VMS3.info FEATURE ARTICLE

(Formerly ECMgt.com)

Subject: June 2002 VMS3.info: Top Discount Merchandisers Analyzed via the Value Framework™
VMS3.info brought to you by ECnow.com
Your Link to E-Commerce Management / E-Business Strategy
June 1, 2002 *4,300 subscribers* Volume 4, Issue 6
VMS3.info Online: http://VMS3.info
View this Issue Online: http://VMS3.info/Jun2002

SUMMARY
The Discount Merchandising Category as a whole is increasing its total share of retail spending in the United States. Wal-Mart, Kmart, and Target have emerged as the three national market leaders. Each of these companies launched with distinct strategies for targeting customers, merchandising, distribution and logistics, and real estate management.

Kmart was the first major discount merchandiser in the United States, and enjoyed the 'first mover' advantage for several decades. Wal-Mart and Target started in the 1960's, and at this point both have by-passed Kmart on a number of strategic measures.

Wal-Mart has a formidable advantage in its position as the 'low price retailer' for the merchandise it features in its stores. Moving forward, it can selectively exploit the weaknesses that Kmart currently faces, and expand its store categories to further meet its customers' needs, such as the need for grocery products.

Target positions itself as providing 'higher-end, higher-image merchandise' at prices lower than found at boutiques or main line department stores. It can take advantage of the confusion of Kmart shoppers who react favorably to the Martha Stewart labeled products, but do not find the total shopping experience at Kmart to be consistent with the "store branded" approach Target has taken.

Kmart is in trouble. It has been squeezed by these two well-run competitors, and is struggling to figure out how its value proposition compares with that of Wal-Mart and Target. It has some loyalty among the urban and minority groups of consumers which its competitors have avoided, but needs to develop a complete strategy that effectively serves these targets. Moving beyond the groups that Kmart "owns," the company should selectively operate stores where it can profitably compete with Wal-Mart and Target, and exit markets that Wal-Mart and Target together dominate.

At the end of the day, most consumers come out as winners in this category of shopping. The exception may be the urban shopper, for whom Kmart has been the primary retailer, while being carefully avoided by Wal-Mart and Target. Flawless execution of strategy is imperative in this category. Target and Wal-Mart not only understand the need for a clear strategy, they also execute it. Kmart does neither well at present, and must develop a clear point of differentiation from its competition, and re-tool its operations to support the re-positioned entity. There is a great opportunity for Kmart if the management team creates the right strategy and deploys, manages and evolves the appropriate business models.

STRATEGY EVOLVED
The discount merchandising category is growing by gaining greater share of wallet (process share) from the mall stores and conventional department stores, so Kmart is in an even more ironic position of being a losing player in a winning category.

In the next 2 to 4 years, both Wal-Mart and Target can continue the strategies they have developed, and achieve same store expansion along with new store growth merely by gaining disaffected Kmart customers. Kmart is struggling for an identity and for survival. It does have a niche market of urban shoppers and minority groups that it can continue to own, but it will likely find itself attempting several different strategies with this audience before settling on one that stabilizes it financially.

Both Wal-Mart and Target will likely take advantage of their respective positions during the Kmart mayhem, and take initiatives that extend them beyond their core strategies.

Wal-Mart's approach will be more ambitious and far-reaching. It will expand the sizes of its stores, and undertake a more aggressive effort to introduce new lines of merchandise, particularly grocery items. While Kmart met its comeuppance employing this approach, it is expected that Wal-Mart's deeper management capacity and powerful information systems will enable it to execute this more effectively than did Kmart. It will also expand its "exclusive store brands" to more departments of the store. It will leverage the Internet to improve its logistics operations, giving it an even better window both from the point of sale and to the suppliers, improving the connectivity between inventory purchased and produced.

Since Target is a smaller entity than either Wal-Mart or Kmart, it will get a proportionately higher boost in sales growth as a result of the Kmart malaise. It will continue to develop its "exclusive store brands," that will expand its initiatives of working with branded and fashion label manufacturers to develop lines of products that are sold exclusively at Target. Compared to Wal-Mart, Target's evolved strategy will be more focused and incremental, and the company is less likely to aggressively move into entirely new categories of merchandise or expand geographically outside of the suburbs.

The question for Kmart is as much 'Can it survive?' as 'How can it survive?' It suffers from a number of structural disadvantages, only some of which can be eliminated during the time in which it is in bankruptcy protection. Announced plans to target urban minorities as its primary audience may make sense, but it has significant implications for the types of products featured in stores. While many of the brands and merchandise appeal equally to all target audiences-household cleaning products, for example-there is ample market research that shows that a store designed to cater to different minority groups must feature and promote merchandise that has specific appeal to these groups.

