Chapter Six: Entering the Dreaded (Gasp!) Tri-State Market

Bill Kellogg and the management team at Kohl’s were well aware that the retail landscape was always changing, a sort of revolving door for many of the existing stores in malls and strip centers across the country. They knew that new retail business models, including their own, were coming into markets and gaining market share rapidly, at the expense of the current, established players.

Expansion into new areas has always been a key objective for Kohl’s. And with huge parts of the United States virtually untapped (at least until the last few years), the company would constantly prowl for distressed companies looking to sell their real estate assets. A week didn’t go by during the 1990s when Kellogg was not approached by a retail real estate company, or someone representing an ailing regional retailer interested in beginning discussions regarding a possible acquisition.

Certainly the early success of the Mainstreet acquisition from Federated Department Stores in 1988, which gave the company overnight presence in major cities in the Midwest, was validation of Kohl’s strategy to grow by building new stores in new markets, while also establishing major presence through acquisition. Though it was always difficult when and where the opportunities would arise, growth by acquisition has always been part of the Kohl’s strategy. It was simply a matter of maintaining a state of readiness that would allow them to pounce when a juicy opportunity would present itself.

While the Real Estate division tended to focus on a Three Year Plan to build new stores in either new cities or ‘back-fill’ opportunities in existing markets, they were well aware that the whole process could be put on its head if a major acquisition came into play. While the guys in Real Estate were very much part of the due diligence leading up to an actual offer being made to acquire real estate assets, we had to move ahead with a plan that did not include the deal, until it was truly close to getting “signed.” As a member of our Real Estate Committee, I remember this process as ever-changing, with a fair amount of zigging and zagging. In other words, though we had a basic strategy for acquisitions (a 3 year plan that was coordinated with the strategic placement of regional distribution centers) we never knew where the next big bankruptcy opportunity would present itself. Rigidity would have pulled us down for sure, so flexibility was always built into our plans.

One of the biggest acquisitions in Kohl’s history took place following the bankruptcy of Caldor in 1998, a major regional discount chain in the Northeast. While Caldor had enjoyed some successes in the 1980s, for the most part it struggled throughout the 1990s, unable to compete effectively as the national powerhouses Target and Wal-Mart forced their way into their territory.

Headed by Bill Kellogg and following much negotiation with the other suitors (both retailers like Wal-Mart and Target and real estate companies like Kimco), Kohl’s announced in February, 1999, their intent to secure the rights to occupy 33 former Caldor sites for $142 million: six units on Long Island, New York, six stores in Westchester and Rockland County, 11 stores in New Jersey, nine stores in Connecticut and one site in Baltimore, Maryland.

The purchase of the Caldor stores gave Kohl’s an extraordinary opportunity to enter one the largest markets in the United States with a bang. Real estate is scarce in this densely populated market, and it would have been impossible to obtain real estate locations as desirable as the ones we obtained with the purchase. Once the deal was finalized, we got in and completely gutted the interiors of each and built as close to Kohl’s prototype interiors as we possibly could at each site. Since each Caldor store was a bit different (widely varying dock locations, emergency door exits, etc.), it was a major undertaking for our guys in construction. Remodeling an old store is a whole lot different than building one from scratch.

While the construction process was unusually difficult (we had to deal with the area unions, and local building inspectors, some of whom were colossal pains), we finally got the stores set for opening.

By late 1999, word was clearly out about a Wisconsin-based retailer that was enjoying major success well beyond its Midwest base. In the mid-Atlantic markets, such as Washington, D.C. or Charlotte, North Carolina, we were highly regarded. Moreover, the wider retail community, not to mention many investors, had become increasingly aware of who we were, and they knew of our goal of becoming a national chain.

But to the guys on Wall Street, the planned opening of 32 stores in the early Spring of 2000 right in their own backyard, the Tri-State area (New York-New Jersey-Connecticut, exclusive of Manhattan), threw them for a loop. In my discussions with various retail analysts in the year leading up to the opening (shortly before I cashed out and moved on), I heard lots of concern and skepticism. While they praised the accomplishments of Kohl’s in becoming a regional retail powerhouse, the idea of bringing it to what they considered the center of the retail universe was alarming. We heard things like: “Well, this market is really quite different,” suggesting that the Tri-State market was by far the toughest to break into in retailing. We read things like: “Kohl’s ability to successfully penetrate this highly competitive market remains to be seen…”

In addition, there were questions about the significantly higher costs associated with entering this particular market. Kohl’s sold receivables to raise the $142 million needed to assume the Caldor leases (as part of the company’s blitzkrieg of the market, buying up distressed stores as much as possible), and diluted existing shareholders by issuing 2.8 million shares of stock to cover the $150-plus million in renovations for the 33 Caldor locations. Pre-opening expenses were indeed higher than our other markets, mostly due to higher labor costs.

Barron’s, which always seems to have a healthy skepticism regarding stocks with high P/E ratios, published an article one week before the opening of the stores in the Tri-State Market challenging the then P/E of 54 as being ridiculously high. They cautioned that New York was an extraordinarily challenging retail environment, where the market took new entries, and with great relish, “chews them up and then spits them out.” Buyer beware, they warned.

This was one time I could say with a lot of confidence that I knew better. When I had joined Macy’s in 1983, I lived on Long Island and commuted to Manhattan and was the Merchandise Councilor (or Assistant Store Manger) of the largest store in the world, Macy’s Herald Square. After a hectic Christmas season (where I supervised the disbursement of thousands of the highly sought after Cabbage Patch dolls in the 5th Floor toy department), I was promoted and became Store Manager of the Massapequa store in the Sunrise Mall on Long Island.

