Having had some experience these past few months learning about and launching Facebook applications, and discussing the issue with people who have worked with me on these projects, here is my take:
1. There are a lot of stupid but incredibly popular apps out there. For the time being, FB profilers, as part of that whole ‘herd instinct’ dynamic, love to be poked, take ridiculous quizzes, identify themselves as cartoon animals and basically pass the time online mindlessly. It’s what people want. Suppliers are giving people what they want.
2. There is this huge part of the facebook app developer community who do it for the love of the game, to get some exposure, and to enjoy the thrills and chills of self-expression. They are not in it for the money, or to monetize anything. They are college kids who have some free time on their hands, and who are less into the idea of making more serious or utilitarian apps. As a result, there is incredible 'noise’ and an explosion of inventory, and that makes it increasingly difficult to build an app with the idea of it having an incremental impact on a business model.
3. All in, developing FB apps that are well-designed, are FB-friendly, and that set up all the mini-feeds, etc., correctly, cost at least $5000, give or take a couple grand depending on your experience and the team you have working on the project. Your first ones can be a lot more, as you discover that people who you have free-lanced are: 1. on learning curves, and that they are learning on your nickel, and 2. the FB rules and 'best practices’ are always changing, so developing a FB app is often more like a journey than a destination.
4. For an app that is not seasonal (e.g., Trim a Tree or Carve a Pumpkin) or event-driven (Give Owen Wilson a Hug) that does not take off virally (so we’re talking about a huge percentage of new apps), attracting and getting people to download your app to their profile through ad programs like Cubix costs about .75-1.00 a user. In addition, launching a press release through PRWeb (about $300-400 total cost) has had a very good ROI for us. Our TopNetPix FB app has been holding steady with about 1250 users for now close to a month, with virtually no tweaking and no additional what I call customer acquisition costs. While not moving up virally, it is holding it’s own, which is a positive - people using it obviously feel it’s worth keeping in their profiles.
Will more serious FB apps, like TopNetPix and our recently launched Cool 100, start to become more important in the overall mix as more and more FB users start to see their profile page as more of a homepage or portal to launch to other places on the Internet? We’ll see.
Irving & Camille Rusinow, on the set, early 1960's
My Stepdad, Irv Rusinow, was a maker of educational films, mostly in the 1960’s and early 1970’s. Chances are that if you went to elementary, junior high or high school during this time, you saw a film that my Dad produced and directed. My Mom filled in as an ‘actor’ every now and then, and this photo is on a 'set’ during one of those times. If any relation wishes to learn more about the Rusinow family tree, or to provide information to this tree, you are welcome to contact me and I’d be glad to give you access information to the account I’ve set up on Ancestry.com.
Northern Goshawk - ABA Area #568
On December 29 driving down by the Boulders resort in Carefree, AZ, Jen spotted and I identified a soaring, immature Northern Goshawk, which was a new bird on my life list, American Birding Association (ABA) Area species #568, just as the year was coming to a close. Goal for 2008: reaching 600, or put another way, going out and identifying at least 32 new species to my list either in the U.S. (not including Hawaii) or Canada. Easy, you say? Well, according to recent records, only 714 ABA members in the United States currently have attained that goal. Only 309 have at least 700. And only 30 have at least 800. The most? 874. But getting to 600 by the end of 2008 will be just fine.
The Bubble Returns
The more I get into what’s now happening out there on the Internet , the more I am reminded of Spring, 2000, when investing in that space was like running into a buzzsaw. Not that I won’t continue investing in stuff I like. But it does give you pause. This brings it all back, only with new names:
Chapter Fourteen - The Last Few Years
Retailing is never easy. But boy, when I look back these past 25 years, it sure was easier “back in the day” than it is today!
The challenges facing the young man or woman just coming into the industry in the early 21st century are daunting indeed. Consider that actual retail space in America has grown at a torrid pace, doubling since 1986, far exceeding population growth in the country, as companies opened tens of thousands of new stores in hundreds of new shopping malls and strip centers selling everything from hardware to bed linens to office supplies to bath and beauty products to handbags. And with the advent of the modern-day Internet, consumers now have thousands of new and exciting shopping options to consider at the mere touching of a computer keypad. With so much competition, with products being pitched to consumers from every possible angle, how in the world does a retailer carve out a niche big enough to stay profitable? It’s a huge question…but there are answers. It all starts by realizing that you have to be smarter than in the past, and open to change.
Novel retailing concepts have burst onto the scene, ready to defy the old ways of thinking. These new ideas force the industry to stay on its toes and keep its eyes open. Complacency equals death is this new, more contentious than ever environment. As Jay Van Cleeve, an analyst with Robert Baird, a Milwaukee-based firm that was an early supporter of Kohl’s, said in a 1988 Fortune article: “Every decade or so a retailer emerges with a new way to skin a cat…The magic of the company is that it combines the cost structure of a discounter and the brands of department store. It straddles those worlds and takes share from both.”
Kohl’s Department Stores is a great example of how a group of entrepreneurial retail executives discovered that a part of the market was not being served, then developed a business model to fit that need. They realized that the time tested way of doing things was no longer working. They may not have reinvented the wheel, but they sure as heck rejected the “leave good enough alone” attitude that lulled the industry into sleep for so many years.
And when you rise up to meet the customers’ needs the way Kohl’s did (especially when nobody else is!), they reward you magnificently. That is the story of the rise of Kohl’s Department Stores.
On a cool, early May 2003 morning in downtown Milwaukee, the CEO of Kohl’s Department Stores, Larry Montgomery, gazed out from the podium of the main hall of the Midwest Airlines Convention Center, ready to address over 1000 people assembled for the annual shareholder’s meeting. In keeping with company tradition, a representative from all of the nearly 500 Kohl’s stores had traveled to Milwaukee to be part of the event, and eagerly awaited Montgomery’s comments.
While 2002 had indeed been a challenging year in tough economy, Montgomery had many positive accomplishments to report. He gushed with pride as he kicked off the meeting: “Congratulations to all of our associates for another outstanding year.” Like his boss before him, Bill Kellogg, Larry quickly attributed the success of the past year to the Kohl’s employees: “I have often said that the credit for our success belongs to our associates. We have achieved a great deal of success through the efforts of an exceptionally talented and dedicated group of associates who take great pride in delivering brands, value and convenience to our customers.”
The meeting continued. It was time for what ultimately matters in any business: the numbers. Arlene Meier, the company’s Chief Operating Officer, then took over, and presented Kohl’s recent financial highlights:
–Kohl’s delivered a 22 percent increase in total sales, reaching $9.1 billion, gaining major market share, clearly at the expense of the major traditional department stores;
–In 2002, Kohl’s led its direct competitors in comparable store sales with a 5.3 percent increase. Over the past five years, the ever-important comp-store sales increase rose 7.4%, by far the highest of its peer group;
–Net income reached $643 million, up about 30 percent over the prior year. Kohl’s now had now enjoyed over six consecutive years of earnings growth in excess of 30 percent;
As Arlene handed the microphone over to Kevin Mansell, Kohl’s President, who began to review Kohl’s merchandising and advertising strategies for the past year and new initiatives going forward, Larry Montgomery no doubt felt a great sense of pride. What he had accomplished with Kohl’s was sure to be studied in the business schools for years. The company had for many years now consistently achieved numbers that were without question the best in the industry. And with their power move into California and the opening of so many stores in L.A., they were now a major national player. Ignored for years, they now had the respect, and fear, of the big guys.
But Larry also kept an eye on the horizon, and saw some threatening skies. Things had gotten so much tougher: comp store sales for the first couple of months of the new fiscal year had not been stellar. He would soon report to Wall Street the plans to build 80 new stores in 2003, and 95 to 100 stores in 2004, a huge undertaking. The company had not had a stock split since April, 2000, and the company’s P/E ratio had lowered significantly from earlier years. A significant number of executives who joined the company in the last couple of years had stock options that were ‘under water’, and had not yet been able to experience the euphoria of seeing their net worth (at least on paper) soar as your company performs well. And since these stock options are a vital part of the incentive package Kohl’s offers these executives, one could only wonder what effect this must have had on their morale and their drive to succeed. No doubt about it, the crew at Kohl’s was beginning the feel the strain.
As Larry looked out at all the associates, he recognized that the punk performance of the stock had impacted their 401Ks and other savings and retirement strategies. The pressure had been building, and now the Board was getting more involved in the running of the business. And next on the agenda was a shareholder vote: the results supported (by a razor-thin margin) the listing of stock options as an expense on future financial reports. The shareholder vote went against the advice of the Kohl’s board, the first time that had happened in the company’s history. This was clearly stepping a toe into undiscovered country.
A few weeks after that annual shareholders meeting in May, 2003, the performance of Kohl’s started to deteriorate significantly. After announcing the first negative quarterly comparable sales figure in its history, the analysts went on the attack, furthering sinking an already declining stock price. Deutsche Bank Securities analyst Bill Dreher described the results as “the first major crack in Kohl’s big high-growth history,” and intimated that the fast ride was starting to come to an end.
The rest of the year, as Larry Montgomery later reported in the 2003 Annual Report, was an extreme disappointment. Comparable stores were DOWN for the year, at (1.6). Unthinkable only a few years before. There was significant gross margin erosion. The metrics of the business had never been so bad compared to previous years. The media and analysts following Kohl’s reported on the ‘stall’ of the business model, and started to seriously question whether the fairytale story was over. It was ugly. No one had at Kohl’s had ever experienced anything quite like this.
While 2004 started on a positive note, with lots of articles and analyst reports throughout the Spring and Summer speaking of a ‘rebound’ (consider the USA Today headline on April 8, 2004: Kohl’s Works to Refill Customer’s Bags – Discounter tries to rebound after setting bar for competitors, then falling below it), the year was another disappointing one. Yet again, comp store sales were awful (only up .3%). Interestingly, Larry Montgomery spoke of 2004 as a year “we made considerable progress toward advancing our financial and business objectives.” Certainly not glowing remarks.
2005 was a marginally better year for Kohl’s, as comparable store sales rebounded, up 3.4% over a year before. But those increases were on depressed numbers, so the much heralded CAGR numbers that the company had so proudly strutted around the retail arena for so many years did look nearly as great as they once did. Now, instead of showing CAGR’s in the 25-38% range, like in year’s past, Kohl’s now had 5-year CAGR’s for net sales revenues of 16.9% and 19.7% for net income. Not terrible, certainly, and somewhat impressive when compared to most of the competition. But now the story was a new one: Kohl’s stock was languishing, and the growth story had stalled.
2006 stands out as the best performing year in the past several years, with comp store sales up an impressive 5.9%, and net income rising 32%. Most metrics of performance for the year were extremely good, and the stock price zoomed up toward the second half of the year and stayed over 70 for months. In April, JP Morgan purchased Kohl’s proprietary credit card operations for over $1.5 billion, with proceeds helping to launch a $2 billion stock repurchase plan.
2007 is ending up as a year of very mixed results. In the first half of the year, Kohl’s was hitting on nearly all cylinders, and by mid-year was reporting record sales and earnings, and just as importantly, decent(although uneven) comparable store growth. In May, Larry Montgomery raised full-year forecasts, and Kohl’s stock was trading above or around $75.00, sacred ground for a company that had split their stock three times in the past when the stock got above that number and stayed there for a few months.
But by the end of the third quarter in 2007, things had started south, yet again. Again, comparable stores were down, this time plummeting 2.6%, putting a real damper on net revenue for the entire company (up only 4.8%). Montgomery was forced to slash the full-year estimates that he had elevated a few short months previously. These sorts of downward revisions never used to happen. Now Kohl’s was starting to behave like every other large retailer that goes through good and bad cycles. And the stock took a hit as a result, and reached 52-week lows in November, 2007, at below 50. The stock was trading below the price it was when I left the company seven years ago, in April, 2000.
For the old-timers, the true, serious challenges that started to surface for Kohl’s around 2002 and have continued ever since would have to be addressed by a new breed of leaders. The people who built up the modern Kohl’s into the major retail leader that it is today have moved on.
