminating some brands in order to have shelf space for
a wider variety of merchandise.

Commitment to Quality Customer Service Mystery shoppers make 24 visits

to every Kmart & Big Kmart each year and 36 visits per year to Super
Kmarts. The quality ratings received from the mystery shopper account for
40% of the store managers’ bonuses.(2)

Identifying customers, markets, products & competitors

Kmart’s current customers include middle income families. The primary

customer group is women between the ages of 24 and 45, with children at
home, and with household incomes between $20,000 and $50,000 per year.
It is estimated that 180 million people shop at Kmart each year. The typical
customer will shop and average 4.3 times per month. Usually spending about
$40 during 95% of all visits. 57% of customers are female, 46 years old and
almost half have children younger than 18.

Their markets exist in the United States, Guam, Puerto Rico, and the Virgin
Islands. Kmart has pulled out of their Canadian, Mexican, Czech and Slavic
markets.(1)

Kmart’s main product lines include: Martha Stewart Everyday, Jaclyn Smith
women’s apparel, Kathy Ireland’s women apparel, Kgro horticultural
products, Sesame Street, Penske Automotive, Route 66, Bench Top and
American Fare.(2) They also carry market dominant brands such as General
Electric, Huffy, Sara Lee, Rubbermaid, Procter & Gamble, Fruit of the Loom,
Nabisco, Hallmark, Gillette, etc. (2) In the Big Kmarts they have also set up
on-line service terminals, "Kmart Solutions", that allow for orders to placed;
items include flowers, toys, Whirlpool appliances and Western Union
services. (1)

Kmart’s product lines also include on-line shopping. Not only can you
purchase items at their web-site; but they have just expanded their presence
on the Internet with the launching of www.musicfavorites.com.(1)

Kmart’s main competitors are in the general merchandise segment of the

retail industry, namely Wal-Mart and Target. They also have to compete with
department stores and specialized stores (a.k.a., "category killers") in the
retail industry.

Company Analysis

Strategic Performance Indicators

The retail industry compares the leading companies in terms of sales per
square foot, comparable sales growth, EBIT (Earnings Before Income Tax)
Margin, Total Selling Square Feet, Total Stores and EPS. (2)

SWOT

Kmart’s internal strengths include their current CEO Floyd Hall and their
current Restructuring plan. Floyd Hall has demonstrated himself to be of
great value to Kmart. He saved them from near bankruptcy in January 1996.
He negotiated with leaseholders, vendors and creditors not to force them
into bankruptcy in spite of the junk bond rating they had received.

Their internal weaknesses include their inability to compete with Wal-Mart on

price, their image, and inability to implement goals and strategy, and their
corporate culture. Kmart’s image is so negative that 49% of Wal-Mart’s
customers indicated in a survey that they drive past a Kmart to get to a Wal-
Mart. The reasons cited for perceiving Wal-Mart as better included the
perceptions that Wal-Mart’s prices are cheaper and that their products are
better both in quality and value.

The external opportunities for Kmart are their private-label merchandise,

which has improved in both quality and value. Overseas Expansion is
another opportunity for all companies within the retail industry. Although
Kmart has recently pulled out of some global markets and ventures, they are
still active in others. Also, when they are through restructuring, they will
probably have other opportunities for global opportunities.

The external threats facing them include Wal-Mart’s competitive pricing

strategy. Wal-Mart will not be undersold; they will beat any price by 5%. Wal-
Mart also has such strong supplier relations they are able to stronghold them
into lower prices.

Industry Analysis

Identifying Competitors and Market Shares

The discount retail industry consists of several segments: full-line discount

stores, specialty discounters, warehouse clubs and others. There is
overlapping for any store between the different segments. For the purpose of
this analysis we examined Kmart in the general merchandise segment of the
retail industry.

This segment of the retail industry grossed $253 billion in sales in 1997.
Kmart currently ranks second in this segment with 12.7% of the market,
which is $32,183 million of sales for 1997. The leading competitor in the
industry is Wal-Mart (who is currently "America’s largest revenue measured
by total revenues" (1)) with 46.6% share of the market and $117,958 million
in sales, which is 3.67 times larger than Kmart’s sales. Dayton Hudson Corp
(who owns Target and Mervynn’s) ranks third with 10.9% market share and
$27,757 in sales for 1997. (5)

Dominant Economic Characteristics of Industry

The retail industry’s dominant economic characteristics include growth in

GDP, growth in disposable income, the consumer price index, and interest
rates. These variables indicate the sales that can be expected.

