Mall Rats Desert the Ship

The merger with Kmart gives Sears what every large retailer in the mall seems to want: a way out.

On the face of it, Wednesday’s news of the marriage of Kmart Holding Corp. and Sears, Roebuck and Co. isn’t tough to figure. Together, the two retailers will have nearly 3,500 store locations and some $55 billion in combined revenues. That makes the new company — Sears Holdings Corp. — second only to Wal-Mart in number of stores, and just behind Wal-Mart and Home Depot in total revenues.

But this is also a union of two troubled companies, whose hopes clearly are pinned in large part on what the deal will do for a floundering Sears. True or not, it is now an article of faith among mall-based retailers that growth and financial salvation lies “off-mall,” where competitors such as Home Depot, Target, and, of course, Wal-Mart have thrived. Kmart, less than two years out of bankruptcy, has some 1,500 off-mall stores in high-traffic areas that can quickly be converted into Sears stores. “We see several hundred conversion opportunities,” said Sears chief executive officer Alan Lacy during the press conference announcing the deal.

In fact, the idea for the merger was born last spring, when Sears was negotiating to buy some 50 Kmart stores for the very purpose of expanding its presence outside shopping malls. In the past year, Sears has also opened four “Sears Grand” prototype stores in off-mall locations, some of them former Wal-Mart stores. A sense of that strategy’s importance was suggested by Lacy’s comment that Sears Grand stores were becoming a “regular shopping experience for customers, rather than the four trips a year to the mall.”

In addition to their convenience for customers, off-mall stores provide retailers with more flexibility for growth than the stagnant U.S. mall market. Indeed, the same strategy is espoused by Robert Cavanaugh, the chief financial officer of J.C. Penney Co. Inc., in the upcoming December cover story of CFO magazine. Like Sears, J.C. Penney has struggled recently, but is now in the fourth year of an operational turnaround that is widely considered a success. On Tuesday, JC Penney announced a 66 percent increase in operating profit for the third quarter.

The Sears-Kmart merger, however, is likely to be bad news for J.C. Penney, which has 10 off-mall locations and has formally announced plans to open 75 to 100 more “in the next few years. “In a conference call announcing his own retirement, J.C. Penney chief executive officer Allen Questrom complained that analysts had not taken the strategy seriously enough and suggested that the company might open as many as 200 off-mall stores in coming years.

Clearly, however, Sears intends to use the merger to move far more quickly, particularly since it already has experience in converting Kmart properties. “In 2005, we will be opening up 60 new [off-mall] stores,” said Lacy, describing moves that Sears had put in place before the merger. “That’s the biggest net growth of our stores [in decades], but fundamentally, it is not enough.”

The merger also poses another possible issue for J.C. Penney. In selecting Questrom’s successor, the company bypassed former Wal-Mart merchandiser Vanessa Castagna for the CEO slot. Castagna, who was instrumental in fixing J.C. Penney’s merchandising systems during the turnaround, quit last week. At the press conference announcing the Sears-Kmart merger, two different analysts alluded to her availability, asking whether the newly formed giant would be hiring any big guns, one of them noting that “some very important talent has come on the market recently.”

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