Bill Kellogg retired from day-to-day operations in January, 2001 and remained Chairman until March, 2003, when he was succeeded by Larry Montgomery. He then continued as a member of the Board and as the presiding director of non-management board meetings. As one of the richest men in the world, he continues to enjoy simple pleasures, and spends much of his time fishing. He has even taken up the game of golf, which he almost never played while he was the CEO at Kohl’s. Bill has taken a more active and slightly more visible role in supporting philanthropic pursuits, including a camp for kids in the farm country of Wisconsin. He has been on the board of Carmax.
Jay Baker retired in February, 2000, after 13 years with the company. He has been extremely supportive of certain non-profits in both Naples and the Milwaukee area, particularly in the arts, where in 1997 he donated $3 million to the Milwaukee Repertory Theater. He has also made major donations to his alma mater, the University of Pennsylvania, donating $11 million in 1999 to support the construction of a graduate center with an endowment to provide 12 scholarships a year. Jay has also made a similarly large donation to New York City’s Fashion Institute of Technology. Never one to pursue any passionate hobby during his career outside of his undying love of retail, in recent years he has taken up collecting sports memorabilia and is traveling abroad more with his wife Patty. He is on the board of directors of Briggs & Stratton, the Milwaukee-based engine manufacturer.
John Herma retired in June, 1999, after 21 years of service at Kohl’s. John and his family have traveled extensively around the world. Like the rest of the founding partners, though, he has maintained the ‘lay low’ tenor of the Kohl’s life in his personal life, and has kept a relatively low profile in professional circles. Like Kellogg and Baker, Herma has been quite supportive of local Milwaukee charitable causes.
The baton passed on to a new generation of leaders, headed by Larry Montgomery (whose background we have already covered in an earlier chapter) and Kevin Mansell.
Kevin Mansell joined the company as a Divisional Merchandise Manager in 1982, and became Executive Vice President – General Merchandise Manager in 1987. He is smart, level-headed, and methodical in his approach to the business. From what I saw when I worked at Kohl’s, his direct reports generally like him a lot, and Jay increasingly relied on him to carry out the company’s merchandising mission prior to Kevin’s promotion to head merchant. Kevin was named President in February, 1999 and over the last few years has been positioned to take over the top spot from Larry Montgomery when he relinquishes the CEO position and moves aside, probably retaining his role as Chairman of the Board.
To be sure, the success of the Kohl’s business model will be severely tested in the years ahead. The previous superior performance of its stock relative to other larger cap retailers has always been driven by the notion that the company maintain a high growth rate, leverage expenses and not disappoint Wall Street. The performance of the company the last few years has put much of this into doubt; hence, the dismal performance of Kohl’s stock vs. the S & P 500.
Going national, as we’ve seen, is a big boost to any company, but it certainly comes at a cost. For Kohl’s, it means their “off the radar screen” cover has been blown for good. In the dog eat dog world of retailing, those who are right behind Kohl’s in the pack will be increasingly nipping at their heels, doing their best to copy, damage, and out maneuver them at every turn.
As we’ve seen throughout this book, retailing can be a tough road to travel on. It’s tough becoming a retailing leader. Arguably more difficult staying on the pedestal. As many of the former top guns like the Gap and Home Depot can attest, your moment at the top can be fleeting.
And in recent years, consumer fears about job security, terrorist attacks, and global instability have strained consumer confidence. The explosive growth of online retailing has strained classic bricks and mortar businesses in competing for market share. But eventually, it all comes down to consumers buying merchandise, and the retailers with the best business models–those that address the needs of the customer in offering what they want at the prices they want in the shopping experience they want—will thrive in the future. In other words, somebody has to be there to meet the customers’ needs.
The question for the aspiring retailer is the same as it has always been: will it be you or your competitor across town?
Acknowledgements
The pages that follow are the result of my personal experiences over primarily a six year period while I was a senior executive with Kohl’s, as well as the accounting of a dozen or so other executives I had the privilege of working with. While I was directly involved in almost all of the entries into new store markets in the mid to late 1990’s and thus have been able to draw on personal experience for much of the writing of this book, I am indebted to many people, both in and outside of the company, some former and current employees, who have encouraged me to put the Kohl’s story on paper.
If you had to categorize a book like this as being either authorized or unauthorized, well it is clearly in the second group. I did not, however, set out to write a kiss and tell. Remember, Milwaukee is a small town and I still interact with some of my former co-workers, on and off the golf course! But I do get into some things that are a bit controversial, recognizing that the mere self-publishing of this runs against the grain of the time honored tradition at Kohl’s of not rocking the boat. My intent was to write a fair accounting of the incredible and impressive rise, and eventual stall, of Kohl’s in a very competitive industry.
As the pages that follow will attest, the Kohl’s success story demonstrates that the combination of hard work, entrepreneurial spirit and adherence to an outstanding business model will always prevail. The rise of Kohl’s as a national powerhouse is a great testament that a new ‘concept’ in retailing, if executed properly, can do very well, even in today’s very crowded retail field.
On a macro level, I’d like to acknowledge the help and guidance provided me by three individuals, who have been my mentors over the years. All three have had an enormous influence on me, and how I approached the writing of this book.
Ken Werner has been my mentor all my adult life since I was 25. Ken was my first boss in the post-college real world, when he was an assistant store manager at a Gimbels store in Milwaukee and I was a newly-minted trainee in the men’s department. Recognizing early on that I didn’t know what I didn’t know, Ken has proceeded for the next 25 years to tell me what I needed to know so at least I now know some of the things I didn’t know! If this makes no sense to you, that’s OK. But when Ken reads this, he’ll get it. And isn’t that what’s really important in an Acknowledgement?
I worked for Gary Henkin at two different times while I was taking time off from being a student at the University of Virginia. At the time, I didn’t know what I wanted to do with the rest of my life. Gary, as the co-founder of a start-up called Washington Tennis Services (now called WTS International), was my first true mentor who truly introduced me to the world of entrepreneurialism. As the Store Manager of The Olde Town Tennis Shop (part of the original WTS business model) at the ripe old age of 19, it is that location on South Union Street in Old Town Alexandria that I truly ‘caught’ the retail bug.
My Uncle Al, Major Alfred Grande, Jr., who after a twenty year stint in the Army became an entrepreneur and successfully started his own business (a printing and mailing company in Arlington, Virginia), has played a different role than mentor in my life, but who is someone, political ideologies notwithstanding, who I’ve admired greatly and who has had much more of an impact on my life than he’ll ever know. Well, maybe he knows now. Heck, he even introduced me to Fox News!
Sincere thanks go to the many former Kohl’s executives who are more comfortable being ‘off the radar screen’ than being acknowledged here individually for their contributions.
And, of course, sincere thanks are in order for Mike Valentino, from Cambridge Literary, who accepted my invitation back in 2001 to help me write and edit this book. It’s only taken six more years to pull it together and get this on my blog!
I compiled accountings of events, press releases, stock analysts reports and statistical data from dozens of sources and believe that the information herein is accurate. But please understand that this book wasn’t written as a doctoral thesis, so approach all the datapoints with this in mind. The vast majority of this book was written in 2001. In the weeks and months leading up to the self-publishing of this, I tried to add updates where appropriate.
And finally, heartfelt thanks are in order to my girlfriend Jen Ellis and the members in my immediate family who have been supportive in the writing of this book. Leaving the corporate mainstream and embarking on a new life at age 46, right about the time of the stock market crash and assorted other unsettling world events, has been an extraordinary experience. In the seven years since I left Kohl’s, I’ve been trying to go out there and enjoy the ride.
Table Of Contents - The Rise & Stall of Kohl's Department Stores
Note: Today I have accomplished what I had been hoping to finish for the past 6 years - ‘publish’ my book about Kohl’s Department Stores! The book has been 'posted’ these past couple of weeks as I have edited and updated, chapter by chapter. The table of contents will be a part of this post.
It is my hope in the next couple of weeks that I will put the book back into one document, then have available here on this site for easy downloading. And if, upon reading, you come across something that needs correcting or improvement, please let me know.
CONTENTS
AcknowledgmentsChapter One - Cheeseballs in the Aisle – The Early YearsChapter Two - Building the TeamChapter Three - Defining the Business Model: The Wedge –“Thank You Sir, May I Have Another?”(Getting the Brands)–Hi-Lo–Low Cost Culture–Narrow, Deep & In-Stock Assortments–Private Label–The RaceTrack–The Convenience Factor–“Associates are the Key to Our Success”–The End Result – The All-Important Profit Spread Chapter Four - Tweaking the AssortmentsChapter Five - Staying Off, Then Getting On the Radar ScreenChapter Six - Entering the Dreaded (Gasp!) Tri-State MarketChapter Seven – La-La Land: Finally Going NationalChapter Eight - e-Commerce: Do We Have To?Chapter Nine - The Smaller BoxChapter Ten - Wall Street’s Love Affair with KSSChapter Eleven – It’ Made a Lot of People Rich Chapter Twelve – Watch Out If You Miss Chapter Thirteen - What Lies Ahead –Heading for a Mid-Life Crisis?–Dealing With Change–Hi-Ho, Hi-Lo, It’s Off to Court We Go–Once the Needle is In, It’s Tough to Take Out–The Competition Hasn’t Packed it In Quite Yet Chapter Fourteen – The Last Few Years
Chapter Thirteen - What Lies Ahead
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?
Chapter Twelve - Watch Out If You Miss
Wednesday, October 9, 2002, was a most unusual day for the company.
That morning, Kohl’s announced a comp store sales decline. That in and of itself, while unusual, was certainly not unheard of. Often weather-related or tied to shifts in the advertising calendar, the best way to judge how things were going was to look at the blended average of comp store sales over a two month period. So if September sales were tough, at least historically, you could always count on sales in October to come roaring back and get things back on track.
But in addition to announcing a 3.2% comp store drop, Larry Montgomery also provided analysts with downward guidance of projected earnings for the quarter, cutting the estimate to between 34 and 35 cents a share from an earlier projection of 37 cents a share.
While there were hundreds of companies during the stock market challenges of 2001-2002 that were almost incessantly reducing their earnings estimates, this sort of thing just didn’t happen at Kohl’s. This was the first time that this kind of a “miss” had been announced at the CEO level. Arlene Meier, our CFO, could always play Wall Street like a Stradivarius, beating the First Call estimate by at least one penny 32 quarters in a row. That kind of record doesn’t just happen. These things were highly orchestrated and planned, with an emphasis on no surprises.
As a result of all that credibility that had been built up over the years, Kohl’s had ‘justified’ in the minds of most of the top analysts on Wall Street a price-to-earnings (P/E) ration north of 50.
But with the downward guidance, it became a whole new ball game. To put it mildly, the stock went down. OK, the stock plummeted. In a few short days, KSS went on a wild descent that took over a billion dollars out of Kohl’s market capitalization.
It is a part of Kohl’s tradition that when you miss a month, you re-group, re-load and fire everything you’ve got at the next month. This involves adding promotional events, taking steeper discounts in already established events (e.g. for the mid-month Saturday One Day Sale, taking the entire stock of sweaters from the original plan of 30% to say 50% off), and just doing just about whatever you have to do to knock the cover off the ball.
Kohl’s did, in fact, come “roaring back” in October with an 18% same-store sales increase. In addition to all the ‘incremental’ volume generated by the additional promotions, the month was aided by generally cooler than normal weather throughout most of the country where the company operated stores.
And two months after that historic ‘we’re revising downward’ announcement, Larry came back and reported that oh my, as it turned out, they made it after all, posting net income of $133.4 million, an increase that “marks our eleventh consecutive quarter of earnings growth in excess of 30%.”
The earnings per share? Not the 34-35 cents a share they guided back in mid-October. Not the 37 cents that was the original guidance. Rather, Kohl’s posted net income of 39 cents a share.
By then the stock had recovered nicely, making over a 20% increase in the weeks following that precipitous drop to $48 per share after the announcement in October. And fourth quarter earnings for 2002 were back in the Kohl’s groove, with net income of $279 million, or 81 cents a share. Wall Street was expecting 80 cents.
