Reference no: EM132163089

By now, institutional and individual investors are completely aware of the stresses that Sears Holding (SHLD) and JC Penney JCP +1.3% are going through. These icons of America—homegrown retailers—are looking like they may never recover the crowns they once wore. The companies that once were praised by stock analysts are now greeted with headlines like “Which is Worse: JCP or SHLD?,” “The End Might Be Near for JC Penney,” and “Sears Treats Customers Like They’re Total Idiots.” What happened? How did things get this way? The popular opinion is that poor management has led to the demise of both companies. For Sears, that would presumably be Eddie Lampert, while Ron Johnson would be credited for running Penney aground. There is much evidence that this indeed could be the case for both companies. One simply needs to google both names and follow the development over the past two or three years. The damning narratives are all there to review, and it’s very hard to deny that both executives may have chosen the wrong strategies to lead these companies. The challenge was certainly there: How to propel a classic, branded company to compete among changing technologies without losing its original identity? Quite simply, JC Penney tried to be something it isn’t: a boutique retailer. That’s a little like an astrologist trying to become an astronomer: it’s not only too unrealistic, it’s downright seeking a totally new identity. In this case the astrologist was Johnson, and it appears that he never conducted consumer surveys to validate his retail instincts. Fast forward two years later and Penney’s outcome is very doubtful. Sears is a little different. While Penney’s now former CEO had substantial retail operating experience, Sears’ CEO is a hedge fund manager with limited retail experience. Prior to Lampert’s taking the title, there had been several other CEO’s appointed and dismissed by him. He is similar to Penney's Johnson in that he tends to make strategic decisions based on intuition rather than referencing marketing research data. I think it is too simplistic to explain away these two companies’ current state by solely blaming their CEOs. Something more has to be working against their execution plans than just poor management. Perhaps a systematic shift in the way consumers make purchases has exacerbated the situation. That is, could customers finally be using the Web more for their shopping needs? Total retail foot traffic, (a proxy for visiting the actual stores) for November and December has steadily decreased from 2010 through 2013. n 2010 ShopperTrak measured about 34 billion retail store visits versus about 18 billion for 2013. And sales in stores were half of sales made by online transactions, so consumers were still buying—they were finally doing it differently. They are no longer physically going to the stores with the same predictability. The trend may surprise many because we seem to think that consumers are slow to accept Web-based retailing. Our instincts lead us to think that shoppers have to physically see and touch the merchandise before they buy. We have our reasons for this. Remember eToys? Back in the early 2000’s most optimists thought Web-based retailers would take off, but wary shoppers eventually lost interest in buying toys through the Internet, and returned to the bricks-and-mortar stores. It looks like that finally has changed, and the data supports it. New retail space opened last year has decreased sharply from the period 2000 to 2008. True, over recent years the trends are improving, but CoStar Group reports stores opened only about 44 million new square feet in 2013 versus more than 300 million back in 2008. What does this say about the current state of Sears and Penney? I think that both stores are suffering from poor strategic decision making as well as being at the epicenter of changing shopping habits. While the CEO’s have been the lightning rods for the missteps, the latent new shopping habits have finally emerged and are forcing many retailers to face stressful decisions. This of course creates opportunity. Once upon a time cell phones were never going to replace rotary phones. How Sears Became the Worst Retailer, and Company, in America Once upon a time, before Amazon.com, much of America and Canada shopped at Sears. Folks with access to little more than the local general store could comb through its catalogs and buy everything from, well, combs to stately do-it-yourself houses. For decades, its brick-and-mortar stores were the only place to shop, including in my hometown of Cupertino. The tallest building in the world once hosted the firm’s headquarters and shared its name. Before Walmart’s agenda to keep workers and communities in poverty with “low prices” swept through much of the land, Sears offered decent wages for employees and a place to buy solid appliances, have your car filled up and serviced, take awkward family photos at the portrait studio, buy insurance and yes, purchase clothes. But the last 20 years have not been kind to Sears: in 1992 the retailer suffered its first quarterly loss since the 1930s, and the company has been stuck in its ways as its competitors adjusted to shifting consumer habits. In stepped in Edward “Fast Eddie” Lampert, a financier who had already swooped up Kmart while that flailing company was mired in bankruptcy. In 2005, Kmart acquired Sears, and Lampert christened the combination of two losing retailers Sears Holdings. What has followed for eight years is a story of cost-cutting and employee turnover so sordid that even Wall Street’s most heralded publications, from Forbes