With unprecedented success and speed, Kohl’s Department Stores over the last 15 years has established itself as a dominant, high growth national department store. The combined value proposition of providing the customer with value and convenience has allowed the company to enter new markets, often when the naysayers were predicting doom and gloom. Yet, time after time, the company has almost immediately captured major market share from competitors that had been in those markets for generations. The new kid on the block kept surprising the old timer. It’s a story that Kohl’s has repeated from coast to coast.
So what lies ahead for this dynamic company? Are there new mountains to climb, different lands to conquer? I often hear a related question, typically from friends on the golf course or from people who have just met me and learn of my former employment with Kohl’s. They ask, “What should I do with my stock?”
Keep in mind that a very high percentage of people in the Milwaukee area have invested in their hometown company over the years, and up until the last five years or so, with nearly always with stellar results. In recent years, of course, people have become alarmed at what has happened to the stall of the share price of Kohl’s, and cynicism prevails. Accordingly, the question, “What should I do with my stock?” has become a little more probing.
I’m not a stock analyst, so I am in no position to make recommendations. And since leaving Kohl’s in 2000, I have not been privy to any inside information, whatsoever. However, I have dutifully watched how KSS has performed in the market almost every day since I joined the company in 1994 (I left in 2000). And I am comfortable in making some observations which might be helpful to those considering either buying or selling KSS:
Give some thought to the classic strategy of ‘buying on the dips’, particularly when KSS gets caught in what I call a retail index “downdraft” (i.e., when some retailer issues bad news, often all the other retail stocks get hammered in sympathy–but in reality it should only be that one company that takes the major hit). Historically, in the case of KSS, this selling has been unwarranted, and the stock has often recovered quickly, usually making a nice upward move in the days that follow.
Buying the stock when it is in the 45-50 range and selling when it is in the 55-60 range is also an interesting strategy. Look at the charts and form your own opinions. And ask some former executives who used to play this game, legitimately, with their 401K, and enjoyed some excellent tax-free gains. Just kidding.
Here’s something else to consider, based on history now over seven years old. Kohl’s splits its stock when it reaches around 75 and stays there for a couple of months. It looked like it might happen in early 2007, but the stock could not stay at that price for very long, and then made a long descent downward for the rest of the year. While stock splits in and of themselves should have no material effect on the performance of a stock, it is interesting to note that, historically, following the announcement of a Kohl’s stock split, there is usually a nice run-up leading up to the split date. So if and when the stock gets back to the mid-70’s, take note.
But, even though it’s hard not to look back on the past 15 years and not be impressed with the company’s success, I also suggest to friends that Kohl’s has certain dynamics that are working against it in terms of future stock appreciation. The future may not be as bright and promising as a lot of people used to think. For starters, the history of business is replete with stories of companies that eventually reach ‘critical mass.’ How much impact this phenomenon has on growth is debatable, but it is something to keep in mind when you have a company that has expanded as rapidly as Kohl’s. Related to that is Kohl’s company culture in dealing with change. In addition, regulatory and consumer ‘watchdog’ issues may challenge the very heart and soul of the Kohl’s business model. And finally, the competition is now taking Kohl’s far more seriously than it had a few years back. It was much easier back in the old days when nobody feared us. When they finally realized that they should, it was usually too late. Of course, that was then. Those days of staying under the radar screen are long gone, as we will see.
HAVING A MID-LIFE CRISIS
Perhaps one of the biggest challenges facing Kohl’s is something that can never be reversed: they are no longer a small, Midwestern company that can lay low and quietly kick butt. The company is no longer the small skiff skirting in and out, prowling amongst the slow-turning retail battleships lumbering about in Retail Bay.
No, in fact, Kohl’s is now ‘national’ in every sense of the word. The skiff has become a large tanker. The change has manifested itself in every aspect of the company, not only in the number of stores, but in everything else that it does. Everything is now on such a large scale. For example, the corporate offices now occupy a huge complex, with well over 1200 employees. They are a mile down the road from the old headquarters, but it’s an entirely different world. No longer a basement office in the Brookfield store with windowless rooms, the current headquarters is not fancy, but it has a spacious feel to it and even includes a day care center. Still, in keeping with Kohl’s low cost culture, even this new headquarters is understated and in no way “showy.”
The merchants inside must now deal with the huge scale of being a national company. The approach to building up inventory has also been dramatically impacted by Kohl’s rapid expansion. Now that the company is so enormous, when a Buyer orders he or she does so in tremendous quantities. And there are lots of regional issues to understand when it comes to inventory, a far cry when the company didn’t need to think beyond the Midwest. These are just a few examples of how different things become when you “grow up.”
I’m a huge believer that all companies have life cycles. Having been a student of retailing all my adult life, I have a strong conviction about this notion with retail companies. The basics of the life cycle are similar for most companies, however:
A company is launched. It is essentially a baby. The company could become hugely successful – or fall apart and go out of business fast. At this early stage, there is really no way to know for sure.
The company starts to hit its stride. It is like a lanky teenager, full of swagger and confidence, yet inclined to make adolescent mistakes that come from lack of experience. Still, some on Wall Street and the industry start to take notice.
