Analyst Perspective: Kmart's Acquisition of Sears

New entity will have $55 billion in combined revenue but must overcome significant barriers to succeed, and it will take more than scale to unseat Wal-Mart

New entity will have $55 billion in combined revenue but must overcome significant barriers to succeed, and it will take more than scale to unseat Wal-Mart

Boston — November 18, 2004 — The rumored acquisition of Sears, Roebuck and Co. by Kmart Holding Corporation came to fruition this week, and the newly established entity, Sears Holding Corp. will be the third-largest retailer in the United States, trailing only Home Depot and number-one retailer Wal-Mart Stores in this market segment.

On paper, the acquisition looks like an ideal marriage. By combining supply chains and aggregating its purchasing power, management estimates at least $300 million in savings. Predictably, Wall Street has responded favorably.

Scale Requires Alignment

With 3,500 stores and an estimated $55 billion in combined annual revenues, it's easy to be blinded by the massive scale of the newly formed retailer. However, significant barriers must be overcome before this acquisition can be called a success. Sears Holding Corp. must align the capabilities and goals of merchandising, the supply chain and IT. Neither retailer has proven capable of doing it, and those failures don't bode well for the future.

The litmus test for effective alignment has to be Wal-Mart, which, with $258 billion in 2003 revenues, topped the Fortune 500 list this year.

With mostly organic growth and the constant mantra of "Always low prices. Always," Wal-Mart has created and maintained a culture that eliminates business process ambiguity. One only has to look at how Wal-Mart introduces new technology to see the power in alignment of goals and objectives. New technology must meet the deceptively simple criteria of lowering cost and improving service. Once past that, every level of the organization the technology touches — from headquarters personnel to store associate — has the responsibility to test the technology in an applied setting. If approved, the technology is mainstreamed and use is mandatory.

Unfortunately, the newly created Sears Holding Corp. doesn't have the common culture typical of an organically grown company. Store format, operating procedures and target demographics differ widely within the new entity, which makes swift and decisive action to align goals and capabilities all the more critical.

Merchandising Is King

Merchandising is king in retail. The decisions Sears Holding Corp. makes in this area will have a great effect on the performance of the supply chain.

An integrated merchandising strategy — with goals based not only on revenue but also on margin — is essential to fast-tracking the alignment process and addressing the concerns of downstream business functions.

Naturally enough, Sears Holding Corp. must build supply-chain capabilities around efficiency. However, those capabilities also must be responsive to the merchandiser's ongoing need for speed and flexibility.

Lastly, on the scale that Sears Holding Corp. will operate, technology is essential. The company must become more technically adventurous as it drives for differentiation. Unlike the direction that Kmart took four years ago — which almost resulted in the destruction of the company — technology must be viewed as the enabler for business success, not the cause.

Battling Against the Odds

Can the management team of Sears Holding Corp. create the alignment and congruence of goals and objectives necessary for success?

Mergers and acquisitions at this level usually disappoint investors and frustrate customers and employees. That underscores the difficulty of combining and successfully operating what are two very different companies.

Yankee Group believes the odds are against Sears Holding Corp. working. One thing is certain: It's time to challenge conventional retailing wisdom and start building an integrated blueprint for the future.

For a second opinion on the Kmart-Sears merger, see the AMR Research alert "A New Retail Force: Sears And Kmart Set To Merge."