This presents a different business model challenge for Kmart, and it will require its management to re-tool thinking and business practices that have been ingrained in the company for dozens of years. It is unclear whether the leadership will formulate the vision and execute it, since the company's current management comprises turnaround executives with expertise in 'getting out of bankruptcy', rather than 'niche merchandising'. Although the vision appears to be the right one, Kmart is further handicapped since it cannot fully focus on it until the bankruptcy issues are behind it.

To summarize its dilemma, Kmart lacks the operational and low cost position of Wal-Mart, the product innovativeness of Target, and doesn't appear to have gained a good understanding of the customers it serves, as is exhibited by its varied merchandising approach.

STRATEGY MANAGED
Wal-Mart is generally recognized for a number of best practices. Target is also a largely well-run operation. Kmart remains the also ran of the three.

Since it positions itself as a low cost provider, Wal-Mart has been ruthless in controlling its main cost areas: personnel, cost of goods sold, distribution, and real estate.

Store employees are paid just slightly above minimum wage, and it is entirely a non-union shop. Yet, in many locations, Wal-Mart is the employer of choice, since it provides more employee benefits and a better work environment compared with other job options in the area. The employees, called 'associates', are generally a highly motivated group, thanks to the "family style" of store management that is part of the company culture. This enables store managers to use employees more flexibly, without the resistance or unionized workforce rules that can be found at other retailers.

The buying power the company has by virtue of the volumes it orders has enabled it to negotiate the best terms from the manufacturers with which it does business. It also makes sure to purchase merchandise from countries and locations that assure the lowest total landed cost at any given time, and will adjust the volumes it orders from suppliers opportunistically to keep this low cost position.

Wal-Mart's distribution system in North America gives it another significant cost advantage. It strategically locates distribution centers to support clusters of stores, and uses state of the art automation to manage and move inventory from these centers to the stores. It has forged deep and long-term strategic alliances such as JB Hunt for truckload carriage of freight, and Union Pacific for moving containers and trailers by rail. Data from its point of sale systems at the stores are captured in real time and transmitted to company headquarters to determine trends, merchandise turns and other key metrics. Consequently, Wal-Mart is very effective at minimizing slow turning items, and leveraging information about products that are performing particularly well.

Since it located its initial stores primarily in non-urban areas, or the outskirts of town, the cost of land and related expenses such as taxes, utilities, roadways and other infrastructure are also relatively lower, and sometimes subsidized by the local communities via business development funds. While Wal-Mart has more recently moved into suburban locations, it has fundamentally stayed away from putting stores in dense inner city venues. So while its real estate costs for some of its newer stores may be greater than the stores it developed earlier in its history, it continues to avoid high-end commercial real estate investments.

Target's relative cost position does not match Wal-Mart's. Since Target tends to locate its stores in suburban areas, has a different merchandising strategy, and has fewer stores than both of its competitors, all the key cost areas are greater relative to Wal-Mart. This higher cost position is offset by its strategy of offering what are perceived to be more upscale, and, consequently, higher margin goods. The store is able to do this because many of the lines of merchandise it offers are perceived as competing with department store and shopping mall retailers, which generally charge higher prices than does Target, for the lines they carry.

Kmart's recent filing for bankruptcy, and announced plans to lay off 22,000 employees and close at least 284 stores provides ample evidence that the company has a cost management problem. There are problems in each of the key cost components of its operations.

With its tendency to locate in more urban areas, and with some parts of the company unionized, Kmart's personnel costs tend to be higher than either of its competitors. Employee turnover also tends to be higher, since these jobs are still low paying compared to non-retail jobs, and opportunities in denser areas for better paying employment are somewhat better for qualified workers.

Kmart's scale should provide it with a strong hand in negotiating favorable prices for its merchandise, but it seems to have taken some mis-steps when compared to Wal-Mart. In particular, the company is closing down many of its "Jumbo" stores that sold grocery items in addition to the dry goods found in its traditional stores. So while the concept of getting greater "share of wallet" from a Kmart shopper had a certain appeal, Kmart's operations were not tuned appropriately to handle perishables and non-dry goods, along with its traditional lines of merchandise.

As mentioned earlier, Kmart also suffers from the problem of using Target's approach of merchandising with its Martha Stewart product lines, and using a low price approach for the other lines in its stores. This mixed message appears to have confused customers, and needs to be carefully examined by the company leadership as it transitions from bankruptcy.