The company matures. This very important stage is the key to the company’s future. There is a once in a lifetime opportunity to re-invent, re-engineer and buy yourself some precious time. Think of it as corporate wrinkle cream. It’s an anti-aging strategy that can make the company lean and hungry during what should be, ideally, the prime money making years in the company’s history.
Unfortunately, few companies can pull this part off with genuine success. Most companies start to show their age. When this starts, they get The Stink (it’s like getting sprayed by a skunk – once something bad happens to your company, the “smell” of it is almost impossible to get rid of). When interviewing candidates to join the company, Larry Montgomery would always ask us: is this candidate moving up in his career, has he leveled off, or is he heading down? We clearly had a bias toward hiring the guy moving up. It is much the same with companies. Those that are moving up are the ones that people are interested in. Like Larry considering a new employee, investors want companies that have both proven themselves yet still have lots of room for growth.
In today’s business climate, the aging process has accelerated. That wrinkle cream doesn’t work so well anymore. Companies come and go a lot more quickly than they used to.
Let me illustrate what I’m talking about with a few examples: The Gap, Home Depot and Target.
The story of Gap’s rise and fall is, like its image, classic. Under CEO Mickey Drexler, who joined Gap in 1983 when the company had just $500 million in sales, Gap grew gloriously by spurring–and then riding–America’s casual-dress trend. Whenever growth appeared to slow, Drexler came up with something new: GapKids, babyGap, and then discount Old Navy, which opened in 1994 and became the first-ever retail chain to reach $1 billion in sales in four years. (Gap acquired the more upscale Banana Republic chain in 1983.)
By 1997, Mickey Drexler could do no wrong. As the nation’s largest specialty chain, the San Francisco-based retailer, at the time comprising of over 3,500 Gap, Banana Republic and Old Navy stores worldwide, was running on all cylinders. These ‘go-go’ years at Gap were reflected in the meteoric rise of their stock.
As a result, Drexler had achieved ‘rock star status’ at retail analyst conferences and throughout the retail industry in general. For example, at the annual Goldman Sach’s Retail Conference held at the Pierre Hotel, where I once saw him speak, Drexler had a standing-room only crowd in the ballroom. Yes, he was on top of the world.
What a difference a couple of years make.
In October, 2002, after 28 consecutive months of comparable-store declines, Mickey Drexler was under fire, accused of mismanaging yet another supposed turnaround (for the previous couple of years, Drexler would attribute sales shortfalls to adding too much fashion in the assortments, only to tell analysts a year later that, in the case of this particular sales disappointment, assortments were too basic).
But in the late 1990’s the company began building too many stores, expanding its retail square footage by more than 20% annually. When laid-off dot-commers stopped loading up on casual clothes, Gap took desperate measures to lift sales, stocking trendy duds like miniskirts and low-rise jeans to chase teenage shoppers. Grownups, once Gap’s mainstay, fled to rivals such as value retailers Target and Kohl’s.
The fallout was disastrous. Profits vanished. “It took us 30 years to get to $1 billion in profits and two years to get to nothing,” lamented Gap founder and chairman Don Fisher. Meanwhile the company’s debt, which had fueled that store expansion and once totalled $3.4 billion, was downgraded to junk. Gap’s fall guy was the once-infallible Drexler. Gap announced his “retirement” in May, 2003, but clearly, according to various sources, he was pushed out. Seeking what Fisher calls “much more professional management,” Fisher and the directors, after a four-month search, brought in an outsider to run the company.
Paul Pressler, a senior executive from Disney, took over as CEO of the $14 billion retailer, and after several years of trying unsuccessfully to turn the ship around, also left Gap. As an aside, Mickey Drexler went over to J. Crew and did it all over again, hitting a homerun and making his investors, and himself, very happy.
There are other examples of fast-growing companies that are the darlings of Wall Street and then slam into a wall as they begin reaching ‘critical mass’ with more mature stores. Home Depot is a good example. After enjoying phenomenal success in the 1990s, they hit a speed bump in the new millennium. Their founders, Arthur Blank and Bernie Marcus, retired from the company, and a new CEO was brought in. Jack Nardelli had been one of the top guys at General Electric. When he didn’t succeed Jack Welch after his retirement, he went looking for a company to head and landed at Home Depot. After a couple of years at the helm, Nardelli was unable to transfer his magic touch at GE to Home Depot. Suggesting that Home Depot was simply too far along in its life cycle to continue to hit homeruns, Nardelli, like the Gap’s Pressler, couldn’t cut it, and years later was also given the boot.
Another company that has felt both top and bottom-line pressure is Target. With Wal-Mart vigorously pushing its ‘lowest price and best value’ message throughout land on the one side, and Kohl’s squeezing them from the other side with more upscale price and brand pressure, Target has begun to feel that is running out of ‘low hanging fruit’. While they have aggressively tried to differentiate by launching new lines of popularly priced, quasi-luxury and designer names such as Mossimo, Michael Graves, Todd Oldham, Cherokee, Stephen Sprouse and Isaac Mizrahi, Target will be challenged in the years ahead to put up the same great numbers of the past. Again, is it possible that their day has also come and gone?
