Chapter Fourteen - The Last Few Years

Retailing is never easy. But boy, when I look back these past 25 years, it sure was easier “back in the day” than it is today!

The challenges facing the young man or woman just coming into the industry in the early 21st century are daunting indeed. Consider that actual retail space in America has grown at a torrid pace, doubling since 1986, far exceeding population growth in the country, as companies opened tens of thousands of new stores in hundreds of new shopping malls and strip centers selling everything from hardware to bed linens to office supplies to bath and beauty products to handbags. And with the advent of the modern-day Internet, consumers now have thousands of new and exciting shopping options to consider at the mere touching of a computer keypad. With so much competition, with products being pitched to consumers from every possible angle, how in the world does a retailer carve out a niche big enough to stay profitable? It’s a huge question…but there are answers. It all starts by realizing that you have to be smarter than in the past, and open to change.

Novel retailing concepts have burst onto the scene, ready to defy the old ways of thinking. These new ideas force the industry to stay on its toes and keep its eyes open. Complacency equals death is this new, more contentious than ever environment. As Jay Van Cleeve, an analyst with Robert Baird, a Milwaukee-based firm that was an early supporter of Kohl’s, said in a 1988 Fortune article: “Every decade or so a retailer emerges with a new way to skin a cat…The magic of the company is that it combines the cost structure of a discounter and the brands of department store. It straddles those worlds and takes share from both.”

Kohl’s Department Stores is a great example of how a group of entrepreneurial retail executives discovered that a part of the market was not being served, then developed a business model to fit that need. They realized that the time tested way of doing things was no longer working. They may not have reinvented the wheel, but they sure as heck rejected the “leave good enough alone” attitude that lulled the industry into sleep for so many years.

And when you rise up to meet the customers’ needs the way Kohl’s did (especially when nobody else is!), they reward you magnificently. That is the story of the rise of Kohl’s Department Stores.

On a cool, early May 2003 morning in downtown Milwaukee, the CEO of Kohl’s Department Stores, Larry Montgomery, gazed out from the podium of the main hall of the Midwest Airlines Convention Center, ready to address over 1000 people assembled for the annual shareholder’s meeting. In keeping with company tradition, a representative from all of the nearly 500 Kohl’s stores had traveled to Milwaukee to be part of the event, and eagerly awaited Montgomery’s comments.

While 2002 had indeed been a challenging year in tough economy, Montgomery had many positive accomplishments to report. He gushed with pride as he kicked off the meeting: “Congratulations to all of our associates for another outstanding year.” Like his boss before him, Bill Kellogg, Larry quickly attributed the success of the past year to the Kohl’s employees: “I have often said that the credit for our success belongs to our associates. We have achieved a great deal of success through the efforts of an exceptionally talented and dedicated group of associates who take great pride in delivering brands, value and convenience to our customers.”

The meeting continued. It was time for what ultimately matters in any business: the numbers. Arlene Meier, the company’s Chief Operating Officer, then took over, and presented Kohl’s recent financial highlights:

–Kohl’s delivered a 22 percent increase in total sales, reaching $9.1 billion, gaining major market share, clearly at the expense of the major traditional department stores;

–In 2002, Kohl’s led its direct competitors in comparable store sales with a 5.3 percent increase. Over the past five years, the ever-important comp-store sales increase rose 7.4%, by far the highest of its peer group;

–Net income reached $643 million, up about 30 percent over the prior year. Kohl’s now had now enjoyed over six consecutive years of earnings growth in excess of 30 percent;

As Arlene handed the microphone over to Kevin Mansell, Kohl’s President, who began to review Kohl’s merchandising and advertising strategies for the past year and new initiatives going forward, Larry Montgomery no doubt felt a great sense of pride. What he had accomplished with Kohl’s was sure to be studied in the business schools for years. The company had for many years now consistently achieved numbers that were without question the best in the industry. And with their power move into California and the opening of so many stores in L.A., they were now a major national player. Ignored for years, they now had the respect, and fear, of the big guys.