Kmart's automation and distribution system is also quite formidable, but Wal-Mart appears to have a stronger management group overseeing this portion of the operation, and simply does a better job of keeping costs low and leveraging information more effectively to keep a high inventory turn ratio. Kmart tends to have relatively more stores, than does Wal-Mart, in the Northeast and Upper Midwest, where winter weather conditions can contribute to greater costs of doing business as compared to the Sun Belt, where Wal-Mart has a disproportionately higher presence.

With a more urban skew toward its store locations, Kmart faces other cost disadvantages in addition to personnel costs. Costs of real estate, local taxes, and developing and maintaining support infrastructure for urban stores are greater than for a store found in a less dense location.

STRATEGY DEPLOYED
The discount merchandising business is huge, and consequently can be divided into various segments for analytical purposes. Geography, target demographic groups, and merchandise offerings are key to this category.

Geographically, Wal-Mart took more of a rural focus, Target stores tended to focus on suburban locations, and Kmart historically concentrated its stores in denser urban areas-all three companies providing greater selection and lower prices to people who previously had only local retailers or shopping malls for their shopping needs. Over time, each company has "muscled into" the others' territories, so it is common to see two, or even all three, of these retailers located in close proximity to each other in different communities, especially in suburbia.

While at a high level, the participants served by all the three companies are the same (retail consumers), the target demographics have different roots with each retailer. While Wal-Mart has positioned itself toward families with children and Target has focused on younger women (ages 25-40) and teenaged girls, Kmart tends to reach out more toward minorities and others who are found in greater proportions in urban areas (in fact, Kmart has recently announced a renewed effort to reach this audience.) While these target groups also overlap to various degrees, there are distinctions found in each which the stores attempt to leverage.

In terms of the respective company's merchandising process, Wal-Mart takes a consistent low cost provider position and selects products that meet this formula. Target positions itself as offering higher end and unique merchandise and fashion items at more affordable prices. Both companies are very effective in understanding what appeals to their customers (the 'discover' component of Process in the Value Framework), negotiating effectively with their suppliers to develop product offerings that meet their overall missions, and performing quite effectively at the store level in managing the merchandise and promoting it to its shoppers.

Kmart finds itself being squeezed in by its two merchandising competitors. For example, its Martha Stewart lines of household products would suggest a strategy that parallels Target's. However, since it tends to serve lower income households, their target audience is highly motivated to get bargain prices. Since its distribution system is less cost effective than Wal-Mart's, Kmart's margins are severely eroded when it attempts to compete head-to-head with Wal-Mart on price.

It is unclear how good a fit the Martha Stewart image is for the urban, minority audience that comprises an estimated 39% of Kmart's current revenues. This may become even more problematic for Kmart as it re-trenches by shutting down suburban stores and intensifying it marketing efforts to reach this audience.

What's more, both Target and Wal-Mart have taken the Martha Stewart approach to certain lines of merchandise. For example, Wal-Mart now offers the Mary Kate and Ashley line of clothing and accessories for teenaged girls. Target has used its attractive red logo to develop "Private Label" lines of merchandise with a distinct, somewhat irreverent "personality." Target also features clothing categories with designer names that sell in higher end fashion boutiques with different lines of merchandise.

All three companies have Internet sites and provide e-commerce for their customers. From a functionality standpoint, there appear to be more similarities than differences among them. Each company has taken a different approach to how its Web sites are organized. Wal-Mart.com is a joint venture between Wal-Mart and the venture capital firm Accel Partners, and operates out of Silicon Valley, not in Wal-Mart's Arkansas headquarters. Kmart has had several different approaches for its BlueLight.com site, and although it remains based in San Francisco (Kmart is headquartered in Michigan), more of the strategic decisions are now being made in Troy. Target from the start has kept its Web operations at its Minnesota headquarter offices, and has not attempted to create a stand-alone entity as its two competitors originally have.

More important is how these companies are using the Internet to manage their vendors across the supply chain. All three have significant initiatives to take advantage of this opportunity. Wal-Mart is furthest along, and uses its larger scale to leverage its vendors to do more business with it via the Internet. Since the fashion and design component of Target's merchandise is a critical part of its store's strategy, design collaboration with its vendors, and inventory management of these items is the most sophisticated part of its Internet strategy. Kmart is also increasing its investment and commitment to the Internet, and it can actually take advantage of its competitors' efforts as they are often the groundbreakers for the same vendors that Kmart does business with.