Unfortunately, the bump in the road experienced in the Fall of 2002 continued to affect Kohl’s into 2003. Clearly affected by the war in Iraq and a persistent, sluggish economy, Larry Montgomery announced on May 8, 2003, yet another (the second in recent company history) downward revision to projected quarterly earnings. Instead of the expectation of 36 cents per share by 24 analysts, Larry said that everyone should expect more like 32 cents per share. Like the last time the company lowered guidance, the stock plummeted, this time by 5.8% the day after the announcement and another 5.0% the following three days.
In explaining the need to announce the change, Larry referred to the impact of cool weather on dampening sales. In a press release, he stated: “…we had a very late start on the selling of spring apparel…with more normal temperatures arriving in the majority of our markets for the last week, we did see a positive change in sales trend for the final week of the quarter.”
Boy, was the blaming of sluggish sales on weather a switch for senior management at Kohl’s! In the ‘old days’ (i.e., when Bill Kellogg was at the helm), you would never attribute tough sales on unseasonable weather conditions, unless there was a tornado or something severe, like a power outage. And only then would the store guys get a little bit of a break! No, Bill had sort of a ‘macho’ thing with weather, and really didn’t take kindly to the idea that sales get impacted by weather. I remember we once had a company come in that claimed to be able to forecast long-term weather trends with the idea that the merchants would alter their buying plans based on those meteorological predictions. For example, if there was a forecast for a very cold winter, why not build up your inventories on outerwear, sweaters and cold-weather accessories, like gloves and scarves? But Bill would have none of it, and it simply was not part of our culture then to talk much about the weather and the impact it had on sales.
But the reality in 2003 was that Spring weather came late all over the United States, and it was obvious that it was impacting sales adversely. So Larry called it like he should. But what was revealing about the admission was that Kohl’s, like everyone else, was beholden to Mother Nature. The company was mortal, just like everyone else. In the past, the company always had a little something in their ‘hip pocket’ to pull out whenever they needed to ‘make’ a quarter. Obviously, now, there’s not enough left in the kitty to save the day. It’s not the sort of thing that can destroy a great company, of course, but the psychological impact should not be underestimated.
Still, perhaps part of the problem was that Kohl’s had been so successful in meeting (or exceeding) expectations that people became spoiled into thinking everything would always be perfect. And the company always seemed to find a way to pull a rabbit of the hat when the need arose. The skill of Arlene Meier, like any great CFO, had much to do with it. She would always hold in reserve a ‘rainy day’ strategy that she could count on to dip into to insure a quarter was made. How could she do this? Well, it clearly had something to do with the fact that there were 32 quarters made in a row, almost all of them right down to the penny of analysts’ expectations. But this was not the “fuzzy math” that has made the public so skeptical when it comes to corporate America. Everything was above board. I can say without hesitation that Arlene was a straight shooter, my point being that there clearly was nothing left at that point to help make the quarter, or she would have made it happen…regardless of the weather. As we’ve seen, Kohl’s has used extended promotional calendars to insure the making of a month or quarter without fail. This is something they would have been extremely reluctant to do in the past. So, clearly, the dynamic at the corporate office had changed. Thoughts of invisibility have since been torn down. There are very real threats out there that the company needs to guard against. Humility, in the long run, may turn out to be a more valuable weapon in the retail wars of the near future. After all, bravado(one of Montgomery’s strengths, I might add) can only get you so far.
The moral of the story is don’t disappoint Wall Street. Of course, that’s easier said than done. A lot easier. Always challenging, the Kohl’s business model forges ahead, but it clearly isn’t getting any easier by putting up numbers that don’t consistently meet Wall Street expectations and need occasional downward guidance.
As we will see further in the upcoming chapter What Lies Ahead, the performance of Kohl’s stock in the last five years has been a major disappoint. The stock consistently trades in a P/E range of 12-18 for the last several years, way down from the early hyper-growth days of the 1990’s. Toward the end of 2007, the share price is the same as it was five years ago.
I continue to bump into former colleagues during my travels in Milwaukee, and I’m struck by how many of them quickly confide in me how things are so much tougher today than they were even just a few short years ago. I recently ran into a senior merchant and his wife at a downtown restaurant. After exchanging pleasantries, we talked a little business: “Nothing is ever easy anymore,” he admitted. “Now we have to scratch and claw for everything we get.”
I didn’t want to ruin his dinner. But I couldn’t help but think, brace yourself, the road ahead looks quite bumpy.
"Associates Are the Key to Our Success" (part of Chapter 3)
Any successful company will invariably take note of the collective efforts and hard work of their employees. Kohl’s, of course, is no exception. Let’s break this down this review into two categories: hourly paid associates, and executives. Both have played vital roles, and Kohl’s has treated both populations well, generally keeping disputes and internal controversy to a minimum.
Without fail, in the opening letter from the CEO in the Kohl’s Department Stores Annual Report, there is always glowing praise and appreciation for the hard-working hourly associates in the stores, warehouses, and corporate offices:
1995 – “Our record results are due to the hard work and dedication of each and every one of our Associates…”
1997 – “Kohl’s record-breaking numbers are the result of the efforts of each and every one of our 32,000 associates.”
1999 – “When we talk about the people behind Kohl’s success, first and foremost are our Associates. They are truly exceptional.”
2001 – “There are many attributes that differentiate Kohl’s from the competition and position us for continued growth. None of them would be possible without our outstanding team of Associates.”
Yeah, I know most all other companies do the same, but with Kohl’s the continual thanking of the sales associate is always front and forward. You can rest assured that the phrase “associates are the key to our success” will continue to be part of the KSS mantra, even though the primary spearcarrier of that mantra, Bill Kellogg, is long gone from the daily running of the business.
How this concept plays out in the real world isn’t quite so ecstatic, of course. The rate of sales associate turnover is improving…but it’s still not particularly good. It’s just an improvement from how positively dismal it was a in the mid-1990’s. Of course, it’s difficult for any store to retain these workers over an extended period of time. For the most part, company loyalty is a thing of the past. Keep in mind, the average hourly rate for a sales associate is about $10.00 –12.00.
Yet to financially support the claim that “associates are the key to our success”, the company, after years of evaluation, eliminated their traditional employee pension plan in 1996 and gave associates the opportunity to roll their pension funds into a 401K plan. The company began making annual contributions to this plan.
In addition, the Employee Stock Ownership Program (ESOP) each year makes a contribution. From an initial contribution of $1 million in 1992, the value of the company contributions to this program was more than $87 million at the end of 2002. Also, the corporate headquarters has headed excellent daycare facilities, as more recently, has launched a healthcare facility for employees to get quick and low-cost access to a primary care physician.
“Taking care of your people” has also clearly been a priority with the executives in the company. From the beginning of the business model, Kohl’s put a major emphasis on executive recruitment and development. Bill, Jay and John knew they were going to grow quickly, so they put a great deal of time into the interview process: Saturday mornings was always the day for interviewing people at the corporate offices, where we had an in-house staff always under pressure to fill all of the open and newly created corporate and regional storeline positions. With the kind of growth we were experiencing, we were often bringing in over 250 new executives into the company, just to handle the new store openings. Today, that number is no doubt much higher.
Recruiting for the stores was not as easy as it might appear today. To begin with, we often required new executives to join us at a level below their existing position at their current company, so that they could learn all about the “Kohl’s culture” without undue pressure and, using a term I must have used thousands of times during my years of recruiting, “set themselves up for success.” For example, we would tell a District Manager of a group of sporting goods stores that we’d want him to come in as a Store Manager of one of our larger volume units. Or we would want a Target Store Manager to come in as an Assistant Store Manager just for a short period of time to get acclimated to our company. Most everyone who joined Kohl’s from the outside had to do this, myself included, enduring what I often referred to as The Ego Hit. While it was a very difficult pill for many people to swallow (and lots of capable, sharp people didn’t), those who did take the ‘hit’ more often than not came in, got acclimated, then moved up the career ladder. But it could be a hard sell when you were trying to take the cream away from your competitors.
Another challenge while recruiting was that the basic concept of stock options was foreign to many people in the industry, and they tended to discount the upside in their consideration of the offer. Before the stock splits in the late 1990s, the mentality of most recruits was “show me the money.” To make matters more challenging, Kohl’s, as part of its low-cost culture, has historically had low base salaries compared to the rest of the industry. For example, the average base salary for a store manager at Kohl’s in the last ten years has been approximately 25% less than the average salary for a store manager at Target. That spread is even greater when compared to store managers at Sears, Macy’s or JC Penney’s.
But that ‘gap’ has been filled by the long and rich tradition of end-of-year bonuses given to all executives based on the achievement of a total company attainment of certain earnings per share (EPS) hurdles. At the beginning of each fiscal year, certain assumptions were presented to all of us in determining how these hurdles were established. In true Kohl’s conservative fashion, the presentation focused on what it would take to achieve a 5% bonus:
–5% comp store increase for both Spring and Fall
–successfully opening scheduled new stores for the year
–an inventory shortage that was close to historical averages (which, incidentally, has been very low compared to the department store industry as a whole)
–a basis point reduction in S,G & A expenses (typically, around .24%) reflecting the continued leveraging down of expenses through top-line growth and solid expense management
While a possible 5% year-end bonus was nothing to sneeze at, things got more interesting when the possible bonus scenarios discussed the “what if” comp store sales for the year were greater than 5%. I mean, for so many years, we were knocking the cover off the ball with comp-store sales significantly greater than 5%. What effect on the bonus would a comp-store increase of , say, 7% , or even 9% have on the bonus percentage?
Basically, for every 100 basis point improvement in comp-store sales (say, from 5% to 6%), the impact on earnings would be significant, and the bonus would rise about 3.5 points (in this case, from 5% to about 8.5%). Get up to around a 9% comp-store increase, and the executive bonuses would get close to maxing out (in the range of 22.5% to 33.0% of base salary, depending on your level).
The bonus plan was a major incentive for all of us. What is noteworthy is that it was based on a team effort, yet another example of how the culture of the company focused less on the individual and more on the collective achievements of the entire organization. The results were always a much anticipated major part of the quarterly meetings. The then CFO, Arlene Meier, would show updates letting us know where we stood. I recall in the mid-1990s, after the second year of maxing out our bonuses, we went for the THREEPEAT. Mission accomplished later that next year, we celebrated by handing out bottles of root beer at the year-end Management Committee. The bottles had custom labels with Jay Baker’s photograph, with the line underneath which read “This 3-Peat’s For You!”
As it has turned out, over the decade of the 90’s, the executives at Kohl’s have maxed out their bonuses on all but two or three of the years. How can you tell? (hint: the annual 10-K’s list additional compensation for the top execs; you can do the math and make the determination).
During the major rapid growth years of the 1990’s, Kohl’s was able to successfully recruit some of the best executives in an industry where a lot of executive search companies bemoaned the lack of talent. Retailing is amazingly tough, it takes you away from your family for huge chunks of the week (and weekend), and not as many people are getting into it after college as before. But Kohl’s consistently has been able to open new markets with a high quality of executives, some moved in from existing markets to complement the new hires.
Fast forward to 2007, and the issue of executive retention and compensation has a different ‘take’ than the heady days where we enjoyed the benefits of three stock splits in 48 months, from April 1996 to April 2000. To be sure, Kohl’s financial performance has deteriorated this decade, and as a result, executives have not had same kind of bonuses as in years past. In addition, Kohl’s stock has significantly underperformed the S & P 500 in the past seven years; the stock is trading in December, 2007 at a lower price than when I left the company in April, 2007. There has been no stock split since then.
But it is important to acknowledge that while the executives that have joined Kohl’s in the last few years have not yet been able to make major financial gains with the appreciation of their stock options, during the ‘rise’ of Kohl’s in the 1990’s into a national player many, many executives became millionaires(and three became billionaires) as a result of the the impressive performance of the company.
Private Label (part of Chapter 3)
(Note: This post is a continuation of the periodic ‘release’ of a book I wrote back in 2002, and recently updated, now called The Rise and Stall of Kohl’s Department Stores. This section, titled Private Label, is part of Chapter 3. To begin reading the book from the beginning, you need to go back to earlier posts, and start there. Once all of the chapters have been posted, it is my intent to then set up the book in a pdf file in the Writings section, which will be available for free download).