But Larry also kept an eye on the horizon, and saw some threatening skies. Things had gotten so much tougher: comp store sales for the first couple of months of the new fiscal year had not been stellar. He would soon report to Wall Street the plans to build 80 new stores in 2003, and 95 to 100 stores in 2004, a huge undertaking. The company had not had a stock split since April, 2000, and the company’s P/E ratio had lowered significantly from earlier years. A significant number of executives who joined the company in the last couple of years had stock options that were ‘under water’, and had not yet been able to experience the euphoria of seeing their net worth (at least on paper) soar as your company performs well. And since these stock options are a vital part of the incentive package Kohl’s offers these executives, one could only wonder what effect this must have had on their morale and their drive to succeed. No doubt about it, the crew at Kohl’s was beginning the feel the strain.

As Larry looked out at all the associates, he recognized that the punk performance of the stock had impacted their 401Ks and other savings and retirement strategies. The pressure had been building, and now the Board was getting more involved in the running of the business. And next on the agenda was a shareholder vote: the results supported (by a razor-thin margin) the listing of stock options as an expense on future financial reports. The shareholder vote went against the advice of the Kohl’s board, the first time that had happened in the company’s history. This was clearly stepping a toe into undiscovered country.

A few weeks after that annual shareholders meeting in May, 2003, the performance of Kohl’s started to deteriorate significantly. After announcing the first negative quarterly comparable sales figure in its history, the analysts went on the attack, furthering sinking an already declining stock price. Deutsche Bank Securities analyst Bill Dreher described the results as “the first major crack in Kohl’s big high-growth history,” and intimated that the fast ride was starting to come to an end.

The rest of the year, as Larry Montgomery later reported in the 2003 Annual Report, was an extreme disappointment. Comparable stores were DOWN for the year, at (1.6). Unthinkable only a few years before. There was significant gross margin erosion. The metrics of the business had never been so bad compared to previous years. The media and analysts following Kohl’s reported on the ‘stall’ of the business model, and started to seriously question whether the fairytale story was over. It was ugly. No one had at Kohl’s had ever experienced anything quite like this.

While 2004 started on a positive note, with lots of articles and analyst reports throughout the Spring and Summer speaking of a ‘rebound’ (consider the USA Today headline on April 8, 2004: Kohl’s Works to Refill Customer’s Bags – Discounter tries to rebound after setting bar for competitors, then falling below it), the year was another disappointing one. Yet again, comp store sales were awful (only up .3%). Interestingly, Larry Montgomery spoke of 2004 as a year “we made considerable progress toward advancing our financial and business objectives.” Certainly not glowing remarks.

2005 was a marginally better year for Kohl’s, as comparable store sales rebounded, up 3.4% over a year before. But those increases were on depressed numbers, so the much heralded CAGR numbers that the company had so proudly strutted around the retail arena for so many years did look nearly as great as they once did. Now, instead of showing CAGR’s in the 25-38% range, like in year’s past, Kohl’s now had 5-year CAGR’s for net sales revenues of 16.9% and 19.7% for net income. Not terrible, certainly, and somewhat impressive when compared to most of the competition. But now the story was a new one: Kohl’s stock was languishing, and the growth story had stalled.

2006 stands out as the best performing year in the past several years, with comp store sales up an impressive 5.9%, and net income rising 32%. Most metrics of performance for the year were extremely good, and the stock price zoomed up toward the second half of the year and stayed over 70 for months. In April, JP Morgan purchased Kohl’s proprietary credit card operations for over $1.5 billion, with proceeds helping to launch a $2 billion stock repurchase plan.

2007 is ending up as a year of very mixed results. In the first half of the year, Kohl’s was hitting on nearly all cylinders, and by mid-year was reporting record sales and earnings, and just as importantly, decent(although uneven) comparable store growth. In May, Larry Montgomery raised full-year forecasts, and Kohl’s stock was trading above or around $75.00, sacred ground for a company that had split their stock three times in the past when the stock got above that number and stayed there for a few months.

But by the end of the third quarter in 2007, things had started south, yet again. Again, comparable stores were down, this time plummeting 2.6%, putting a real damper on net revenue for the entire company (up only 4.8%). Montgomery was forced to slash the full-year estimates that he had elevated a few short months previously. These sorts of downward revisions never used to happen. Now Kohl’s was starting to behave like every other large retailer that goes through good and bad cycles. And the stock took a hit as a result, and reached 52-week lows in November, 2007, at below 50. The stock was trading below the price it was when I left the company seven years ago, in April, 2000.