My point in bringing all this up is threefold:
1. When you get big in retailing, it gets much, much harder to maintain your excellence. And the rate of your stock price appreciation.
2. As these kind of retail stories almost always play out, the natural order of the corporate life cycle sets in. It’s extremely difficult to change that order.
3. You aren’t that smart when things are going so well, and you aren’t that stupid when things aren’t going well.
A few analysts around 2001 started to raise some flags suggesting that Kohl’s in the next few years was creating a critical mass that points to a moderate long-term deceleration of comp and total revenue growth. Simply put, comp and revenue growth, which grew by approximately 8% and 24%, respectively from about 1996-2001, would be susceptible to a slight but noticeable deceleration of its impressive historical track record. Of course, this eventuality was just about inevitable. It’s a whole lot more difficult putting big numbers on the board when you have 500 stores compared to when you had 200 only a few years earlier. Detractors of the Kohl’s bright future scenario pointed out that this deceleration happened to Gap, it happened to Home Depot, it’s happening to Starbucks, it happens to just about everyone in retailing when they hit ‘critical mass.’ They are basically saying that all good things must come to an end, and runaway growth cannot last forever.
They may well have a good point. And while the Kohl’s business model will no doubt continue to be well-received by customers in both existing and new markets for the next several years, there are three key forces at work which will mitigate the company’s incredible growth rates and overall performance statistics:
1. Kohl’s is experiencing a deceleration in future square footage growth. In 1995-2000, square footage increased at a 23% CAGR. Over the next five years, the company increased square footage more in the 18-20% range, which included back-filling existing markets, store expansions and remodels, and entry into new markets, like the West Coast. All other things being the same, it becomes more difficult to maintain historical sales growth rates when you’re not growing your real estate at the same rate you had been.
2. Maturity of its older store base will lead to stagnation in some of the original areas where Kohl’s first put down stakes. This was further illustrated in 2002, when stores over five years old picked up only 2%. What’s particularly striking about that number is that remodeled and expanded stores (Kohl’s will typically remodel a store every 6-8 years, often expanding older stores in existing markets up to the newer, 87,000 square foot prototype) are included in that comp base, something that has been historically one of the drivers of consolidated comp growth. But even remodeling doesn’t seem to be doing the trick for these older stores anymore. While Kohl’s always had the Target-like expansion strategy of building a few miles away from a store once it was projected to reach $25 million, in some major markets that is simply becoming harder and harder to do.
3. The number of new stores required to keep the growth numbers going increases exponentially. Assuming the current projections of 20% top line growth and comp-store growth in a significantly downwardly revised (from historical ranges) to 2-3%, Kohl’s would have needed to build or acquire an increasing number of stores each year. The numbers would have been on the order of 90 in 2003, 110 in 2004, 140 in 2006. You get the picture. The expansion model will ultimately run out of steam. As it has turned out, Kohl’s was unable to keep that growth going, and has lowered growth expectations as a result. The Kohl’s story is still a growth story, and still leads much of the industry, but it’s a much slower rate of expansion.
As the company attempts to hit even these 'muted’ growth numbers, there will be extraordinary pressure on the organization. Their efforts will need to involve bringing in hundreds of new executives, and real estate/construction will be pushed to its limits. And then there’s the pressure on storeline management to keep the stores at the same level of performance that got you to the dance in the first place.
Target is an example of how things get a bit off-course when you’ve reached ‘critical mass’ and are in a high-growth mode. Around 2000, the company was on a major construction tear throughout the United States, and as we visited stores throughout the country we were struck by how the selling floor standards, on average, had really deteriorated. In addition, stock replenishment in certain markets were an absolute disaster: this from a company that has taken merchandise processing and fulfillment to a new level in the 1990s. I remember Larry Montgomery and I visiting our new stores in the Washington, D.C. market in Spring, 2000 and walking into the Laurel, Maryland, store to check out our competition. We were aghast at the shelves in cookware and other parts of the store that were virtually void of inventory. We were so intrigued by the situation that we flagged down the Store Manager to see what he might tell us. He confided that the region was having a lot of trouble keeping key items in stock. It is a problem that continues to challenge them to this day.
For Kohl’s, middle age is setting in. In the old days, Kohl’s was a skiff zooming in between and around the big battleships in the bay. Kohl’s is now a much larger ship out there, and how it navigates in these early years of the 21st century retail environment will have a major impact on how well it performs in the years ahead.
DEALING WITH CHANGE
Companies that have successfully dealt with growth and achieving success beyond ‘critical mass’ all seem to have one characteristic in common. They have fostered a corporate culture that is willing to take risks and accepts that change will be a constant. You can readily find advice from old business sages who extol the need for companies to continually push the envelope in an effort to further develop strategies to grow and prosper. Not just change in the number of stores you’ve opened, but change in response to competitive threats.