to Fortune, have savaged Lampert’s performance as CEO of Sears. A decade ago, BusinessWeek suggested he was the next Warren Buffett, which at a superficial level made sense. Both have invested in companies that were seriously underperforming and undervalued. Only Buffett has a strong track record and is widely respected as a sage, rational and respected investor. The reclusive Lampert, however, has turned Sears into a joke, but Sears’ employees, from top executives to the clerk and mechanics who assisted me when I visited the local automotive center to have a couple of parts replaced, are not laughing. Walk into a Sears and you see the results of Lampert’s warped leadership and mismanagement. Sears and Kmart have all the charm of a dollar store without the prices, nor even the service, and with even more disengaged employees. Bright fluorescent lights highlight the drab floors, peeling paint and sad displays of merchandising that are reminiscent of department stores in the communist Soviet Union. Some employees carry iPads, others do not: Lampert’s affection for technology led to a policy of employees required to use tablets on the shop floor, even though most clerks said they were unnecessary. Queue at the automotive department and plan to wait: the clerk with whom I dealt with explained that hours are hard to come by for employees. Depending on how a department fared over the previous four weeks, sales figures determined the budget for hours the next four weeks. So employees were either standing around bored, or were harried and embarrassed like the clerk who assisted me at the Manchester Mall location. So, call a manager? “We don’t really have any,” said Zach (not his real name). We tried to call the store manager, but only heard a busy signal when he called human resources or employment. “Yeah,” said Zach, “that’s normal.” Dismissive management and the lack of hours make for a toxic work environment, even for retail. “Lots of infighting here,” said Zach, “so thank God I’m finishing my degree in two years.” My two days at a Sears was just a microcosm of what has unfolded at this once proud retailer for years. So what happened? The Ayn Rand-loving Lampert hastened Sears’ decline by dividing up the company into over 30 business units. A lover of data, he brought John DePodesta, a statistician who was part of the baseball team Oakland Athletics’ number-crunching, over-achieving winning ways a decade ago, onto Sears’ board. Lampert’s faith in laissez-faire capitalism and data would push each individual business unit to slash costs and maximize profits. Such an approach would work fine among 30 different companies—but not within a company of $21 billion revenues and falling. The problem: the invisible hand of the market is not enough to guide any business to prosperity and maintain brand trust. That is why they engage in what we call strategy; it is why companies innovate; and of course, that is why they influence policy in DC (lobbying) or in states and municipalities (beg for tax credits or favorable zoning). Oddly enough, the free market-loving Lampert threatened to move Sears out of Illinois, which the company has called home since 1893, if the company did not receive a preferred tax rate. And while competition is great for the marketplace and consumers, within the company, Lampert’s vision has become disastrous. In order to boost profits, business unit managers brought in other brands such as LG and Stanley, cannibalizing Sears’ iconic brands such as Kenmore appliances or Craftsman tools. Search on Yelp for any local Sears, and the reviews are so vicious they make other Yelp reviewers appear compassionate. And for a Sears employee, a living wage is hardly the reality. Many commentators accuse Lampert, who became CEO of Sears earlier this year, of simply holding out to pick Sears apart for its assets. After all, Sears either owns or has incredibly cheap long-term leases on land across the country. One quarter of the Cupertino store, for example, is now a high-end health club. But many of Sears’ properties are also in decaying shopping areas retailers and customers avoid, such as the Manchester Mall location in Fresno or Santa Monica Boulevard in Little Armenia. Lampert’s irrational, micro-managing and imperious ways have been compared to Michael Douglas’ Gordon Gekko, though in reality Lampert makes the Wall Street character look like Mr. Rogers. Sears’ competitors should send fruit baskets to Lampert’s Florida mansion daily, for he has become a gift that keeps on giving, allowing other retailers to shine. After all, skinflint Walmart has achieved some impressive sustainability achievements and enacts capital achievements per square foot over six times the rate of Sears; Target’s foundation has a half-century record of community giving; and Kohl’s keeps expanding while encouraging employees to volunteer within their communities. Whatever you may think of Sears’ competitors, they are, for the most part, formidable, well-run businesses. But with Lampert at the helm, Sears does zero for a country and the communities that once made this one of America’s most successful companies. And with a rubber-stamp board of directors, Sears is still well on its way to oblivion, earning scores as the country’s worst and most embarrassing retailer—and company. Required: Discuss why you believe the management teams at Sears & JC Penny continued to make poor decisions? What steps should the Board of directors take once it appears a management strategy is failing? How can we, as accounting professionals, assess when a management strategy appears to be working and when it is failing?