The proliferation of non-branded, or private label, merchandise over the past 30 years has radically altered the retail landscape. It’s one of those areas where consumers have responded better than the industry had originally expected. Eventually, just about everyone in the business scrambled to take advantage of it.
When I was a storeline executive in the 1980s, private label for many of the larger department store groups was just emerging as an important revenue stream. Some companies, such as May Department Stores, Federated Department Stores and The Hudson Bay Company (Canada’s largest retail group) began to launch new lines that were developed in-house, in that the names of the new lines, with all the accompanying labels, tags, and marketing material, were their own developed intellectual property. These new lines gave retailers some control over their product, in that they could price, market and promote it however they chose. Private label was viewed as an opportunity to create a competitive edge.
But not all retailers fell in love with the idea. Quite the contrary, as we will see. But first, some background. When Macy’s opened an award-winning 256,000 square foot store in the Dallas Galleria in the Fall of 1985, I was privileged to be the Store Manager. The opening, in the grand tradition of doing it ‘big’ in the State of Texas, included black-tie events on the wide marble aisles in the store itself, a kick-off mini-concert with Paul Anka, and many other splashy attention grabbers that we knew would surely create the proper buzz. The idea was to get people curious enough to come on down and check us out. At the time, our strategy was to make this Macy’s the only one in the country that had all of its sales associates on commission, and not to conduct the infamous One Day Sales. Basically, I was given the directive to copy Nordstroms, which at the time was in their heydey for their legendary service levels and ability to sell goods at regular price.
In the first four days of business, the store did over $2 million in sales, smashing all previous Macy’s records at the time. To say the least, they were pretty heady times. The word was out there about this new store in Dallas (to this day one of the most expensive department stores ever built) and the industry lost no time in taking notice. Retailers from all across North America would come visit the new store. Often I was there to escort these people and (in many cases) their entourage around the store. I had the honor and privilege of escorting the late Stanley Marcus, then Chairman from Neiman-Marcus, and Marshall Field’s former CEO Phillip Miller (who, following his visit, wrote me the most complimentary letter I have ever received; it is framed and is in my home office) and many other executives who wanted to see what this new store was all about. They were suitably impressed, and I took a great deal of pride knowing that they were taking notice of our entry into the market. On more than one occasion, the leader of an entourage would hold court with his minions somewhere in the store, point something out, and basically make the point: “We need to do it like this.”
Another one of those executives was the late William Dillard, Sr., who at the time was the Chief Executive Officer of Dillards, based in Little Rock, Arkansas. Mr. Dillard, upon walking the missy apparel departments on the main floor, began to question all the space dedicated to private label. I could tell that he obviously didn’t think it made much sense. He almost had a visceral reaction when we would walk through an area dominated by private label merchandise. “Where are the brands?” he would question. The look on his face was priceless. Mr. Dillard’s company clearly at the time had a disdain for private label, and they were leveraging this as best they could to develop extremely close relationships with the major branded players of that day: Liz Claiborne, Ralph Lauren/Polo, Haggar, Maidenform. In the late 80s, vendors absolutely loved Dillards. Every year they would win their individual “Retailer of the Year” award and get constant mentions in Women’s Wear Daily. But they were out of touch with where the future was heading. (Footnote: It’s interesting to note that many years later, Dillard’s underwent a major shift and started to vigorously go after private label. Orchestrated by William Dillard’s two sons, Bill and Alex, Dillard’s established a strong relationship with the buying group Frederick Atkins in New York, and began buying large commitments of apparel, and eventually hardgoods, off-shore, through agents in Hong Kong, Singapore and elsewhere. This new initiative created strains back home with the national brands, who had to give up valuable real estate to make way for all of this private label. Relationships with most of these vendors soured significantly in the mid 90s, as Alex Dillard put the screws on, demanding gross margin guarantees, and was perhaps the most aggressive in the industry when it came to taking end-of-season chargebacks. The shift from being the most loved of retailers by the major brands to being despised was truly remarkable).
Over time, many of these new private label lines created genuine brand equity, in that they would begin to register with customers the same way, for example, the name Dockers would, connoting certain selling points regarding relative quality and value. Rather than seeing it as some sort of quirk or gimmick created by the store, customers came to see these private label items as something that attracted them to the store just as much as the brand labels did.
As a generalization, private label was an opportunity for retailers to sell fashion ‘basics’ at generally higher gross margins. Whereas, for example, a typical Liz Claiborne blouse would sell at ‘keystone’(i.e., two times cost) plus $3-4, and therefore an initial mark-up of around 53% or so, retailers could sell a one pocket garment washed tee shirt at a mark-up significantly higher, say around 58%. Those extra 500 basis points of markup were huge in helping the bottom line, or at least the projected bottom line.
Other retailers, notably Wal-Mart and Target, would ‘knock-off,’ or copy, perceived fashion items, to include fashion basics, and would work with mostly off-shore factories in getting merchandise at the lowest landed cost possible. Using merchandise lingo, they would “take a lot out of” the garment: for example, reduce the gauge, or weight and ‘beefiness’ of the sweater, simplify the stitching, reduce the quality of the buttons, things like that.
In the end, retailers would have a lot of ‘water’ (another garment term, meaning that the spread between what they paid for a garment and what it retailed for on the selling floor was substantially higher than similar branded product) in private label. It gave merchants more flexibility in promoting goods: for example, with these ‘inflated’ retails, buyers could promote their merchandise at 33% off and still run the goods at keystone.
To his immense credit, as the chief merchant of Kohl’s from 1986 until his retirement in 1999, Jay Baker had a somewhat unique approach towards private label. This approach, which continues today to be the cornerstone of the merchandising philosophy at the company, is in my view a major reason behind Kohl’s success. It is based on three key objectives:
Grow and maintain private label to 20% of total revenues, while never losing focus on the importance of national brands in attracting the customer to the store. When private label programs at Kohl’s gradually took shape in the early-90s, Jay made sure that the proprietary assortments complemented the merchandise provided by the national brands. Private label simply added to the value proposition. Customers have never been overwhelmed by seas of private label, such as at JC Penney in the 90s; instead, they have been introduced over time to a select group of names such as Sonoma, etc. And although these private label products were pulled together into meaningful shops and presentations, overkill was never the message. Yes, the private label products were prominently displayed and readily available. But the importance of national brands was never neglected or forgotten.
In 2002, Larry Montgomery further underscored the company’s intent to focus on national brands while still offering customers meaningful private label programs: “Our private label is never going to be more than 20% to 25% of any given classification because our customers are telling us they want the national brands. Brands are always going to have a clear edge. Everybody knows, for example, what size they take in Levi 550 jeans. The brands we carry have huge credibility with the customer.”
Develop product with quality on par with top-line department stores. From the beginning, the private label strategy at Kohl’s was to create a dramatic distinction from the merchandise at the discounters, namely Wal-Mart and Target, and even the ‘middle’ retailers, namely Sears and Penney’s. While Wal-Mart and Target were doing everything to get the lowest cost of something (often to the detriment of quality), Kohl’s made an early commitment to develop private label product that would compete favorably with those programs offered at stores run by the large national players: Federated, Macy’s, May, Dillards..
(*footnote: Beginning around 2000, Target made a major change in their private label development, and clearly attempted to ‘trade up’ the customer by bringing in designers such as Michael Graves, Mossimo and Stephen Sprouse to create more updated, hip [and many would say, in light of their comp store stumbles in the past year, ‘too hip and over the top’] assortments and thereby separating themselves from the Wal-Mart customer. Kohl’s, in typical fashion being a late ‘second’ to many new ideas after the initial store concept was born in the 1990’s, finally came on board and created lines for celebrities like Daisey Fuentes, Ashley Judd and in 2007, Vera Wang).
3. Do not maintain the same high gross margins as department stores. So what does that strategy give you as a competitive advantage? Same quality + lower prices = greater value. Which translates to greater market share. Jay Baker, as well as his successor, Kevin Mansell, have refused to use private label as a pad to prop up the numbers, particularly gross margin. The temptation has been there, of course, but such a strategy, they came to believe, would eventually backfire.
Jay Baker’s private label strategy has contributed enormously to the success of Kohl’s. Private label now accounts for over three billion dollars in annual sales. Helping this initiative is the relationship that Kohl’s forged several years ago with Hong Kong based Li & Fung Ltd, the $4 billion global sourcing and production powerhouse. Instead of having buying teams at various points in the Far East and elsewhere, Li & Fung have provided Kohl’s merchants with turn-key full-package suppliers who can handle everything from buying piece goods (the fabric used to make a garment) to overseeing production to booking space on ships for the trip to the United States. While the company owns no factories or sewing machines, Li & Fung manage production in more than 100 plants in 67 countries. While Kohl’s low-cost culture has always tried to avoid middle-men or third-party service providers, the partnership created with Li & Fung enabled Jay Baker and his merchants to focus on the development of brand equity in the stores while relying heavily on their partners in the Far East to ensure consistently high quality control through on-site management at the factories.
Kohl’s continued to expand its quest for still more private label brands. The first major foray into creating a major stake in creating brand equity in private label at Kohl’s took place in 1994 in the denim jeans category. Jay Baker recognized that there was plenty of room for another line of jeans to complement the exploding Levi’s and Lee denim businesses. The line of Genuine Sonoma was created. The next year, playing off the success of the line, Sonoma expanded into men’s, missy and kid’s apparel, and in later years, extended to shoes, accessories and home products. It is by far the most successful and dominant private label line at Kohl’s.
Other apparel and accessories private label lines include Croft & Barrow, and Fairway and Fairway. Entry into the private label health and beauty aids categories occurred in 1995. Spearheaded by buying veteran Nancy Wargin, who joined Kohl’s in 1997 and recognized the opportunity to go after the same kind of merchandise that The Body Shop and The Limited’s Bath & Body Works had sold so successfully, Body Source was launched with much fanfare in the stores and has been a huge success.
The company has done such an excellent job marketing and positioning the in-house stable of labels that many customers, in marketing surveys and focus groups, now view such names as Sonoma on the same level as Levi’s or Nike or Columbia. Anecdotally, reports are abundant of shoppers approaching department managers of apparel areas at Kohl’s competitors and asking them where the Sonoma merchandise is! Talk about a spear through the heart!
Chapter Eleven - It's Made A Lot of People Rich
It’s pretty clear that virtually anyone who was either involved at the senior level or who had invested in Kohl’s Department Stores during the period of the leveraged buyout in 1986 until the last stock split in 2000 did well financially. The success of Kohl’s has made a lot of people rich.
For starters, anyone who had faith in the “vision” and skills of Bill Kellogg, Jay Baker and John Herma have enjoyed outstanding returns on their investment. Whether they were the investment bankers who were part of the 1986 leveraged buy-out or the mutual funds who got on board during the IPO on The New York Stock Exchange six years later, they were richly rewarded. In fact, it was damn near impossible to not get a terrific return on your money if you invested at any point along the way during the early years.
For the three men who were the prime movers in the management-led leveraged buyout in 1986 – Bill Kellogg, John Herma and Jay Baker – they have now taken their place in the ranks of the richest people in the world. In fact, Bill is regularly listed in the annual Forbes billionaire list. John and Jay, based on the value of their stock ownership prior to retiring, are probably in the $500 million – 1 billion range. In fact, as of February, 2003, Bill, Jay and John still owned over 60 million shares of Kohl’s stock, representing over 16% of the shares outstanding. It is interesting to note that while all three have sold some of their holdings in Kohl’s stock in the last several years in order to diversify their asset portfolios, they still seem to have considerable confidence in the current leadership and the prospects for future performance.
Over a dozen or so of the original senior executives who were part of the LBO in 1986 and/or the IPO in 1992 have since cashed out and left the company with proceeds between $15 –50 million.
The two key executives currently running the company following the retirements of Kellogg, Herma and Baker – Larry Montgomery and Kevin Mansell – have positions in Kohl’s stock and stock options (both exercisable and unexercisable) in the tens of millions of dollars. It’s in the public domain.