But accepting change is not as simple as it may sound. In fact, it is fairly easy for a company to grow complacent if they don’t actively promote a corporate culture that strongly encourages, nurtures and instills change. It’s particularly challenging when a company has enjoyed a long record of success, with little adversity. The best armor is that which has been hardened by fire. It is nearly impenetrable. But companies that have never felt the heat can be in for a shock when the tough times suddenly come knocking.
While I saw very little outward ‘let’s rest on our laurels’ complacency while I was at Kohl’s, it simply is not a company that freely embraces change. Granted, ‘change’ is everything in a company like Kohl’s because it is growing so quickly. New markets, expanding corporate offices, new faces. But the ‘change’ that I am referring to involves keeping an eye on the future, envisioning how the competition will stiffen. Kohl’s has never been the kind of company that “throws things up on the wall and see if they stick” to find ways to either drive the top line, increase gross margins, or reduce expenses. Instead, the tendency is to stay with what has worked in the past. Not surprisingly, you did not see people in the organization get rewarded for their willingness to step out and take a risk, or to try something new. That should be a cause of serious concern. But it isn’t.
From my vantage point, I have some personal experience with the company’s general corporate aversion toward change. My approach toward business has always been, to use an old Tom Peter’s phrase, “If It Ain’t Broke, Change It!” Perhaps this came from my previous lives in traditional department store retailing where the speed of change was so urgent to keep the business model viable, and to make it flourish. But if you don’t keep tweaking the business model and testing new ideas you are going to discover belatedly that the competition is breathing down your neck much sooner that you ever thought they would. That was always my concern, and I was constantly looking for ways to improve what we were doing. I enjoyed being creative, and “throwing things on a wall to see if they stick” (a style of managing businesses that I still employ today).
Allow me to provide an example to support the point. As we’ve discussed earlier, the profit ‘spread’ between Kohl’s gross margin and S, G & A is the fundamental reason why the company has been so successful for so many years. Remarkably, the company has managed over the years to keep gross margins only minimally decreasing and kept reducing S, G & A significantly, therefore creating even a greater ‘spread’. Other companies could learn a great deal from what Kohl’s has accomplished in this most fundamental business aspect. One of the best (and admittedly ‘easiest’) ways to keep S,G & A down as a rate to sales is to keep up the pace of growth. Ask the CFOs of dozens of other retailers out there who are struggling with languishing same-store sales: heath insurance costs, average hourly wages, utility costs, the rising expenses go on and on. And if you’re not growing, you’ve got serious angst. In Kohl’s case, the unprecedented continual growth over the past decade has enabled them to ‘leverage’ their expenses.
But looking ahead, I was concerned that eventually growth would slow. And of a more immediate concern was the feedback I was getting from my District Managers and Store Managers that we were ever so slowly putting the screws on their budgets. Consider the overall trend: really strong sales, month-in, month-out=more inventory to process. This evolved into the establishment of overnight teams, which took away money from the shifts that the store was opened. This was a practice we copied from Target. Yes, having people working at midnight meant that the stores looked great in the morning, but we paid for it with our inability to employ as many associates as we would have wanted during store hours. But there was no way around the obvious equation: more inventory = more work for the stores.
Despite all of the expansion and the challenges it brought, stores continued to have only four executives, and the pressure on them continued to slowly be ratcheted up. It was managed because the company was beating plan, everyone was maxing out on their bonus, the wealth accumulation was genuine through the appreciation of the value of stock options. Life was good, even though the job was getting more stressful. And I really wanted to explore ways to fulfill the ongoing 'requirement’ of reducing expenses without making it all that much more difficult for the store guys.
So I proposed to the organization that we consider consolidating the separate functions of the service desk, located in the back of the store, with the check-out area in the front of the store. For years, I’d heard that many of our customers were dissatisfied that they had to go to the back of the store to handle a return or other credit matter. It was an even greater irritation for those stores that were two-story. True, if you don’t get all those people to go to the back of the store, you lose the selling opportunity as they pass merchandise during their trek to the back. Still, I argued that you’d end up offering customers a better level of service. In fact, I’d point out, you’d be offering greater convenience too. And, of course, there would be significant savings through the consolidation. The positions of Customer Service/Credit Manager and the Sales Desk Lead could be consolidated into one person – time and motion studies indicated that there was significant down-time at both locations throughout a non-big event day.
Without going into all the details, navigating these ideas through the corporate culture was excruciatingly painful. Without the support of any of the four principals, but as head of Store Administration, the division directly responsible for planning and managing storeline budgets, I plodded ahead, scheduling meetings, consolidating support, trying to convince people that we should at least test these ideas to see if, after throwing them on the wall, they stuck. And remember, these weren’t sweeping changes at the highest level. They were down to earth, right inside the store initiatives that did not carry enormous risk. Yet they were met with heavy resistance.
In the end, there were indeed plans drafted to test the consolidated customer service/ check-out area, using the Kenosha, Wisconsin store as a pilot. But after I left the company, both ideas were dropped. Lest I come across as complaining, let me make it clear that it is the challenge of any spearcarrier of a new idea to adopt strategies that successfully navigate through all the naysayers and obstacles. And I realize in hindsight that I lacked some of those interpersonal skills required to maximize the chances for initial buy-in and acceptance of such new concepts.