During that time, I learned a lot about the area’s retailing, the competition, the opportunities. And over the subsequent years, as I worked with other retailing environments including Texas, Florida, California, Canada and in about twenty other states, it became quite clear to me that New York was essentially no different than any other major metropolitan area when it came to retailing. The basic formula remained the same. Provide your customer with a well-managed store, with well-stocked assortments at a great value, in a pleasant and convenient shopping environment. That’s how success in retailing works. Moreover, compared to the Caldors that previously occupied the real estate, I knew that our assortments were dramatically different, with a much greater emphasis on ‘soft’ goods, such as branded apparel and home textiles, which had fewer competitors in the area. Our model was altogether different than theirs, offering a new and somewhat unique shopping experience.

Admittedly, getting all of the above done in the Tri-State market – hiring and retaining high quality associates and managers, instilling an entrepreneurial work ethic to ensure high levels of customer service and overall selling floor standards – has been particularly challenging to many of the retailers in the area over the years. The Tri-State area customer has earned a reputation of being “rough” on a store, and turnover rates tend to be higher for associates and executives than in most other parts of the country. In this market, it wasn’t unusual for shoppers to rummage through a clothes display table that a manager may have spent hours arranging just right. And they wouldn’t dream of putting any of it back. If this had been, say, DesMoines, Iowa, chances are the customers would have neatly folded the item and replaced it on the table. But it was more than just that. There is a greater density of customers in the Tri-State area, which means more shoplifting, more unions, more everything. Was Kohl’s ready for all of that? Since so many of our Wall Street friends and family members lived in communities in the Tri-State area that were less than a ten minute drive to one of our new stores, all of us in the company knew that we had one chance to get it right, that first impressions were ever-lasting, and that tactically we wanted to get out of the gate quickly.

Yet, if you could cover the basic blocking and tackling in the Tri-State Market, you were golden. And that’s exactly what we set out to do. With 33 stores opening in a 4-week period, the storeline senior management team was faced with hiring over 4,000 new sales associates and over 75 new executives. We brought in many of the new executives six months before the grand opening, and had them shadow existing store managers in Milwaukee and Detroit, so that they could familiarize themselves with our systems and procedures and overall corporate culture. Store Administration, the group at our corporate offices that I was responsible for at the time, paid particular attention to most of the administrative aspects of coordinating the arrival of millions of dollars in inventory into stores (some with construction delays) managed by new teams of executives and associates. The new stores also had teams of current managers and department heads that either flew in from the Midwest or drove up from the Philadelphia market to help the new stores receive all the goods, assist in the hirings and training and get the place in shape in time for the grand opening. It was a round-the-clock kind of effort.

In addition, like any new market Kohl’s enters, a great deal of time and energy is put into the development of an aggressive marketing campaign to spur brand awareness. Tri-State was certainly no different. The company launched ‘coming soon’ ads in print and media months before the actual grand openings in March and April of 2000. In Manhattan, where many suburbanites worked, Kohl’s went on the Jumbotron in times Square on New Year’s Eve. Our public relations team worked with local newspapers to get some great coverage about the new retail kid on the block. It was by far the largest new store undertaking in the history of the company.

In the end, the opening of 18 Kohl’s stores opening in March and a second set of 15 opening a month later in the Tri-State market was a huge success, breaking all previous new market records for the company. Normally, when a new group of stores opens in a market, they operate at between 70 percent and 80 percent of a ‘mature’ Kohl’s store, which in 2000 was about $19.5 million (that number has since increased to around $21.5 million in 2003). We conservatively planned for the opening, and used our Philadelphia stores, which had opened as a new market in 1997, as a benchmark for the New York metro region. However, we all knew that with the high density of core customers (i.e., dual income families) in the market, the stores would perform well.

And indeed, they did. In keeping with the tradition of Kohl’s under-promising and over-delivering, the average new Kohl’s store in the Tri-State market finished the year well above the ‘80% of a mature store’ forecast. In fact, the average new store exceeded the established average mature level for the rest of the Kohl’s stores throughout the country!

There are many reasons why this region has become so successful. The key is population density. Even though there is a glut of stores in the area, still they were absolutely starving for what we had to offer. As we had seen in other parts of the country, the shoppers loved the brands and merchandise we offered…especially because it was almost always on sale. We put Sterns (a division of Federated) out of business within two years.

The Tri-State market continues to perform extremely well, despite the ongoing challenges of running clean and fully-replenished stores in the area, and hiring high quality people (the market is clearly storeline management’s most difficult). Since the original opening in 2000, more than fifteen stores have since been added to help fill-in the market, including a two-level, 105,000 square foot store at the site of a former flea market in Massapequa and a 94,000 square foot store in Oceanside, both on Long Island.

A sweet irony accompanied this success. Kohl’s quickly became a frequent shopping destination for many of those securities analysts and their spouses who lived in the suburbs but worked on Wall Street. Yes, the very same ones who were so skeptical just a year or so before. In the weeks and months that followed the Grand Opening, we often heard from them about their shopping experiences, and most of it was quite complimentary.

A couple of years later another acquisition opportunity presented itself in the area, again with a floundering regional discount chain based in the Northeast. Bradlee’s, a long-time fixture in Massachusetts and other New England states, finally threw in the white towel. Kohl’s, along with some other retailers, negotiated the purchase of the sites similar to the way they acquired the Caldor stores in the New York-New Jersey-Connecticut markets. Most of the stores were in Boston, which was a natural extension of the push up from New York. The stores opened in 2002.