For the old-timers, the true, serious challenges that started to surface for Kohl’s around 2002 and have continued ever since would have to be addressed by a new breed of leaders. The people who built up the modern Kohl’s into the major retail leader that it is today have moved on.

Bill Kellogg retired from day-to-day operations in January, 2001 and remained Chairman until March, 2003, when he was succeeded by Larry Montgomery. He then continued as a member of the Board and as the presiding director of non-management board meetings. As one of the richest men in the world, he continues to enjoy simple pleasures, and spends much of his time fishing. He has even taken up the game of golf, which he almost never played while he was the CEO at Kohl’s. Bill has taken a more active and slightly more visible role in supporting philanthropic pursuits, including a camp for kids in the farm country of Wisconsin. He has been on the board of Carmax.

Jay Baker retired in February, 2000, after 13 years with the company. He has been extremely supportive of certain non-profits in both Naples and the Milwaukee area, particularly in the arts, where in 1997 he donated $3 million to the Milwaukee Repertory Theater. He has also made major donations to his alma mater, the University of Pennsylvania, donating $11 million in 1999 to support the construction of a graduate center with an endowment to provide 12 scholarships a year. Jay has also made a similarly large donation to New York City’s Fashion Institute of Technology. Never one to pursue any passionate hobby during his career outside of his undying love of retail, in recent years he has taken up collecting sports memorabilia and is traveling abroad more with his wife Patty. He is on the board of directors of Briggs & Stratton, the Milwaukee-based engine manufacturer.

John Herma retired in June, 1999, after 21 years of service at Kohl’s. John and his family have traveled extensively around the world. Like the rest of the founding partners, though, he has maintained the ‘lay low’ tenor of the Kohl’s life in his personal life, and has kept a relatively low profile in professional circles. Like Kellogg and Baker, Herma has been quite supportive of local Milwaukee charitable causes.

The baton passed on to a new generation of leaders, headed by Larry Montgomery (whose background we have already covered in an earlier chapter) and Kevin Mansell.

Kevin Mansell joined the company as a Divisional Merchandise Manager in 1982, and became Executive Vice President – General Merchandise Manager in 1987. He is smart, level-headed, and methodical in his approach to the business. From what I saw when I worked at Kohl’s, his direct reports generally like him a lot, and Jay increasingly relied on him to carry out the company’s merchandising mission prior to Kevin’s promotion to head merchant. Kevin was named President in February, 1999 and over the last few years has been positioned to take over the top spot from Larry Montgomery when he relinquishes the CEO position and moves aside, probably retaining his role as Chairman of the Board.

To be sure, the success of the Kohl’s business model will be severely tested in the years ahead. The previous superior performance of its stock relative to other larger cap retailers has always been driven by the notion that the company maintain a high growth rate, leverage expenses and not disappoint Wall Street. The performance of the company the last few years has put much of this into doubt; hence, the dismal performance of Kohl’s stock vs. the S & P 500.

Going national, as we’ve seen, is a big boost to any company, but it certainly comes at a cost. For Kohl’s, it means their “off the radar screen” cover has been blown for good. In the dog eat dog world of retailing, those who are right behind Kohl’s in the pack will be increasingly nipping at their heels, doing their best to copy, damage, and out maneuver them at every turn.

As we’ve seen throughout this book, retailing can be a tough road to travel on. It’s tough becoming a retailing leader. Arguably more difficult staying on the pedestal. As many of the former top guns like the Gap and Home Depot can attest, your moment at the top can be fleeting.

And in recent years, consumer fears about job security, terrorist attacks, and global instability have strained consumer confidence. The explosive growth of online retailing has strained classic bricks and mortar businesses in competing for market share. But eventually, it all comes down to consumers buying merchandise, and the retailers with the best business models–those that address the needs of the customer in offering what they want at the prices they want in the shopping experience they want—will thrive in the future. In other words, somebody has to be there to meet the customers’ needs.

The question for the aspiring retailer is the same as it has always been: will it be you or your competitor across town?