But make no mistake, Kohl’s corporate culture engendered a ‘don’t rock the boat mentality’. It was truly cultural, preached down to the new recruits by the elders, from one generation to the next. “Creative reach” was not appreciated, and certainly not rewarded. It wasn’t the kind of place where visionaries, or “change agents” were going to flourish.
Now, some may argue against the point I’ve been making. They would say that it is far more critical to maintain focus, to stick to basic blocking and tackling. After all, the company has had extraordinary focus. Its mantra: consistency, keep things simple. And you certainly can’t dispute the numbers of several years ago.
To my way of thinking, however, that’s precisely where some trouble may lie in the future. With things getting tougher, Kohl’s will need to shift strategy and test new concepts to improve their business model. Their corporate culture may make well stand in the way. The ship is built for a nice steady ride, but it has a heck of a time trying to change direction.
HI-HO, HI-LO, IT’s OFF TO COURT WE GO
When you’re in retailing you always try to keep your nose clean and not get in the sights of consumer groups, state agencies, or national media do-gooder consumer advocates. Kohl’s former Chief Operating Officer, Arlene Meier, maintained extremely high standards regarding adhering to established accounting procedures.
Over the past several years, however, different consumer shopping issues have been paraded before the media spotlight. For example, NBC’s Dateline started going into retailers with a secret camera right before the holidays, buy things, and then see if the scanning at the register correctly recorded either the ticketed, signed or advertised price. Certain stores would get crucified, with the film crew returning to the store the day after and discovering that store management and/or corporate headquarters had not yet corrected any problem that had been uncovered the day before.
While I was at Kohl’s, I lived in fear in the days leading up to the airing of this year’s big test. In the early years, because we were just a regional, ‘off the radar screen’ player, we were not featured, and the big guys got all the spotlight: K-Mart, Sears, Macy’s. But over time, Kohl’s also became fair game. Several states, including Wisconsin and Michigan, produced audits which showed serious scanning errors that led to fines and (much worse) bad publicity. Our attorneys did their best to handle these matters as a “quiet settlement” with each state, but sometimes the media got wind of it and the negative publicity was a hard slap in the face. These were things we never had to worry about back when we were small potatoes.
Some more background is necessary to make a point about how much more difficult it now is for Kohl’s to maintain the ‘secret sauce’ of their business model. As I mentioned earlier, during many of the years I was at Kohl’s I served as the official driver/escort to the various entourages that would make the trek to our corporate offices in Menomonee Falls, Wisconsin. These visits were often orchestrated by one the brokerage houses that also acted as our investment bankers. Goldman Sachs has such a relationship with Kohl’s. The head analyst, George Strachan, would lead a group of 8-12 analysts to meet with Bill, Jay, John, Larry and Arlene, and then I would be asked to join the group in the conference. I would then take them out to a local store. Usually the store was aware of our visit, but we tried to not get these local stores all bent out of shape every time we had a visit. As the person directly responsible for the Milwaukee market, I just tried to do my best in putting very solid Store Managers in two or three stores that we often visited. I counted on them to get the job done. And they learned the routine: walk up to the group, introduce themselves and then say they’re around if we need anything, and then work the floor, a little ahead or behind us in the event we did indeed have a question.
I was always struck by the observations of a Wall Street security analyst who came into a Kohl’s store for the first time:
Analyst: “My gosh, you have a lot of things on sale!”
Me: “Yes we do. Right now we’re in the middle of a sales event so we have a lot of things on promotion.”
Analyst: “It looks like everything is on sale. What percentage of your revenue is merchandise that is on sale?”
Me: “You know, I really don’t know. It’s not something we track in the stores.“ My answer was a dodge on my part, but I was stating the truth: we didn’t track what percentage of merchandise was on sale at any particular time. I continued: ”But our customer clearly responds to the value she sees when she comes to shop with us.” I was surprised at how infrequently the analysts would question or challenge what I was saying. They would simply scribble down some notes, then move on to another subject. And my blood pressure would then come down!
For the typical customer, the conveyance of value via a hi-lo strategy has been an enormous part of the Kohl’s hugely successful business model. By showing a retail price, and then putting it on sale at minimally 25% off and often much more, the customer makes a quick and compelling calculation that she ‘saved’ several dollars for each item she purchases. Everday Low Pricing (EDLP) doesn’t have the same effect, particularly with apparel. Put out a table of sweaters one weekend at regular price $30, sale $19.99 and next weekend put out the same sweaters at special everyday low value $19.99, and I GUARANTEE you won’t sell as many sweaters. EDLP only really works for the true low cost leader (i.e., Wal-Mart, and with the case of home goods, Bed Bath & Beyond). While I will never know for sure, back in the 1990’s, I would estimate that, on average, somewhere in the neighborhood of 93-98% of our merchandise was on sale at any particular time. I mean, that was the model. It was the way we ran the business.