Because in the recent past both GDP and disposable income have been
increasing, the retail industry has enjoyed positive growth. However, in the
first and second quarter of 1998 the economy has slowed causing sales to
slump. GDP is also directly related to retail spending. Consumer spending is
approximately two-thirds of GDP. The recent slow down in GDP can be
related to the economic turmoil in Asia and Russia. This has dampened the
export market and put a drag on the American economy.

The recent reduction in interest rates by the Federal Reserve Board is an

attempt to off set some of the adverse effects of the global economic slow
down. This is also meant to help spur consumer spending and use of credit.

General Economic Conditions affecting Industry

Other general economic conditions affecting the retail industry include, for
all segments include consumer confidence, changes in consumer’s demand
and shopping preferences. The current trends in the retail industry indicate
that consumers perceive shopping as a chore, it is no longer "fun" as in the
1980’s. Consumers are shopping more at general merchandise stores,
because they can eliminate trips. The Big Kmarts & Super Kmarts both will
help minimize trips for the consumer. Because consumers perceive shopping
as a chore, if retailers want to get them in the door, then they need to focus
on making shopping more "entertaining". (7)

Porter 5-Forces Model

The rivalry of the competition is incredibly fierce. We currently our "over

stored" as a whole. We have 22-sq. ft. of store space per person in our
country. The only real way to gain any significant share of the market is by
under cutting the price of the competition.

The power of the suppliers is strong. Retailers must maintain good relations
with their vendors. If their reputation is soiled with the suppliers, then they
risk losing their source of merchandise and will be driven out of business.

The power of the buyers is also strong. Retailers are at the mercy of the
consumer’s demand and preferences. Currently consumers find shopping to
be a chore. The convenience of the general merchandise store allows
customers, to buy more items in fewer trips. The trick is getting them to
come to your store—a pleasant and entertaining atmosphere is the push
today.

The power of new market entrants is weak. The market is extremely easy to
enter into, but it is hard to compete at the levels of economies of scale that
the larger chains possess.

The power of substitutes is very strong. This force includes the specialized
discount stores, the "category killers", these stores are able to undercut the
prices of their items and simultaneously provide a wider variety of
merchandise for their category.

Industry Prospects and Overall Attractiveness

The overall attractiveness of the industry is good, because it is relatively

easy to enter. However, the industry is also over stored. In order for a new
entrant to compete for any significant share of the market they will need to
achieve economies of scale, in terms of cost-to-price ratios, consumer appeal
—in terms of service and store appearance.

Performance Analysis

Financial Trends

Kmart’s five-year sales figures are relatively flat. Sales for years 1993-1997
all came in about the $30 billion range. Compared to the continual growth
that Wal-Mart is experiencing, Kmart isn’t even a threat.

Net Income for Kmart has been minimal. In 1993 and 1995 the figures were
negative. The other years were below $300 million, compared to Wal-Mart
and Kmart’s own sales figures, this amount is negligible. EPS growth trends
for both Kmart and Wal-Mart parallel that of their Net Income.

Kmart’s overall Sales, Net Income and EPS growth over the last five years is
not very good. The poor figures for 1993-the first half of 1995 is the reason
Mr. Antonini resigned as CEO. By January 1996, Kmart was under the verge
of bankruptcy, which is not surprising given the figures. However, for 1997
and 1998, we see an obvious improvement from the efforts of CEO Floyd
Hall. His negotiating skills are what saved Kmart from bankruptcy.

Ratio Analysis

Kmart’s productivity ratios, ROE and ROA, are negligible compared to Wal-
Mart. For years 1993 and 1995, these figures were not measurable.

Kmart’s liquidity ratios, current ratio and quick ratio, are greater than Wal-
Marts. However, Kmart’s current ratios are sporadic. Wal-Mart’s ratios are
nice and even, indicating that they have a better handle on their cash flows.

Kmart’s leverage ratios indicate that Wal-Mart has higher Debt-to-Asset

ratios than Kmart. However, Kmart has higher Debt-to Equity ratios. Kmart’s
D/A & D/E ratios are both steadily declining.
Kmart’s Activity ratios indicate that Wal-Mart’s TAT & FAT ratios are both
higher. But there is a steady increase in both TAT & FAT for Kmart, indicating
that they are improving. (For actual Figures on Kmart see Appendix 3; for
Wal-Mart see Appendix 4.)

