SEARS AND KMART, A SAD, SAD STORY July 2017 | By: Lawrence J. ✓ Solved

The Sears/Kmart merger has been a disappointment for both companies, and by all metrics the fading retail giant is at the end of its lifecycle.

Sears Holdings Corporation Chairman Eddie Lampert, who is the company's current CEO, has presided over the greatest destruction of retail value in history. In our Winter 2005 Newsletter, we asked whether the Sears/Kmart Merger was a “Happy Marriage or a Double Suicide?” In our Summer 2008 Newsletter, we answered the question: It was a double suicide. It has been a slow death but the end is near.

Sears and Kmart are two of the most iconic names in U.S. retailing. Richard Sears and Alvah Roebuck founded Sears, Roebuck and Company in 1886 as a mail order catalog. It began opening stores in 1925 and ultimately became the largest retailer in the country. Kmart was the successor company to S. S. Kresge Company, which was founded in 1899 by Sabastian S. Kresge. Kmart started up in 1962, the same year as Wal-Mart. Kmart grew much faster than Wal-Mart initially and eventually passed Sears in the late 1980s only to be eclipsed by Wal-Mart in 1990. At its peak, Kmart operated 2,171 stores.

By the time the two merged in March 2005, both were ailing but many thought Eddie Lampert, who had engineered the merger, would somehow stitch the two together and achieve a stronger company. The stock price rose from $124 at the time of the merger to $195 in short order. It did not last. Lampert failed to reinvest in the company, and instead milked it and stripped it of its assets over time. We pointed out in our 2008 paper that Sears had the lowest rate of capital investment to sales of any major U.S. retailer.

The biggest use of this diverted cash was to buy back shares. Capex-starved stores look old and tired, and both Sears and Kmart have fit that bill for many years. Post-merger Capex dropped significantly. Interestingly, prior to Kmart’s bankruptcy in 2002, Kmart had 2001 Capex of $1.385 billion and Sears had Capex of $1.126 billion, or $2.511 billion between the two of them. Post-merger, that number had dropped to $513 million, one-fifth of the 2001 amount, and further declined to $142 million in 2016. Similarly, depreciation decreased from $1.142 billion in 2006 to $375 million in 2016.

It did not take long for the lack of reinvestment to show up as declining sales, assets, and net worth. Sears Holdings revenues slipped from $53 billion in the first full year after the merger to $22 billion in its most recent fiscal year. The Total Assets declined from $30 billion to $9 billion over the same time. Likewise, the company’s net worth declined from $13 billion to negative $4 billion during that time frame.

Unsurprisingly, Sears Holdings stock price plummeted from a post-merger high of $195 to less than $10 today. In 2016, TheStreet.com listed Sears Holdings as the “worst stock in the world.” All of these performance metrics are pointing towards the same end—ZERO. The game is nearly over and the vultures are circling.

When he took over leadership of the company, Eddie Lampert promised to transform the retail icons into a great company. Instead, he has led the organization to ruin with a disastrous strategy. He has been a constant in the company, which has run through several CEOs and other senior officers. Despite the promise of reinvigoration, the management’s approach predominantly focused on generating gross cash flow, which was largely accomplished by reducing costs and cutting capital spending.

Lampert outlined a set of principles intended to bolster the company. He stated a need for an ownership culture, expense and capital spending control, cash flow generation, and divestiture strategies. However, this approach failed to instill a true sense of ownership among employees and instead fostered a corporate culture that prioritized immediate financial returns over long-term investments in the brand and its infrastructure.

The strategy of cost-cutting did lead to brief financial metrics that looked promising, yet these gains were temporary and unsustainable. The sales momentum that would typically come from reinvestment in stores and branding was absent. Throughout its trajectory, Lampert’s strategies alternated between new concepts and pivots that ultimately never materialized into tangible improvements.

By 2012, the decline had accelerated as Lampert took on more roles within the company, ultimately leading to a series of store closures and a disastrous focus on loyalty programs. Revenues continued to fall, underscoring the point that the company’s operational model was fatally flawed. Lampert's attempts to leverage financial engineering over traditional retail investment proved ultimately ineffective as the company's EBITDA consistently fell into negative figures by 2013.

Ultimately, the story of Sears and Kmart reflects broader trends within American retail, where both mismanagement and failure to adapt to changing consumer expectations have led to significant downfalls. Where companies like Amazon thrived, Sears and Kmart withered under the weight of outdated business models, unfocused strategies, and insufficient innovation.

Paper For Above Instructions

This report aims to reflect on the experiences and learning outcomes derived from two simulation games on market externalities and government interventions. The objective of the simulations was to deepen the understanding of these concepts as they relate to real-world economic scenarios.

Comparative Advantage

Through the simulation involving comparative advantage, participants explore how individuals evaluate opportunity costs when making business decisions. The simulation illustrated the production-possibility frontier (PPF), highlighting choices about resource allocation and trade-off assessments. For instance, increasing the production of one good necessitates a decrease in the production of another, reinforcing the importance of evaluating opportunity costs effectively.

Comparative advantage plays a crucial role in encouraging firms to engage in trade. Businesses that can produce goods more efficiently than others benefit from specializing in specific products. This specialization often causes shifts in the PPF, allowing firms to maximize utility and efficiency through trade. The resulting economic interactions are foundational to understanding broader economic principles.

Competitive Markets and Externalities

The simulations emphasized the impact of policy interventions on the equilibrium of supply and demand. For example, government price controls or taxes can affect how equilibrium prices and quantities are attained in markets, leading to potential surpluses or shortages. The simulation illustrated that when the government imposes a price ceiling, demand may surge while supply diminishes, resulting in shortages.

Examples of price elasticity determinants include the availability of substitutes, the necessity of the good, and the time frame for consumer decisions. For instance, in competitive markets, products with abundant substitutes exhibit high price elasticity, leading to significant changes in quantity demanded in response to price changes. This concept is crucial for informed pricing strategies and projections about firm revenues.

Regarding government interventions, simulating markets illustrated that certain interventions, such as subsidies, can enhance consumer or producer surpluses. When the government subsidizes a good, it can lower costs for consumers while ensuring producers maintain profitability, showcasing how policy can positively influence market dynamics.

Production, Entry, and Exit

The simulation analyzed entry and exit decisions in markets, emphasizing how economic factors influence business ownership decisions. Key factors impacting decisions included anticipated competition, potential profitability, and market demand. For instance, a driver in the simulation needed to assess marginal costs to determine optimal hours for driving, showing how critical these factors are in determining production strategies.

In evaluating fixed costs’ impact on production decisions, the average total cost (ATC) model is invaluable. During short-term adjustments, fixed costs can constrain output levels. Conversely, a business may adjust its output more freely in the long run as it can change its operational capacity.

Market Structures

The examination of market structures showed that monopolies and monopolistic competition lead to inefficiencies that distort true market equilibrium. Firms in monopolistic competition struggle to set prices efficiently due to product differentiation, often resulting in excess production or shortages.

Oligopolistic firms, on the other hand, utilize strategic pricing models to maintain market control, often leading to price rigidity, where prices change slowly in response to market fluctuations. This study effectively correlated strategies observed in simulations with real-world applications, reinforcing the importance of contextualizing microeconomic principles.

Conclusions

The simulations provided valuable insights into the relevance and application of microeconomic principles in real business scenarios. Understanding concepts like market structure, externalities, and optimal resource allocation will play a key role in informing future business strategies. As a recommendation for upcoming ventures, embracing flexibility and a commitment to innovation will be crucial, given the rapid evolution of market dynamics influenced by evolving consumer behavior and technological advancements.

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