The issue of hi-lo, and how to validate it, has faced retailers for the past 30-plus years. In the 70s and 80s, both May Department Stores and Macy’s were taken out to the shed and substantially fined for their inability to satisfy certain state’s concerns that the retail prices of sku’s (stock keeping units, or items) of key classifications of merchandise, namely mattresses and fine jewelry, were not properly ‘validated’ in that there were virtually no sales at the ‘hi’ or regular price. Hence, the argument that the regular price is really bogus, a ploy to improperly convey a savings when, in fact, all customers ended up buying the item at the same low price.
Following Kohl’s entrance into the Boston market in 2001, The Boston Globe ran a front page article in October, 2002 challenging the legitimacy of the company’s pricing strategies in the local stores. Ironically, adding insult to injury, when readers opened up their papers further, they found a 32 page Kohl’s ‘insert’ with ‘entire stock on sale’ headings!
The article prompted involvement from the Massachusetts attorney general’s office. The managing attorney of the Consumer Protection and Antitrust Division of the attorney general’s office, Diane Lawton, sent a non-compliance letter to the Kohl’s legal department, claiming that the retailer’s policies are “illusory” and violated local consumer laws.
For a company that went out of its way to stay off the radar screen, the challenge was no doubt devastating. The company had dealt with product recalls and the occasional challenge of signing and scanning accuracy, but this struck at the heart of the business model: the hi-lo concept.
In the years that followed, Kohl’s has by necessity backed off on having so much of their merchandise on sale, and have established strict on-sale, off-sale guidelines with the buyers to ensure proper compliance to state law and consumer protection regulations. But make no mistake, this shift in pricing strategy has had a negative impact on sales. It is not an insignificant change to the old business model. And it doesn’t help, in my view.
ONCE THE NEEDLE IS IN, IT’S HARD TO TAKE OUT
When I was asked to open up the Macy’s as the Store Manager in the Dallas Galleria in 1985, the senior management at the 34th Street store at Herald Square in Manhattan eagerly articulated their vision of the ‘new’ Macy’s. Headed by Ed Finkelstein and Art Reiner, they informed me that this new Macy’s was going to focus on the customer, with no One Day Sales and every sales associate on commission! This was without a doubt breaking new ground.
“We want to create a shopping environment similar to Nordstrom’s,” Art said. At the time Nordstrom’s was an upstart regional department store primarily on the West Coast, and was clearly eating into Macy’s market share in California, particularly in San Francisco. I was sent out to the West Coast several times to bone up on their business model, and subsequently went back and drafted a strategy that was truly a major departure from Macy’s usual way of doing business of being highly promotional, with an emphasis on ‘stack it high, let it fly’.
To support this new model, we ended up building at the time one of the most expensive retail stores in the country. Marble everywhere. Pearwood with brass trim around a spectacular escalator. Special wall fabrics and carpeting. We opened up an area called Little Shops, featuring Escada, Gaultier and other high end fashion designers, right next to the Fur Salon. Scenes from the hit TV series “Dallas” were often filmed in the Dallas Galleria. We were thinking big, and going after Nieman-Marcus.
Well, all the hype did, in fact, generate some pretty impressive volume, something like $2.2 million in the first four days of the grand opening. And one year later, when first year sales were tallied, the store broke a Macy’s record with sales of over $57 million. All without ever having a One Day Sale, which had become a major part of Macy’s monthly promotional calendar.
But then an interesting phenomenon took hold. It started to get tough to ‘anniversary’ last year’s numbers. After a while we decided to add just one One Day Sale, to help bump up the numbers. We’d insert the promotional ‘needle’ just a wee bit, thinking that we could easily soon pull it out. Our commissioned sales associates were permitted to ‘pre-sell’ in the days leading up to the event. While this obviously had a dampening effect on those days, our first One Day Sale was a big success, generating sales of over one million dollars. A couple months later, with sales weakening, we put in another One Day Sale. And then a couple of months later another, and another after that (OK, we said it would be just once, but…). Within a year our promotional calendar was basically the same as any other Macy’s in the country. The needle was now firmly in, and it was the beginning of an addiction to One Day Sales, Super Saturdays, and Coupon Sales that plagues Macy’s, its parent division Federated Department Stores, and the industry at large to this day.
Kohl’s has always been a highly promotional retailer. Hi-lo pricing strategies, earlier discussed in this book, has been a critical part of the business model. But around 1996, the promotional strategy was tweaked. Management realized that last minute adjustments to the promotional calendar could help ‘pull out the month’ if sales were sluggish against plan. Initially, the strategy was relatively easy: if it appeared in the middle of a month that making plan was in jeopardy, the merchants added a new sale on the last Wednesday of the month. Merchants scrambled to come up with new merchandise to advertise, the sign shops went into overtime to get all the new signs out to the stores, and store managers quickly revised their sales associate schedules to ensure adequate coverage in the store for the anticipated big event.
During the times when a last Wednesday of the month promotion was added to the calendar, it significantly boosted sales, often taking us out of a ditch and helping us end the month in great shape. This happened a number of times; the stores loved it, because the additional volume helped reduce their payroll costs, giving the stores ‘add-back’ to help reverse most payroll deficiencies as a result of the early sales shortfall.