Recommendations to Corporation

For Kmart we recommend that they establish a sinking fund for retail
technological advancements. Thus allocating funds on an annual basis, that
will allow them to purchase retail technology as soon as becomes available.
This will allow them to compete with Wal-Mart, who works with technological
research companies to test the technology. This allows Wal-Mart to be the
first in the industry with the new technology if it is feasible. Establishing a
sinking fund will cut down the lag time for Kmart to also have the
technology.

We are currently seeing communication systems and teams being placed at

the corporate and managerial levels. We recommend that they create a
"trickle-down-effect" by having team meetings at the associate level. This
will allow all employees to be involved in the Total Quality Management and
Strategic program, which will also help to boost morale and overcome their
current Corporate Culture.

Our third recommendation to Kmart is for them to continue to improve their

bond rating. (There bond rating was upgraded to BB as of October 6, 1998.)
Improving their bond rating will allow them to have access to better capitol
for future endeavors.

Stock and Investment Evaluation

As of Tuesday, November 24, 1998, Kmart Corporation’s stock price closed

at 14-11/16 ($14.69). The P/E ratio is currently 20. This is a faire historical
market average for any given stock. Kmart’s stock price over the last year
has both risen above and fallen below the S&P 500. (1)

The current P/E ratio indicates a hold position for the stock for the long-term
investor who is risk tolerant, given Kmart’s past performance.

However, we will stretch our recommendation to a buy position given in light

of Kmart’s current restructuring strategy, recent upgraded bond rating,
increase in sales for 1998, and low stock price; we recommend buying
Kmart’s stock. This is a good opportunity for the long-term risk tolerant
investor to get in at a low price.

Floyd Hall’s career history indicates that he likes to strengthen a company

financially and move on to another. For the risk-adverse investor, Floyd Hall’s
retirement should signal a buy position, because Kmart should be out of
financial trouble.

Bibliography

1. Stockmaster, www.stockmaster.com.

2. Kmart, www.kmart.com.

3. Wal-Mart, www.wal-mart.com.

4. Strategic Management, Concepts & Cases. 10th edition. Thompson and

Strickland. Irwin McGraw Hill, Inc.
5. S & P Industry Survey. 1998.
6. US Industry & Trade Outlook ’98. Standard & Poor’s/US Department of
Commerce/International Trade Administration. McGraw-Hill Companies,
Inc. 1998.
7. U.S. Industry Profiles: The Leading 100. 2nd edition. Joseph C. Tardiff
Editor.

Historical Overview

1897 Sebastian S. Kresge & John McCrory formed a partnership

Detroit, Michigan Memphis, Tennessee

1899 Dissolved Partnership

1912. S.S.Kresge Company 2nd largest chain of variety stores with 85

stores

and >$10Mil Annual Sales

1929 S.S.Kresge Company expanded to Canada (19 stores)

1929. First Suburban Shopping Center: Country Club Plaza in Kansas

City,

Missouri
1950’s Suburban Shopping Centers & full-line discount stores are growing

1962 Kresge opened 18 Kmart department stores

1966 Kresge died; leaving 735 Kresge variety stores & 162 Kmart stores

Management replaced Kresge stores with Kmarts, and built more Kmart
stores.

1977 Kmart Corporation was founded (95% of sales from Kmart)

1981 Opened the 2,000th Kmart

History of Diversification

1980 & 1983 2 cafeteria chains acquired, both divested in 1986

1984.
1. Builders Square (warehouse-style home centers)

1984.
1. Walden Book Company (Waldenbooks in 50 states)
2. Payless Drug Stores

  1985 Bargain Harold’s Discount Outlets (Canadian

retailers)

1988.
1. American Faire Hypermarts (household/apparel/supermarkets)

1988.
1. Pace Membership warehouse clubs

1988.
1. Office Square (warehouse-style office supply)
2. Opened Sports Giant stores
3. Sports Authority (10-store chain) acquired and integrated with
Sports Giant
4. Purchased 22% interest in Office Max, which rose to 90% by
1991
5. Borders, Inc. (22 book superstores Midwest & Northeast)
6. 1992 13 discount store chain in Czech Republic &Slovakia
 1992 Bizmart (105 office supply stores)

1992 50-50 Joint venture with El Puerto de Liverpool to open 100

Kmart stores in Mexico

7. Joint venture with Metro Limited to open in Singapore (4)