To fully understand the story of modern-day Kohl’s, it all starts with cheese balls in the aisles. And a tall, young Milwaukee kid who got lousy grades in high school. His name was Bill Kellogg and he caught the retail bug at a young age. Or perhaps it was already in his blood, passed down from an earlier generation. Bill’s father, Spencer Kellogg, was head of merchandising for the Boston Store, Milwaukee’s venerable retailer, in the 1950s. As he was growing up, Bill spent a lot of time in the department store and started to learn the basics of the business. But this future executive wasn’t what you might call a whiz kid. In fact, he got a lot of D’s in high school. Deciding that college was not for him, he started working for his father in the corporate buying division.In 1967, Bill left the Boston Store and jumped to another retailer in Milwaukee called Kohl’s, founded by the late Max Kohl, father of U.S. Senator Herbert Kohl. (footnote: Herb Kohl, even though his family no longer owns the business, has always had a fond affection for the success of the company. When we opened the Washington, D.C. market in 1997, he gladly accepted our invitation to help cut the ribbon at the Springfield, Virginia store one Friday morning. He arrived in his trademark bright-colored sportcoat, said some very nice things to the crowd that assembled for the opening, and then spent the next hour walking the racetrack around the store reminiscing and taking enormous pride over the success of his dad’s company). Max and his extended family ran two retail divisions: a food division named Kohl’s Food Stores (later sold to A & P) and a small department store chain in the Milwaukee area, Kohl’s Department Stores, which launched in 1962. Bill started as an assistant manager of one of the Kohl’s three stores.Over a decade later, after starting their department store business in 1972, the Kohl family sold their three unit chain to Britain’s BATUS, Inc., a unit of British American Tobacco(BAT). During this period BAT was attempting to diversify their holdings into four categories: tobacco, paper, financial services and retail. BATUS (British American Tobacco United States) was formed and went on an aggressive buying spree, ending up with close to 20 different retail divisions throughout the United States. The subsidiary also purchased high end retailers like Chicago’s Marshall Field’s and New York’s Saks Fifth Avenue. They bought the four Gimbel’s department store chains headquartered in Philadelphia, New York, Pittsburgh and Milwaukee. They purchased other department store groups: Ivy’s in the Carolinas and Florida, Frederick & Nelson in the Pacific Northwest. And they even got into the specialty furniture business, purchasing the San Francisco-based Brunners.Following the purchase of Kohl’s Department Stores by BATUS, the Kohl family was no longer involved in the day-to-day operations of the business, but they agreed to allow their name stay on the buildings. After a few years, eyeing an opportunity for growth, BATUS funded an aggressive expansion campaign for the now five-store chain, which by 1978 was generating $28 million in revenue. That next year, in 1979, Bill Kellogg was put in charge of running the small division.During the late 1970s and early 1980s, Kohl’s was a cheap discounter with linoleum floors, rough selling floor standards, shaky service, and long lines at the register. It was the norm for a pallet of cans of cheese balls to be stacked head-high in the front of a Kohl’s store. Not exactly high class. Hard goods, such as motor oil, garden hoses and dinner plates, were merchandised on cheap metal shelves with virtually no attention paid to visual merchandising as in traditional department stores. In the apparel departments, there were few mannequins, and most of the merchandise was housed on ‘rounders’, circular metal fixtures that had plastic size rings to separate sizes. There no was real attempt to feature fashion trends. Clearly, this was a store that wanted to keep its costs down, and cared little about outward appearances.There was no real merchandise direction. Years later, the longtime Senior Vice President of Advertising, Don Oscarson, used to keep a can of Cheeseballs in his office as a remembrance of just how ‘cheesy’ things were during the earlier days: I remember the stores back then, particularly from 1978 through 1983, when I worked in Milwaukee for Gimbel’s Midwest. In all honesty, I thought the place was an embarrassment. Year after year sales were generally flat, and the business model was neither distinctive nor stellar. It was a small, regional department store that had some good real estate and appealed to lower-moderate customers in the state of Wisconsin, well before Wal-Mart and K-Mart became major players in this market. But at best it was a mildly profitable entity, with no apparent major upside.By 1986, BATUS, which had struggled with virtually all of their retailing divisions, decided that U.S. retailing was not a good fit for a British tobacco company. Clearly, in retrospect, selling apparel and furniture was nothing like selling cigarettes. A former senior executive at Gimbel’s Milwaukee, Ken Werner, remembers attending a yearly conference put on by BATUS where the top execs from each of the US based divisions met and reviewed the status of things:“I remember the President of British American Tobacco, who oversaw BATUS, coming in from London and making a presentation, and he started by saying that all companies have one of the following four characteristics: low growth, high cash flow; high growth, high cash flow; high growth, high cash flow; and low growth, low cash flow. He then proceeds to show us a chart: for tobacco he put low growth, high cash flow. For Appleton Papers (which at the time was producing 70% of the country’s carbonless paper), he put high growth, high cash flow. For Eagle Insurance (their main financial services business) he put high growth, high cash flow. And then for all us retail guys, he puts low growth, low cash flow. I left the meeting telling my colleagues we were toast.”In the couple of years that followed, BATUS sold most of its retail divisions to the highest bidder. It took time for their position in each division to ‘unwind’. They did decide, however, to keep the higher-end retailers: Saks Fifth Avenue, Marshall Fields, the West Coast-based furniture retailer Brunners, and an emerging specialty apparel store called Thimbles, headed by a former Gimbel’s senior executive, Jay Baker.The actions of BATUS were consistent with a trend that was developing nationally toward the consolidation or eventual demise of dozens of regional retail players throughout the country. This same scenario has played out dozens of times over the last twenty or so years. The stories almost all have striking similarities. Family run businesses were started in a city, and over time became a