In the next couple of years, as situations arose, that last Wednesday of the month has become a standard part of the promotional calendar, in much the same way as the One Day Sales at Macy’s. And before you knew it, all of these ‘last Wednesdays of the month’ were ‘used up.’ We had to initiate additional promotions during other times of the month. It also forced us to get more aggressive in our discounts on existing promotions.
Take, for example, Senior Citizen Day Sales. When I joined the company in 1994, Senior Citizen Day Sales were a monthly event on Wednesdays for only the Chicago stores. The event was an additional 15% off ticketed prices for all persons 62 and older. I don’t know how they originally started, but I do recall that Bill Kellogg did not like them. Over time, as the need to tweak the business increased, the event was eventually added to most of the rest of the markets, and eventually added to many Wednesdays throughout the year. By around 1998, the minimum age that qualified to be a ‘senior’ was dropped from 62 to 55. And more recently, the Senior Citizen Day Sale handle has been expanded to a Sunday-Monday two-day event. And over time, things have gotten more and more promotional. There seems to be no end in sight. The heightened activity can best be broken down into the following categories:
–“Entire Stock” sales: if you go back to the flyers in the mid-1990s, you see a lot of the ads read: “selected stock of sweaters 25% off.” At the time, the merchants rarely pulled out the big gun, ‘entire stock’. Over time, entire stock now represents a significant part of the Kohl’s promotional calendar. It’s so costly for much of the competition to do (because of their higher cost structure) that it creates a clear competitive advantage.
–“50% Off” sales: an infrequent promotional handle a few years ago, now it’s become a staple. 50% off sales have become events in and of themselves; this particular percentage off is a major ‘bait’ to bring the customer in the stores;
–Save an Extra 15% events, offered to our VIP cardholders (customers who charged over $600 a year); and
–Get out of the gate quickly. All retailers are cognizant of starting a month with strong sales (and thus avoid getting into the ditch of despair early), but Kohl’s has taken this much more seriously in the last couple of years. They’ve lost their ‘ace’ in the back pocket with space in the last week to add an event. No longer with that luxury, there is a lot of pressure to start the month strong. And for that reason, new events in the first week of the month have been added to build a bit of a cushion in the event that things soften later in the month.
I can look back at my old promotional calendars and sales record cards from the 1990’s and they look bare compared to the current pace of promotions. The bottom line is that compared to a decade ago Kohl’s has a dramatically busier promotional calendar, with ads that highlight far more aggressive promotions.
From one vantage point, Kohl’s had done a brilliant job getting more and more promotional over time, taking huge market share from the competition, and getting away with it, because of their low cost structure. And you certainly have to credit the merchants in their ability to maintain respectable gross margins. Traditional department stores like Macy’s, Penney’s, Sears, Saks and Dillard’s, with their significantly higher S, G & A costs, can’t effectively compete. Make no mistake about it, Larry Montgomery and Kevin Mansell, when they took over the helm of the top two spots at Kohl’s, made it very clear that even when the overall business climate gets tough and there is pressure on comparable sales numbers, they will do whatever it takes to maintain and increase market share, even if that means putting the promotional needle in even deeper.
Still, it’s fair to ask, “Doesn’t this just mortgage Kohl’s future?”
The answer is not an easy one. To be sure, over the past ten years Kohl’s has gained incredible market share from the competition, by adding promotional events. They’ve accomplished this while maintaining the key financial components of their now-famous business model. The strategy has left many a competitor walking through a Kohl’s store just shaking their head.
What becomes a genuine challenge for the company is that the customer’s expectation of the deal she gets when she shops at Kohl’s has risen tremendously, making it more and more difficult to sell goods at just 20 or 25% off. Raising expectations is playing with fire. As a result, it’s a lot tougher these days to keep that shopper satisfied. Now, what once attracted a great response at 30% off, now needs to be 50% off. Even though Kohl’s is constantly running sales, the customer get trained to wait for the ‘big’ sales. Hence, the ‘big’ days just get bigger and bigger, and become a larger part of the whole volume pie. They become very challenging to anniversary.
Just how far can Kohl’s go? 60% off? 70% off? How about full-page ads featuring “80% off Storewide,” which ran in all markets throughout Spring, 2003, in a strategy to aggressively sell off clearance merchandise?
Try taking that needle out next time around….
COMPETITORS HAVEN’T PACKED IT IN QUITE YET
Imagine yourself for a minute as a senior executive at JC Penney, the nearly 100 year old venerable retailer now based in Plano, Texas. It’s Friday morning, January 14, 2000. You’re coming off a tough holiday Christmas season, headed by a new top executive from Wal-Mart, Vanessa Castagna(who has since resigned). As you take a sip from your cup of coffee, you open up your Wall Street Journal and see this heading on the front page: “America is Shopping With Abandon – Just Not at J.C. Penney.” Your eyes widen and you feel a knot in your stomach. You continue reading. The second paragraph: “Clearly, the 98-year-old chain needs to get its act together. Need evidence? Just look down the road in Plano, at an upstart department store called Kohl’s.”