And then, of course, the hundreds of executives who owned stock options over the years have also benefited, myself included. And while the success story of Kohl’s didn’t create over 1,000 millionaires like Microsoft, in a quiet way, by around 2001 the appreciation of Kohl’s stock had created millionaire nest eggs for over 50 executives working at the corporate offices in Milwaukee and throughout the country where they were veteran storeline managers. From the outset, Bill Kellogg and his senior team strongly believed in the wisdom of incorporating stock options into the overall compensation package to recruit and retain executives from all over the country, recognizing that a fast-growing company like Kohl’s would be on a never-ending search for talent.
For me, the attraction of owning stock options in such a company was compelling. Somewhere along the line in my career I realized that the only way to get materially rich in this world is to own equity and/or stock options in either a private start-up company or a fast-growing publicly-traded company. While I was always blessed with having nice salaries for the various positions I held in retailing, it became pretty obvious that as you made more, you spent more. Your ‘nut’, or overall expense burden, just gets bigger and bigger.
So when I was being recruited to join Kohl’s to fill a key storeline management position in 1993 by Jane Goldman, a former associate with the executive search firm Kerson & Associates, I was particularly intrigued when she repeatedly told me that whoever took the job would hit a financial homerun within ten years, due to the expected appreciation in the value of the stock options that I would receive. In fact, when I did receive a formal offer to join the company in 1994, Bruce Kelso, the Senior Vice President of Human Resources then, presented me with an Excel spreadsheet showing how the projected, “conservative” growth of my stock options would put me in an encouraging future financial position. (note: I later learned that this spreadsheet was one of the original attempts to communicate to prospective executives the significant potential upsides to making a change and joining the company; the practice was discontinued a couple of years later).
Herein lies the beauty of being granted stock options when you’re with a company as successful as Kohl’s was in the 1990’s. Starting back in 1996 Kohl’s scored an impressive 3 stock splits within 48 months. For stock option holders, that’s music to their ears. Each time a stock splits, the number of stock options you hold ‘doubles’. So when it happened three times, as long as the price of the stock kept increasing during this time, fortunes were literally being made. For example, say you had 10,000 stock options in 1995. After the first split (in 1996) you doubled to 20,000. After the 2nd split (in 1998) your numbers jumped to 40,000. Finally, after the 3rd split (in 2000), your initial 10,000 options would have ballooned into a whopping 80,000! Now here’s the really good news: at that point, any time Kohl’s stock goes up $1.00, you’ve increased your net worth by $80,000. And this doesn’t even include all the additional stock options you received along the way as part of you annual performance review. Like I said, stock options remain one of the best ways to get The Big Homerun other than hitching your wagon to a start-up that succeeds.
And then, of course, the individual investors who got in “early” (anytime between 1992 until mid-2000) have also reaped the benefits of Kohl’s unprecedented success and have had skyrocketing returns.
Some great rides must come to an end. New arrivals within the executive ranks at Kohl’s in the last five or so years have had far more trouble accumulating wealth than their predecessors. The last stock split was in April, 2000. It’s fair to assume that many of the executives who have joined the company in the last few years have had significant portions of their stock options “under water” (i.e., the price of KSS is less than the grant price of their options, making them worthless, at least at that point in time). Some of these guys are real ‘hitters’ in the industry, and they no doubt left large compensation packages at their previous jobs, lured away by the opportunity for The Big Homerun. It’s a matter of public record, just by checking out Yahoo Finance and SEC filings and seeing what some of the senior executives at Kohl’s currently own in common stock and stock options, and calculating values.
It’s somewhat startling, actually. When you think that back in the 1990’s several Kohl’s Store Managers and Buyers were on their way to becoming millionaires as a result of all of the stock splits, it’s just in stark contrast to what happens when you’re with a company whose stock doesn’t go up much year after year. Stock options lose a lot of their luster.
Chapter 10 - Wall Street's Early Love Affair
Since its initial public offering in 1992, Kohl’s has grown at a compounded annual rate of over 20%, making it one of the fastest growing retailers in the past 15 years.
And even with the dismal performance of the stock in the last several years, it has been one of the best performing retailing stocks trading since 1994. The stock has had three stock splits, in the Aprils of 1996, 1998 and 2000, an unprecedented run for a retail stocking trading on the NYSE. Someone who say invested $10,000 in the 1992 IPO would have seen their investment zoom up to a value of $640,000 a decade later!
Wall Street was so enthralled that Kohl’s stock was often traded at extremely P/E ratios, reaching into the 70s in mid 2000. Despite the dilution created through the periodic but regular issuance of new stock to help fuel the opening of new stores, analysts on Wall Street generally rewarded the stellar performance of the company with high P/E ratios. Analysts like Shari Schwartzman Eberts at JP Morgan issued glowing reports in 1999 about the “Next Generation of Department Store” as it rolled out it’s “hybrid” concept across the United States.
And for those analysts who remained cautious throughout the 1990’s, skeptical about the company’s ability to maintain growth, they missed the upside of one of the best –performing stocks on the S & P 500. For them, Kohl’s kind of lofty p/e ratios were, as some would say at the time, “nosebleed territory,” and they chose to advise their clients to avoid the stock or, perhaps, buy on weakness. Essentially, they missed the boat.
(Editor’s note: That was then and this is now. When the ‘stall’ of Kohl’s began in 2002-2003, the P/E has seen a generally steady decline: first declining to the 50’s, then 40’s, then 30’s, and in the last couple of years in the high teens and low 20’s. And, unfortunately, from 2003-2007 Kohl’s stock has grossly underperformed compared to the S & P 500).
Let’s return to the original business model: by any measure, it has provided historical numbers that became the envy of the retail industry.
The key metrics or gauges of performance that I am about to outline show a consistency that was unparalleled among major retailers in the United States during the time period of 1992-2002:
1.NET SALES - At the time of the IPO in 1992, Kohl’s management announced a goal of increasing sales 20% a year. This was to be accomplished by adding new stores over time, but also through comparable store sales of between 3-5%. It was a cornerstone of the business model.
For the next ten years following Kohl’s IPO, the company’s compounded annual growth rate (CAGR) exceeded 25%, an incredible achievement.
2. OPERATING & NET INCOME - Perhaps one of the most impressive lines on Kohl’s financial statement has been the selling, general & administrative expenses line. The stores generally manage expenses quite well as a relation to sales, so that even during times when the top-line might be lower than internal expectations, the stores knew how to ‘pull it back’ and come in with a nice selling cost. But additionally, the company has been able to leverage its growth by improvements at the distribution centers, belt tightening at the corporate office and continual customer loyalty with proprietary credit operations.
For the ten years following Kohl’s IPO, the company’s CAGR for operating income exceeded 27%, indicating good leverage. The CAGR for net income is even better, exceeding 30% over this time period.
3. COMPARABLE STORE GROWTH – Always viewed as the prime metric for the performance of a retail entity, Kohl’s excelled at maintaining incredible consistency in comparable store growth over an extended period of time. Below is a chart showing an incredible feat over the years 1997-2002:
Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Year 1997 5.3 11.5 9.5 5.0 14.1 12.1 17.5 1.5 14.4 6.8 11.7 10.3 10.0 1998 10.3 12.5 11.5 17.2 4.9 10.4 3.3 5.8 3.7 3.2 6.7 11.9 7.9 1999 11.2 18.0 1.8 3.7 15.0 6.7 7.7 6.9 6.2 5.3 7.8 8.5 7.9 2000 5.6 6.8 8.4 9.8 5.0 6.7 9.1 9.8 9.5 11.2 14.8 7.1 9.0 2001 7.3 (1.9) 12.7 2.1 1.7
2002
14.4 9.0 5.0 10.7
5.5 5.3
4. NUMBER OF STORES & SQUARE FOOTAGE – A book on the success of Kohl’s would not be complete without an acknowledgement of the impressive addition of new stores and distribution centers in both new and existing markets to help fuel the fast-growth story. When I left Kohl’s in April, 2000, there were 298 stores in 25 states, and three distribution centers. By the end of 2007, there are now over 900 stores in 47 states, and ten distribution centers.
Certainly another aspect of Kohl’s performance that made Wall Street swoon has been the consistency of Kohl’s earnings exceeding projections. Under the cool management of former CFO and then COO Arlene Meier, the company was exceptional in managing analysts expectations and delivered consistent results, quarter after quarter. While many lament this practice of companies trying to meet analyst ‘targets’ within a penny based on earlier guidance, and therefore become pre-occupied with short-term success, this consistency had become the cornerstone, in my mind, as to why Wall Street had been able to justify buying and owning stock as such a high price-to-earnings ratio in the late 1990’s and up until around 2002.
As to how retired Kohl’s CFO Arlene Meier managed to exceed the First Call Quarterly Average Estimate by a penny for often years at a time, what can I say? She was very adept at directing guidance upward, or at times even slightly downward without causing a stir, and that the Kohl’s business was so consistently good over those years that it gave her some flexibility that companies that struggle never have. The old saying, “great sales cure all lot of ills” certainly applies to managing earnings quarter-to-quarter.
And during those high-growth years where we consistently put big numbers on the board, Wall Street loved it.
The Racetrack (part of Chapter 3)
The senior management at Kohl’s always had a vision of their future prototype store: clean, bright, and easy to shop in. It was imperative that our customers who went around our ‘racetrack’, or the somewhat circular main aisles that go around a big-box retailer like Kohl’s, had a shopping experience that was enjoyable and hassle-free.
In comparison to the often excessive attention that traditional department stores paid toward visual merchandising in the stores, with tremendous time, energy and expense spent on lavish mannequin presentations, dramatic lighting, and ever-changing shops, we took the opposite approach. At Kohl’s, we basically resisted the notion of spending valuable time and resources in creating ‘presentational theater’ in the stores to highlight the merchandise(despite my occasional Macy’s-taught inclinations to the contrary). Rather, we focused on keeping it simple, with a minimal emphasis on what is known in the business as Visual Merchandising. We tended to spend much more time on keeping the shopping experience simple, rather than trying to ‘wow’ customers into buying something by creating a great visual ‘splash’ in the front of a department.
Under the direction of Jerry Neal, who joined us from Mervyn’s, the Kohl’s visual merchandising strategy was essentially ‘less is more’: fewer mannequins, scaled back versions of Christmas ‘trim’ and other holidays, and a laser-beam focus on making the shopping experience for our customer as efficient and enjoyable as possible. For example, there was a much greater emphasis on clear and consistent signing not only in key areas in the store, but also at all the merchandise fixtures. Consistency was key.
Over time, we established a ‘cookie-cut’ approach to providing direction to the store on how the merchandise should be ideally presented. While initially there was some resistance to using the discount store word ‘plan-o-gram’, that’s what they eventually became known as. This was particularly helpful as we opened more and more stores; our storeline executives needed to be operators as opposed to merchants, to insure that all the goods got taken out of the trailers, moved quickly out to the selling floor, put on fixtures, signed and ready to be sold. If you notice the next time you visit a Kohl’s, almost all of the fixtures are on wheels, which allows the department supervisors and managers make floor moves quickly and efficiently.
There was also a major emphasis on cubic capacity and getting as much inventory out on the floor as you could, with the rationale that you can’t sell what’s in the stockroom. And that with more inventory on the floor, there was a better chance that you had the customer’s size presented, a further improvement to the shopping experience. In the mid 1990s, major initiatives were launched to increase the capacity of all fixtures with shelves, replacing three-tiered tables with five and six-tiered tables, basically doubling selling floor capacity overnight. The strategy had a major positive impact on the selling of key folded items, like tee shirts, polo shirts, henleys, turtlenecks, and the like.
Around 1999, we began experimenting with developing a more formal program of highlighting some of our best selling holiday gift items and other merchandise during key promotional events (such as Pillow Week) in the main aisles of the store. This approach, however, was not without controversy. There were those who pointed out that sales dramatically increased for items featured on the aisles. Their argument was it’s the bottom line that ultimately matters. But the dissenters didn’t see it that way. They would say, “What about the customer? We keep hearing complaints that the fixtures are too tight in the departments. They’ve literally become a stumbling block for people trying to shop.” As I recall, Larry was more often in that camp, and would roll his eyes on store visits during a major promotion when the Store Manager of one of the Milwaukee stores, for example, got very aggressive and stacked four-color boxes of small electrics in the middle of the aisle.