regional chain in 5-10 states. These were profitable ventures that had significant market share in their trading markets with genuine brand equity and loyal customers. Inevitably, of course, competition would arise. New retailers would come to town and start to steal market share. The most threatening competitors were companies with extremely solid business models with a mission to become national powerhouses, such as Wal-Mart and Target.Moreover, in the 1980s the country experienced a major expansion of “category killers” in home textiles and housewares (Bed, Bath & Beyond; Linen’s ‘N Things), office supplies (Office Depot, Staples, Office Max), and electronics (Circuit City, Best Buy). In addition, major off-price apparel retailers came to town: TJ Maxx primarily on the East Coast, and Ross Stores on the West Coast. And the home improvement retailers, Lowe’s and Home Depot, also began a major expansion.With their rapidly growing businesses allowing them to leverage expenses while being extremely aggressive promoting their merchandise, these interlopers were able to quickly establish a foothold in a new market, and place almost immediate pressure on the ‘hometown boys’. The days of the small, local retailer were numbered. Their business fundamentals were attacked from all angles: the overall saturation of retail dramatically reduced top-line growth, which put pressure on expenses, which often meant a lowering of customer service standards and an inability to invest in technology. Competitors were able to more aggressively promote, which in turn put major pressure on gross margin. Fewer sales, lower gross margins, higher expenses as a percentage of sales. It was a recipe for trouble. And the beginning of their respective ‘death spirals.’ Today very few of them exist. It was classic survival of the fittest.Just take a look at this list (certainly not comprehensive) of sizable retailers that once flourished but are now gone, either through bankruptcy, merger or consolidation: Uptons, Montgomery Wards, Herberger’s, Thalhimers, Miller & Rhoades, Wanamakers, Strawbridges, Abraham & Straus, Bullock’s, Stern’s, Bamberger’s, I. Magnin. And the list keeps growing.The same phenomenon happened to most of the retail divisions owned by BATUS in the mid 1980s. Division upon division essentially were shut down and consolidated into an acquiring company, usually Macy’s, Allied, and Dillard’s.Interestingly, there were indeed moments of intrigue and behind closed doors negotiations involving these divestitures. For example, a bidding war ignited for Gimbel’s Midwest, the best performing of the four Gimbel’s divisions, with three different groups making closely matched bids: Dillards, May and a management-led leveraged buyout syndicate led by the CEO of Gimbel’s Midwest, Tom Grimes. Grimes had been assured that if his bid was close to the others, even if it was not the absolute highest, he would get the prize. But at the last minute, Phil Miller, the CEO of Marshall Field’s, flew to London and made an eleventh hour appeal to the honchos at British American Tobacco to merge the best-performing Gimbel’s stores in the Wisconsin-based Midwest division into the Chicago-based Marshall Field’s division. BATUS took the bait, basically reneging on the earlier agreement with Grimes, who was then offered the conciliatory prize of the CEO spot at Brunners in San Francisco. Grimes cut his losses, and he accepted the offer and new direction in his career, where he stayed through the remainder of his career.Back at Kohl’s, in January, 1986, Batus management called Bill Kellogg to New York to inform him that it was putting Kohl’s up for sale. While certainly not a shock, a very disappointed Kellogg flew back to Milwaukee and quickly informed his senior management team of their parent company’sdecision. One of Kellogg’s key lieutenants in the organization, John Herma, upon hearing the news, was the first to suggest that they explore the possibilities of purchasing Kohl’s from BATUS with a management-lead leveraged buyout, similar to the strategy employed by their sister division in town, Gimbels. After meeting with several investment banks, and in partnership with the head of BATUS Retail, Robert Suslow, a proposal was drafted for investor’s consideration. Team Kellogg then began to approach parties that might be interested in participating in the deal.Earlier, as Kellogg was growing the Kohl’s division, he became acquainted with the mall developers Herbert and Melvin Simon. The brothers took a liking to Kellogg and saw promise in the opportunity in this small but growing and profitable division. The Simon brothers agreed to put in a substantial portion of the LBO offer.After making several successful pitches for others to come in on the deal, the management team was still short of the amount they needed to purchase the entire company from BATUS. Kellogg and John Herma scrounged up as much personal funds as they could, with Herma even triple-mortgaging his home, to finance the purchase. However, despite all their efforts, they were still short of the funds needed. Nevertheless, the pitch was made to BATUS. While the offer was ‘light’, BATUS recognized that they lacked other bidders for the Kohl’s assets, so they agreed to retain 25% of the new entity.By the end of 1986, Bill Kellogg was now truly in control of his own destiny. Between the three top managers of the new entity, they owned over 20% of the company. It was the true beginning of the business model that retailers world-wide have come to know and appreciate and admire.There was no time to sit back and relax. Within months of taking over, Bill was presented with an extraordinary opportunity to increase sales through acquisition. It was the first of many for the company.Federated had a specialty store based in Chicago called MainStreet. This chain had outstanding locations, in the third most populated city in the country. But the CEO of MainStreet, John Eyler (who later in his career took over as CEO of Toys R Us) was unsuccessful in getting the business model to work. Things started to deteriorate, and Federated went looking for a buyer. They had been hoping to attract the teenage customers who were giving so much business to places like The Limited. But their concept never really caught on. In fact, it crashed and burned and they sold the assets to Kohl’s. This was a coup for the upstart retailer for a number of reasons, in particular because it gave them instant access to the Chicago market, and expanded their base beyond Wisconsin.During this period, with some wind at their backs and sales gaining momentum, Kellogg successfully pitched Morgan Stanley’s buyout fund, which raised $300 million for Kohl’s to fund a recapitalization and expansion drive in 1988. Perhaps they didn’t know it fully at the time, but the stage was set for the growing Kohl’s to begin it’s march toward national prominence.