The article proceeds to crucify the state of affairs at Penney’s by reporting comparisons of shopping experiences between your company and those found in one of the 11 Kohl’s Department Stores recently opened in the Dallas Market, your backyard. It isn’t pretty. Kohl’s stores are clean, well-stocked, and customers are effusive in their praise, almost to the point of being giddy. The assessment of the local Penney’s stores is awful, with a customer lamenting, “You walk through here…and it’s a fire hazard.”
Fast forward three years to January 15, 2003. Let’s say you’re still working at Penney’s. The Penney’s obituary clearly was written a bit too early. In fact, things have begun to change, if only to stop the hemorrhaging. Imitation is not only the best form of flattery, it’s also good business. The company’s new CEO at the time, Allen Questrom, centralized buying functions, cleaned up the stores, and basically started to copy Kohl’s where they could, matching Kohl’s with similar ‘50% off’ and “entire stock” sales events.
Fast forward three years to January 15, 2006. You’re still working at Penney’s, but now under a new leader, Mike Ullman. Things are continuing to improve, comp store sales are up. And standards in the stores are much improved.
The point is this: Clearly Penney’s is far more of a competitive threat to Kohl’s than it ever was in the previous ten years. And remember, a large size company like Penney’s, if they could increase their comp-store sales run-rate by 100 basis points, could have a net effect of adding significant pressure on Kohl’s.
For so many years, the big national players didn’t give a hoot about Kohl’s when they were expanding in the 1990’s. Obviously, hindsight is 20/20, but not so long ago we were able, through aggressive additions to our promotional calendar, to dramatically enter new markets and seize major market share. The large retailers were simply caught flat-footed and asleep at the switch. We had slipped under their radar. But now that dim blip that once was lost in the background is shining brightly…as a prime target.
The competition is now well aware of Kohl’s. When Kohl’s opened 28 stores in Los Angeles in March, 2003, the competition was ready. Mervyn’s ran a no-tax sale on the Friday all of the Kohl’s stores had their Grand Opening. And Robinsons-May, a regional department store chain operated by May at the time, ran a major weekend sale during this period, offering $15 award cards to early bird shoppers and 15% off coupons on all merchandise.
It will be much more difficult for Kohl’s to take market share from Penney’s, Macy’s and other major competitors who now recognize the seriousness of the threat to their future existence. That makes it extremely tough for Kohl’s to put up terrific numbers on the board. It’s a situation Kohl’s had never faced back in the "easy” days of the gravy train.
While it’s taken a very long time for the competition to realize what Kohl’s meant to their businesses, many of them have finally developed strategies to deal with the threat. Now, many of Kohl’s competitors look like Kohl’s: centralized checkouts, toned down visual merchandising, clean racetracks with better organized merchandise.
On the occasional time I see a former colleague on the golf course or somewhere in town, more than once I have been told that things have gotten “so much harder.” Perhaps that was inevitable. With critical mass and reaching a later stage in the ‘life cycle’ of a company comes a different kind of work environment, a different kind of culture, a different kind of company.
It’s very difficult to predict which retailers are going to successfully take on Kohl’s in the future. Retailing is so dynamic and subject to change. None of us have a crystal ball. But we can make some educated speculation. To be sure, Target will continue to raise the ‘fashion bar’ by further developing in-house ‘hip’ designer lines, while at the same time introducing national brands whenever they can, such as Calphalon, Eddie Bauer and Woolrich. But this strategy comes with risks. For example, as the private label penetration represents close to 75 to 80 percent of its total, Target is more vulnerable to fashion hits and misses.
While it’s fair to say that the traditional department store groups, notably Macy’s, Dillard’s, Penney’s, Sears and Saks will continue their long struggle to achieve acceptable top-line growth and profit performance in the years ahead, they still maintain large, although dwindling, market share. While their business models are inherently flawed, and thus, will eventually continue their slow and grueling ‘death spiral’, staying in business through consolidations, mergers and cuts, the traditional department stores will still be a threat to Kohl’s in that their presence will provide continual pressure for Kohl’s to try to continue to enjoy the huge comparable store gains experienced in the past.
However, if I were to pick the main threats to Kohl’s over the next five years, I’d choose JC Penney and the Internet. Ed Lampert, who purchased Sears and later bought K-mart (when they went bankrupt in 2002), basically has sucked the business dry and it’s hard to see in 2007 how they can ever be a powerhouse again without major change. Federated, having acquired May Company and changed all their stores (and there company name) to Macy’s, will be a formidable threat in the years ahead after they digest their huge merger.
In what I thought was an unusually candid remark about a competitor, Kevin Mansell, in an interview in 2003, acknowledged: “If there’s one company that’s most similar to Kohl’s from a content and concept standpoint, it’s Penney’s.” Clearly, Kohl’s represents today. But retailing is Darwinian in the worst sense of the word. And the questions is, will Kohl’s adapt and continue to thrive, or will it become tomorrow’s dinosaur?