Rather than scrap the idea altogether, however, Larry’s initial reticence evolved into a compromise strategy that has been enormously successful: widen the aisles and formalize the program. It evolved into the Table and Tower program, which was rolled out during 1999-2000. This was not only a way to get maximum use of our floor space (by going up), but it also had the advantage of putting the merchandise right at the eye level of our average customer (a five foot five woman). Primarily set up during the Christmas holiday period, these displays featured impulse items, everything from boxed picture frames to candles to games to gift boxes of gold earrings. The visual merchandising department used the top of the towers to help “Christmasfy” the store on a limited budget. For the most part, this simply involved decorating them with cheery holiday graphics which also helps to put shoppers into a spending mood.
And playing into the whole concept of making the shopping experience fast and efficient, the merchants continue to highlight merchandise in boxes as a ‘gifts-to-go’ station. These include lots of different kinds of products – I recall at one point puzzles became a very hot item – and then there were the perennial favorites such as soap and bath sets, candle sets, perfume sets. Says Montgomery, “All you have to do is buy it, put some gift wrap on it, and you have a ready-made gift.”
Fast forward to 2007, it is remarkable to now visit Kohl’s traditional department store competitors and see how much they have changed to more closely resemble the ‘less is more’ approach to visual merchandising.
Chapter Four - Tweaking the Brands
By around 1995, having defined the key components of the business model, Bill Kellogg and his senior management team was positioned to take the show on the road. Their model was being increasingly accepted in their home base of Wisconsin and in certain Midwestern cities, and they knew that was only the beginning. When you have something that works this well, it would make zero business sense not to capitalize on it to the max.
But every now and then the model would be tweaked a bit. Perhaps most evident of this ‘re-jiggering’ has been in the adjustments to merchandise assortments, particularly in terms of eliminating existing categories of goods or adding new ones. These adjustments actually fit right into the business model, because it was designed to include room for flexibility. After all, even the framers of the Constitution saw fit to make a provision for amending it.
As Kohl’s entered new markets and new stores sprang up, the size of the selling floor square footage of a prototype was often discussed. Frequently these conversations became fairly animated. On the one side, as I recall, was Bill Kellogg, who espoused a “smaller box” position of 82,000 total square feet. Most of the stores in the early 1990s were built to that specification, and had enjoyed impressive sales per square foot productivity. But the counter-argument, usually headed by the merchants, was the belief that with all the success the company was enjoying, existing stores were already getting tight because of all the merchandise being bought for them to keep up with the sales trend. The group lobbied for a larger pad for prototype stores to the tune of a minimum of 86,000 square feet.
The yin and yang of deciding what the correct size was when we built new stores dragged on. One side: low cost culture, conservative. The other side: slightly aggressive. What made it such a tough issue was that that there were good arguments on both sides.
Of course, as these discussions progressed we would begin to evaluate the productivity of every department on the selling floor to help us draw some reasonable conclusions. It seemed as if everybody had their own case to make. The merchants representing the missy apparel departments would contend that hey, their typical dollar per square foot productivity was $50.00 higher than the store average (at the time, around $265/sq. ft.). “And, oh by the way,” certain “productive” merchants would say, “look over at this department, they’re way behind the average. Take something out of their hide!”
I can tell you from a lot of experience that these square foot evaluations at Kohl’s were tame when compared to the battles that raged inside many other retailers, particularly Macy’s. In these other companies, especially since every store was different in terms of total size, layout, etc., it was an ongoing exercise for the merchants at corporate to constantly hound the CEO about making square footage adjustments at say, the Macy’s at Herald Square in New York City or the Bullock’s store in South Coast Plaza (since changed to a Macy’s as well). It was a major part of what executives did: the former CEO of Macy’s East, Hal Kahn, is famous for visits to branch stores which focus almost solely on floor moves and selling productivity.
At Kohl’s, it was an important topic but not something we got to hung up over. The key was to build stores that were similar in size and layout so we could rapidly ‘cookie-cut’. Keeping things simple was a tremendous advantage over the traditional department stores. And it was an advantage that we intended to keep.
Eventually the prototype store was increased from 82,000 square feet to 86,000, with most of the space going to the missy apparel departments (which now accounts for over 31% of the total Kohl’s revenue). During this process, however, sales per square foot productivity of certain departments would occasionally be challenged. Because of our rapid growth, stores were often tight, and, facing pressure from Bill Kellogg about increasing the prototype size too much, Jay Baker took some major steps to ‘free up’ space for other faster growing and, not surprisingly, more profitable, departments.
From 1995 to 2000, several major departments were eliminated when it was quite evident that they were generating lower gross margins. This allowed for the expansion of either existing higher margin departments or, as we have seen more recently, the launching of new categories of goods.
For example, in 1995, Kohl’s decided to eliminate the entire electronics department, with the exception of clocks, which moved over to housewares. The ax didn’t fall overnight. For a couple of years, the electronics business had been flat, and the gross margins were terrible. We simply didn’t want to compete with the up and coming Best Buys and other big boxes starting to enter our markets. This wholesale elimination of a department, complete with glass caselines, registers (yes, back then not all registers were ‘ganged’ up at the front of the store like they are now), was a major expense and took a great deal of planning. The winner of most of the space formerly occupied by electronics: sport apparel, which jumped the aisle where it had typically been located with athletic shoes, allowing for an expansion of shoes as well.
Even though we walked away from over $75 million of electronics business, we replaced it with much more profitable Nike, Reebok and eventually Champion fleece and other sport apparel and became recognized as having the best assortments in this category in our marketplace. It was a great example of taking a short term hit for a long term gain.
In 1996 and 1997, Jay Baker and the merchants made a similar move to get the company out of three other lower gross margin businesses: lamps, window treatments and ‘knockdown’ furniture (the stuff made with particle board that you can now buy at a Home Depot). In addition to the fact that these businesses did not generate the same kind of higher gross margins that were being generated by almost all the other departments in the store, Jay Baker also realized that we did not have the space to make strong merchandise ‘statements’ to our customer. Why be in the business if you couldn’t present enough styles to convey to the customer that you’re a ‘destination’ business? In other words, we wanted to position ourselves so that we were dominant enough in a particular market that shoppers would get in their cars and come to our store to find specific products.
The stores loved the idea of getting out of the furniture business: sales of the larger pieces usually required a “carryout,” a stockperson who’d be paged by a sales associate to go to the back and bring out a box and meet the customer in the front. All fine and well, but in Kohl’s low-cost culture mode, only occasionally was a guy specifically scheduled for the task, so someone often had to be pulled from another duty. Even on its best days, it was not a particularly efficient process!
As always, of course, if we eliminated one sector we could devote more space to others. With new square footage available, stores expanded their “soft home,” namely in housewares and domestics, two departments that produce excellent gross margins. Categories such as placemats, candles, towels and sheets were expanded in subsequent years with major new fixture capitalization projects. Walk into a Kohl’s store today and you’ll see very powerful merchandise presentations in these areas, created in part thanks to the decision years ago to free up space by getting out of less productive and less profitable businesses.
In addition to the continual addition of new brands to the Kohl’s merchandise assortment, occasionally new categories would be added. For example, in 1999, framed art was added to the Housewares department and became a very profitable and fast-growing business.
Meanwhile, the strategy in our health and beauty area was to primarily stock fashion ‘impulse items’ rather than planned needs. In traditional department stores, the cosmetics department has tremendous breadth in assortment, carrying thousands and thousands of sku’s in primarily three categories: fragrances, color (i.e., things to put on your face other than skincare, like mascara, eyeliner, bases, lipsticks, etc.) and treatment, like skincare and soaps.
Kohl’s recognized early that the department store model with separate caseline islands of Estee Lauder, Lancome, Clinique and a dozen other major players was incredibly labor intensive. Moreover, you couldn’t promote Estee Lauder every week during the featured company sale event. I suppose it would also be fair to say that these guys would never sell to Kohl’s with this kind of model, so it was kind of a moot point.
Instead, the strategy was to focus on self-service merchandise (now there’s a concept that fits in well with low cost culture). This quickly gravitated to health and beauty aids. Before the launch of Bath & Body Works in 1990, personal care was often seen as a routine event, with soap meant to get the body clean and lotion used for healing rough hands and chapped skin. Bath & Body Works turned all that upside down. They turned the process of cleaning into a pampering experience, with an emphasis on softening and scenting. They took fruit and floral scented personal care products to a new level, offering a wide range of products, from shower gels and novelty candles to scented soaps, lotions, skin care creams and similar items. Women loved this idea. They flocked to it, and demanded more. We were more than ready to meet their needs and reap the benefits.
We were quite fortunate to have the expertise of Nancy Wargin in this area. She was a veteran buyer who came to us from the Milwaukee based The Boston Store. I knew her from my days at Gimbel’s. She was aggressive with a New York edge. She was the one who really picked up on Kohl’s new approach to health and beauty, and basically copied the BBW strategy. It was so successful that it soon became part of the new prototype store model that we were rapidly seeding throughout the country.
The health and beauty merchandise was often set up on skirted tables and on t-walls in the Accessories Department. The products are displayed this way for very deliberate, well thought out reasons. The Kohl’s shopper really doesn’t come to the store to fulfill her cosmetic needs; rather, during her visit around the racetrack she is greeted with attractively packaged products that catch her attention. For example, a pencil case shaped like a sneaker with cosmetics inside, or an aroma therapy candle. Gimmicky? Perhaps. But it works. And the customers love it, which is what really matters.
Today, while the entire department by 2002 was heavily geared toward the Body Source private label, Kohl’s began testing an expansion into more national brands, such as The Healing Brand, Neutrogena and Coty. Later, under the stewardship of head merchant Rick Leto, Estee Lauder established a strategic partnership with Kohl’s, with Ashley Judd as their spokesperson.
As far back as the early 90s, Kohl’s was in the fragrance business, but in a very small way. And the merchandise was gray market, meaning we obtained it from off price discounters, the only such category of merchandise in the store that I was aware of. It later morphed into a fairly strong business centered around fragrance gift sets, particularly during the key shopping periods for that category: Valentine’s Day, Mother’s Day and Christmas. More recently, the company is testing merchandising more individual bottle designer fragrances.
Another area of merchandise with an interesting history at Kohl’s is toys. At one point we were seriously thinking of giving it up. With the exception of a couple of classifications, like plush animals, the gross margins were low, and it was near-impossible for us to compete with Toys ‘R Us or Wal-Mart. Plans were initiated to evaluate how a Kohl’s store layout would look without a toy department.
And then, during the critical post-Thanksgiving weekend in 1996, we experienced a ‘whoopin’ from the competition that made us reconsider our gameplan.
The day after Thanksgiving has always been considered the kick-off to the Christmas selling season. Most people consider that day to be the biggest volume day of the year for a retailer like Kohl’s. Actually, it’s more like the 10th biggest volume day. But when you add up the volume for the entire weekend following Thanksgiving, it’s a big deal. And you don’t want to get out-hustled or out-promoted by the competition.
As you’d expect, a great deal of energy and preparation would always go into the planning of sales and promotions for the Thanksgiving Weekend. But it would always seem that our competition, particularly at the time Wal-Mart and Target (keep in mind that back then our competition was both the discounter and the traditional department store), would come out with guns blazing: they set up ‘early bird specials’ and packed their stores with steeply-discounted deals in electronics and toys. Hundreds of boxes of televisions for $59.99 would be stacked down main aisles. Target would lure hundreds of people to wait in line at 5:00 a.m. with the offering of ‘goodie bags’ for the first 500 customers (actually, most of the stuff in the bags were promotional samples given to them by their vendors, like toothpaste, microwavable popcorn, all gratis to Target). The turnouts to these discounters was incredible, and they got out of the gate like a rocket for this very important kick-off weekend to the holiday season.
We all saw it first-hand that cold November morning. I remember being with a couple of the merchants from corporate that day, who agreed to meet me at Target at 6:00 a.m. so we could check out the competition. The fishing frenzy we say that morning was an eye-opener. After visiting the rest of the competition, and of course, a number of our stores in the area as well, we headed back to corporate to report on our findings.
We weren’t the only ones to see how the competition had out-promoted us. Jay Baker, ever the competitor, was getting ribbed by other store guys and presumably Bill Kellogg about the need for us to get more aggressive during times like these. One thing for sure: Jay never would never allow the competition to take market share away from us. He quickly reassembled his team and began to re-strategize for the Next Time.
Long story short: fast forward one year. Thanksgiving, 1997: we had some incredible door busters to get people to come to our store first instead of the competition. Our blowout promotion? Entire stock of Barbie – 50% Off!! It was a madhouse. Kohl’s had the best day after Thanksgiving in years.
The toy department was here to stay. While there is an obvious ebb and flow to inventory levels of the toy department, with an emphasis on higher margin plush and educational toys, Kohl’s now uses toys to attract customers during major promotional periods to draw traffic away from the competition and into their stores.
In recent years, as Kohl’s has ever so methodically traded more ‘upstream’, Kevin Mansell has encouraged his buying organization to be increasingly attentive to the customers’ desire for freshness in the stores and more updated fashions in the merchandise mix. A good example comes from the men’s department where Kohl’s created a knock-off of the highly successful Tommy Bahama line, coming up with a private label brand of very casual, almost Hawaiian style shirts called Panama Jack in the spring of 2003.
In addition, while there are no longer major wholesale ‘eliminations’ of categories of merchandise like the mid-1990s (electronics, lamps), the company is still on the lookout for any groups of products that seem to be faltering or under-performing.
Mansell, when addressing shareholders at the annual meeting in 2003, said, “Another element of bringing freshness and excitement to our stores is our program of continually evolving our fixture presentation packages. Our efforts have increased capacity on the floor, enhanced visual presentation and improved shopability.”
His words pretty much sum up the current Kohl’s philosophy when it comes to merchandise. And the adaptability that he makes reference to will undoubtedly continue to be the most vital element of their overall strategy.
The Convenience Factor (part of Chapter 3)
When you discuss the concept of providing convenience to the consumer in an effort to gain a competitive advantage and hence market share, you’re really dealing with two issues. First are the physical locations of the stores, in comparison with the competition. In today’s time-pressed world, the time it takes to travel between home and the shopping destination has become an increasingly important factor in the decision-making process. The second part is the convenience associated with the shopping experience itself.
Back in the day, when life was less hectic, people had TIME to shop. They would go shopping more frequently, and stay in the stores longer. Customers loved the “pop and sizzle’ of Macy’s, where they would stop and look at the mannequins and the often ornate displays. In other words, going shopping wasn’t just a means to an end, it was also a leisurely pastime. It was the difference between eating merely because you need to in order to survive and dining at a gourmet restaurant, savoring the elegant ambiance and fine food.
Over the years, changes in consumer shopping behavior continued to reinforce the attractiveness of the Kohl’s ‘convenience’ emphasis. Market research indicates that the shopping frenzy of the late 1990s peaked in 2000, followed by a significant reduction in the time and frequency consumers shopped. By 2002, American adults shopped an average of 1.9 stores per week, down from 2.9 only two years before. Clearly, Kohl’s had tapped into the habits of the modern American lifestyle, and took advantage of this knowledge for all it was worth.
Another aspect of convenience is the location of your stores. I can best describe the Kohl’s real estate strategy, and it’s inherent competitive advantage with respect to convenience, by looking at the two primary ‘rings’ that retailers have created around metropolitan areas over the last 50 years or so. The first ring were the major shopping malls built from the 1960’s to the mid 1980’s or so. These are the malls that had Penney’s and Sears as primary anchors, along with the national department store players.
The second ring of retail has taken place more in the last 15-20 years, as a result of urban sprawl and the expansion of suburbia into what used to be pastures and countryside. These new centers are more about big-box strip centers, housing the Wal-Marts, Home Depots, Costcos and Targets of the world, than they are about ‘all under one roof’ shopping malls. Customers can easily visit the store of their choice, without all of the hassles of today’s shopping mall experiences. In effect, this second ring of retail, now surrounding most metropolitan areas some 10-20 miles from the heart of a downtown, provides an “intercept factor” for customers living in areas outside the outer circle, now experiencing some the largest growth rates in the country. These customers are “intercepted” by this newer, cleaner and safer centers of retail before they are able to travel to a mall.
Kohl’s growth strategy has relied heavily on this second ring and the company has developed a genuine aversion to going into malls. Says Larry Montgomery, “It’s very difficult for the customer to come in (to malls) today and fight all the traffic, park in a parking deck, and shop in stores that are more difficult to (navigate) than what we offer.”
As a result of a real estate strategy that has primarily focused on building stores in power strip centers, Kohl’s has been part of a new consortium of big box retailers that allow shoppers to make fast, quick trips and take care of a number of errands. Having other retailers right in the same parking lot is not a bad thing. In fact, it works to the advantage of both. Kohl’s and Target, for example, tend to complement each other. At Kohl’s, the merchandise is about 80% soft lines; at Target, they’re about 65% to 70% hardlines, with hardly any national brands. The two companies complement each other quite nicely.
The idea of in-store convenience has always been an integral part of the Kohl’s business model. The company has placed major emphasis on selling floor standards and maintenance. This is much easier said than done, of course, and it’s always a journey, never a destination. But the atmosphere, at least for those working in the stores, was very different from the traditional stores. They had set up a culture where you were always getting ready for the entourage visit of key leaders who would arrive with much fanfare by helicopter, like a general inspecting the troops….then you could let your guard down. At Kohl’s, these kind of visits by ‘corporate’ were far less frequent and certainly less showy. There was simply an expectation that stores looked good all the time, recognizing that following a major weekend sales event, there was a brief time needed for stock replenishment and selling floor recovery. Emphasis was placed on store cleanliness, and keeping them well-lit and uncluttered.
While always an important part of the big picture equation, starting around 2000 Larry Montgomery started to position ‘convenience’ higher on the overall marketing message to the consumer. By this time it was becoming increasingly evident from market research and focus groups that our core customer had even less time than ever on her hands and that Kohl’s was viewed extremely favorably as a convenient shopping experience. The use of “convenience” has become more heavily used in media campaigns, as a complement to the price and quality monikers so dominant in previous marketing pieces.
The five key selling points of the convenience value-added proposition:
1.You can travel to a Kohl’s faster than the competition. When the company is well-positioned in a market, most customers are within a 15 minute drive to their favorite Kohl’s store.
2. Since the store is usually in a power strip center vs. a mall, you can get in and out more quickly. Says Montgomery: “You can drive to them in your own neighborhood, park in front of the store, go in, and find what you are looking for.”
3. You can buy with confidence knowing that Kohl’s has a ‘no problem, no hassle’ return policy. Return policies are incredibly important to shoppers….and always a challenge to retailers. Customers want to feel like nothing is really “final” when they make a purchase. If it is the wrong size, doesn’t work properly, etc. they want to be reassured that they can return it and get their money asked without going through a frustrating, time-consuming process. All retailers want to provide shoppers with the confidence they are seeking. But at the same time they want to keep down the number of returns as much as possible. Kohl’s has done a good job at this. LL Bean, for example, has in excess of 15% returns, the traditional department stores are at around 11-12%. Kohl’s has managed to keep it around 9%. We were able to do this for two reasons. First, because we had hopefully provided a shopping experience that was pleasant and convenient in which the customer ended up purchasing the right item and therefore had no reason to return it. Of course, the other reason is that at the traditional department stores they tend to be dealing with more expensive merchandise. And people are more likely to be picky about what they return when they’re spending more money. Yet another benefit of the low cost culture.
4.The store has extended hours for your shopping convenience. Perhaps more so than any other recent adjustment to the business model, the lengthening of store hours to make Kohl’s even more convenient to the customer has been met with varying degrees of enthusiasm in the company, particularly in the stores. When this was first being discussed, Store Administration did an analysis showing that you had to be careful to not simply disperse the same volume over more hours, resulting in a lot of expense pressure in the stores.
But Larry Montgomery was sold on the idea of extending hours, and was its key driver. By the 2007 holiday season, Kohl’s was opening its store at 4 a.m. the day after Thanksgiving. Larry no doubt views extended hours as a direct threat to the competition. It’s hard to say whether or not this is a wise strategy. While it has indeed helped the company gain market share over the years, it has also taken a toll on storeline management, and no doubt did not help executive turnover rates, not mention the impact on key full-time hourly sales associates who have ended up working later on the evenings they have to ‘close’. Does the company really win in the end?
As the company’s President, Kevin Mansell has always shared Larry’s focus on convenience in the last couple of years as a differentiator to the competition.. Convenience, not price, he has long maintained, is what gets the customer hooked on your business model: “Price is literally the way you get admitted into the customer mind-set, but they will not shop you based on that.”
Chapter Five - Staying Off, Then Getting on the Radar Screen
What was once a small regional niche department store chain soon started to grow into new areas on its way to becoming a national powerhouse. In the mid-1990’s, Kohl’s expanded into over ten other states, almost all of them markets that were close to existing markets. By ‘back-filling’ in existing and opening contiguous markets, the company could leverage all kinds of expenses, to include distribution, advertising and storeline regional management. Pre-opening costs were effectively lower, allow the new stores to reach profitability quickly.
Our major new market entries in the 1990’s included:
1995—Kansas City, Cleveland, Omaha
1996—Charlotte, Wichita, Louisville, Toledo
1997 – Washington, D.C., Baltimore, Philadelphia, Pittsburgh
1999—Denver, St. Louis
As a bit of an aside, allow me to recall a couple ‘cocktail party’ stories and try to connect the dots.
When I was in Los Angeles as the Director of Stores of Bullock’s, every time I went to a party and someone found out I was in retailing, I would then hear all about the incredible service they got at Nordstrom’s. I never received kudos for being part of what I thought was a pretty damn good department store. It would drive me crazy!
Similarly, when I was a senior executive with Kohl’s, people’s reactions were pretty much the same when they found out what I did for a living. Except where we were opening in new markets. One of my most fondest memories of working at Kohl’s was the incredible reception we had when we entered a new market. I mean, the customer loved us. We worked hard to earn their shopping dollars, but there’s nothing like positive word of mouth to help establish yourself in a new market. There, that’s my digression.
With all of the explosive expansion in the 1990’s, Kohl’s garnished incredible customer loyalty throughout the United States. I’ve never seen anything like it except when Nordtrom’s initially came to a town, and people were blown away by the levels of customer service. Kohl’s created enormous goodwill in those early years.
In all publicly traded companies, the senior management has to decide how they want to portray their company to the outside world. There are many different audiences to address. Two of the most important are the investors and the customers. The investors’ analysis obviously has a significant effect on the company’s stock, which, in turn, directly influences the financial success of the employees. It’s an understatement to say this also serves to build up or tear down corporate morale.
But the company always has to also keep in mind their largest audience, the one by which they ultimately sink or swim: the customers. How do they do this? By becoming high profile “superstars,” always grabbing every opportunity to bask in the spotlight? Absolutely not! While that seems to be the preferred route to success for a lot of companies, Kohl’s chose the direct opposite approach. In fact, Kohl’s corporate culture calls for maintaining a low profile for its executives, throughout the entire organization and at all levels. The emphasis is on the team. And as the old cliché rightly points out, there’s no “I” in team.
Bill Kellogg decided early that he wanted the numbers to speak for the company. Successful performance numbers in such a competitive industry would say more than a room full of highly paid PR spinners. A quiet-spoken, reserved person, it just wasn’t his style to grand-stand or be a showboat. He surrounded himself with like minded individuals. And with the rest of his management team, following the leveraged buyout in 1986 and six years later in 1994 after the IPO, Bill wanted the company to keep a low profile. Even though the company was fast becoming too big to be ignored. Why this almost obsessive need to keep such a low profile is open to question. Maybe it had something to do with the company’s Midwestern, Germanic roots. Whatever the reasons, Bill had a visceral reaction when something or someone at Kohl’s got too ‘public.’
For example, I remember in 1996, Jay Baker’s wife Patty, who was outgoing and along with Jay would show up in the society columns, created a stir when she bought Jackie Kennedy’s piano for $150,000 at a Sotheby’s auction. The corporate and store phones lit up like Christmas trees the next morning, as nationwide coverage naturally referred to her as the wife of the President of Kohl’s Department Stores. Yikes! And to make the event even more public, Patty was interviewed on “Larry King Live” and was featured in People magazine. So much for the low profile.
For a guy like Bill Kellogg, this was the LAST thing he wanted to see. He always looked at things from the perspective of the hourly sales associate, making $8.00 an hour, and how they would react to this sort of thing. You could tell by his demeanor the morning after the auction that he was not pleased; while Bill doesn’t rant, his silence speaks volumes about his feelings toward something. I’m sure he must have been fuming at this highly publicized show of opulence. You’d be lucky to afford piano lessons when you’re making $8.00 and hour…and you couldn’t even get in the door at Sotheby’s.
In a rare interview in the late 1990s, Kellogg clearly touched on his keen intent to keep the company, and the leaders of the company, off the radar screen. “The only thing that would put a damper on us,” the CEO said, “is if our heads get too big.” He certainly wasn’t going to let that happen to himself. And he was determined not to let the others get bitten by that perennial corporate bug known as bigshot-itis.
I recognized this avoidance of the limelight right from the beginning of my tenure with the company, and tried to maintain a low profile (keep in mind, I was a former Macy’s alum, and everyone who worked at Macy’s has a huge head; it’s a time-honored tradition!) For years, I always described Kohl’s to friends and associates as the NML of retailing (NorthWestern Mutual Life, also located in Milwaukee, has for years marketed their company as The Quiet Company).
Kohl’s goes out of its way to keep egos in check. The company has a bias against showboats or peacocks, the antithesis of many New York-based retailers, where strutting your stuff as publicly as possible is the way to make it to the top. New guys who joined the company with a “New York edge” would find themselves in a bit of a pickle.
I was always fascinated by the contrast between Kohl’s ‘quiet’ corporate persona and the much flashier style of most everyone else in retailing. Of all industries, retail was boisterous with lots of merchants with big egos elbowing for the limelight. There were established institutions like Women’s Wear Daily, Home Furnishings Daily, etc. that played into all this. And most retailers became experts at sucking up so that they could get even more attention than they probably deserved.
To be sure, if you wanted to stay out of the picture, and kept your corporate nose clean, you could easily accomplish this. And that’s the tack we took for a long time, while we happily watched everyone battle it out in seeking approval from Wall Street. In so many ways, it worked to our advantage. While sometimes we felt a bit ignored by Wall Street, we knew eventually that the model would rise to the top and be appropriately recognized and rewarded. Patience can indeed be a virtue.
This applied even to our ‘positioning’ in the local communities where we conducted business. Companies like Target and Wal-Mart did much during this time to position themselves in the community as caring, giving, etc. Target, as part of their corporate mandate, directs 5% of their profits to charity. Kohl’s took the opposite approach. No news was good news. Maybe we weren’t getting the positive press of the big contributors like Target, then again we weren’t getting negative press either so the corporate thinking was to keep things as they were and not rock the boat. In fact, though this may come as a surprise to some, Kohl’s contributed virtually nothing to charity until around 1998. While it was difficult to quantify, it was clear that much goodwill was being generated by our competition from their charitable contributions to their local, regional and national markets. Internally among many in the management ranks, there was a growing movement for the company to be more philanthropic, and these early programs finally evolved into the now well-publicized Kohl’s Cares For Kids program.
The Kohl’s Kids Who Care ™ volunteer recognition program is part of the company’s Kohl’s Cares for Kids program which raises funds for children’s hospitals, features fundraising gift cards for local schools and non-profit youth groups, and provides an employee volunteer program to encourage volunteerism to benefit local non-profit organizations.
In addition, in Kohl’s hometown of Milwaukee, the company became more involved in supported local charitable initiatives. As the politicians say, it’s always a good idea to shore up your base. In 1998, over 1,100 Kohl’s Associates made up one of the largest single city teams in the United States for that year’s Juvenile Diabetes Fund Walk, which now continues as a major Kohl’s-sponsored event. And support for The Penfield Hospital in Milwaukee, a past favorite of Bill Kellogg’s, was substantial, with Larry Montgomery joining as a Board Member.
Kohl’s has also maintained a low profile in politics. While companies such as Target, The Limited, Sears, J.C. Penney’s, Dillard’s, Sak’s and Wal-Mart spend hundreds of thousands of dollars every year on lobbying efforts, primarily in Washington, D.C., Kohl’s has spent almost no money over the past decade paying lobbyists to further their interests. But it doesn’t seem like not having a half dozen politicians in our hip pocket has hurt us any. The company is doing just fine without them. As I said before, the numbers don’t lie.
Heck, we rarely joined the local Chamber of Commerce where a store was opening. True low cost culture. We wanted Store Managers focused on offering our customers a great shopping experience, and not running off to some Chamber meeting getting involved in things thought to be a distraction.
By the late 1990s, “staying off the radar screen” was getting to be damn near impossible. Our own success, ironically, was pushing us center stage whether we liked it or not. In recognition of Kohl’s strong performance, the company was added to the Standard & Poor’s 500 Index in 1998. When the announcement was made, the stock took off like a rocket, because all of a sudden every index fund tracking the S & P had to own KSS, so they had to purchase shares. Everyone was beginning to notice us now. Remaining in the shadows, stealthily watching our competitors making all the mistakes, was no longer an option.
In addition to developing an experienced management team to accommodate further growth, Kohl’s also laid the groundwork for both technology and distribution infrastructure. An emerging, state-of-the-art supply chain model began to show genuine results in linking merchandising, planning and allocation, buying, logistics, distribution and point-of-sale to maximize the value passed on to customers. Around that same time, Kohl’s expanded its distribution center in Winchester, Virginia, and began construction on the fourth facility in Blue Springs, Missouri, to prepare for the planned store openings in the western states.
As part of the “stay below the radar screen” culture at Kohl’s, management was expected to keep a low profile with the press. We were rarely quoted. Even Bill, Jay, John and Larry stayed low.
For me, there was an exception when I participated in Kohl’s entry into the Washington, D.C. market, in the spring of 1997. The business writer at the time for The Washington Post, Margaret Pressler, had met me a month earlier at one of our recently-opened stores in Charlotte, North Carolina. After a couple of hours checking out a retail concept she had never seen before, lo and behold, Margaret figured it out, and subsequently wrote a very nice, long article. Still, us store management guys always lived in fear that the local reporter in a market where we were about to open some stores would misquote us or completely botch explaining our business model. That reinforced our belief that the best way to deal with reporters was to avoid them whenever possible.
The lay low strategy also applied to relationships with Wall Street. In retrospect, the strategy played a major role in our success. It helped define our corporate culture, create enormous credibility over time, and perhaps most importantly, allowed us to gain a toehold in the backyards of the competition before they knew what really hit them. Again, I think that in this aspect of our strategy, it was stealth that helped give us the advantage.
To be sure, the Kohl’s concept was slow to be understood by Wall Street. As the corporate-based ‘stores’ guy with responsibility that included the Wisconsin stores, I was often the chauffeur who took the entourage from Wall Street out to a local Kohl’s store for a tour. They’d fly in to Milwaukee’s Mitchell Field, have vans pick them up (at first they used limos but it was so out of character for stretch limos to put up in front of our headquarters that they were asked to switch to less ostentatious travel in future visits). When I first started this assignment (around 1996) until around 1998 or so, many of the analysts who came for the visit were walking into a Kohl’s store for the first time. I was shocked: many of these analysts, I soon learned, were young and green and didn’t know diddly about retailing! They were controlling hundreds of millions of dollars of funds for their firms and yet really didn’t have the perspective to fully appreciate what the Kohl’s model was all about. Of course, almost all of them eventually figured it out, but it took a very long time for many brokerage houses to recognize the upside of making an investment in KSS.
At the end of the day, while others were constantly out muscling one another for the spotlight, the top executives at Kohl’s let the numbers speak for themselves. In particular, the key finance person at Kohl’s for over a decade, Chief Operating Officer Arlene Meier, did an outstanding job providing Wall Street with a straightforward ‘just the facts’ style that analysts eat up. And, of course, it hasn’t hurt that Kohl’s always made the quarter throughout the 1990’s. That creates credibility in a hurry. We didn’t hype, we didn’t message, we just stayed the course and consistently reiterated the Kohl’s mantra about providing value and convenience to the customer. Occasionally Jay might crow a bit in a feature article in Women’s Wear Daily, but all in all, it was an extremely low profile group.
Admittedly, with the retirement of the three original founders of modern-day Kohl’s – Bill Kellogg, Jay Baker and John Herma – the opportunity arose for the new leaders, Larry Montgomery and Kevin Mansell, to change the tenor and tone of the relationship with Wall Street and the press. While some Wall Street analysts have now privately spoken of Larry’s ‘cockiness’ and bravado, which is in such stark contrast to the soft-spoken Bill Kellogg, Kevin’s low-key, matter-of-fact style is very much the original recipe. Larry and Kevin work well off each other, and the soothing effect of long-timer Arlene Meier(who has since retired) ensured that shareholders meetings and conference calls with analysts are smooth, professional and without high levels of testosterone.
“SIR, I THINK WE HAVE SOME INCOMING”
—radar operator to his superior at Pearl Harbor, December, 1940(?), upon seeing major blips on his radar screen of what turned out to be Japanese aircraft
“NOT TO WORRY, THEY’RE JUST B-17’s COMING BACK TO BASE”
–radar operator’s superior
While Wall Street was slow to embrace the true upside potential of this Midwest niche retailer trying to wedge itself between a Target and a Macy’s, virtually all of the future national competitors barely noticed us at all until it was too late. This is a very interesting side story that played an enormous role in the success of Kohl’s. Namely, where the heck were the major competitors at the time like Federated, May, Sears, Penney’s in developing counter strategies to what should have been a clear and present danger? Their lack of insight into an up and coming threat is, in hindsight, astounding. They could have taken steps to cut down the upstart in its tracks. Perhaps their own success and arrogance got in the way. Giants are of course big but they are also clumsy. And sometimes blind.
When the counterattack eventually came, it was a classic case of too little too late. Some companies, like Montgomery Ward, under the leadership of Roger Goddu and with the financial backing of GE Capital, hired away two key merchants from Kohl’s, Lou Caporale and Tom Austin, and tried to copy Kohl’s in the late 1990s. They remodeled stores in creating a ‘racetrack’ selling floor and consolidated registers to make shopping more convenient; if you squinted a bit as you walked through one of their newly furbished stores, you just might think you were in a Kohl’s. But when you got your eyes in focus, it became readily apparent that Wards had a little problem: they had no national brands!! It was a disaster in the making, and sure enough, Wards was never able to attract enough customers and they went bankrupt in 1999.
Sears dabbled with the Kohl’s business model, too, but only later, beginning around 2000. I recall several instances in the late 1990s where we were interviewing key Sears storeline executives (one of Sears top guys, Steve Byers, subsequently joined the company in 1999 and made a significant contribution). When you are opening 35-40 stores a year, we were constantly on the interview trail. If you worked in the stores group at Kohl’s you almost always worked Saturdays. For me, that was the day to interview some of the top store managers, district managers, and regional managers from our competition, people whom we’d fly into Milwaukee. In addition to determining if the individual had the potential of succeeding in our environment, those interviews were also a great way to pick their brains and try to glean a bit about the competition’s strategy. I enjoyed the hundreds and hundreds of interviews over the years immensely. At times I felt like I was doing counter-intelligence work for the CIA!
During this time when you asked the Sears guys, “Well, what does top management think about us?” I was struck by how the two top guys at the time, Arthur Martinez and Robert Mettler, seemed to be so dismissive about us being a competitive threat. I mean, here we were opening stores by the boatload constantly in their market and taking huge market share from them. They were 90 miles away and completely asleep at the switch. We had stores in their backyard since the MainStreet acquisition in 1988; it wasn’t like we started the company in Alaska! You’ve heard the expression, “hide in plain sight.” Well, this was the most blatant example of that phenomenon I’d ever seen.
But during this time Sears was the classic dinosaur, and had created a business model that was appreciated by Wall Street less for their ability to sell merchandise at high gross margins cost-efficiently than for their huge credit card operation and the profit that was generated from all those folks in middle America who bought their refrigerator and happily put in our their Sears credit card. I mean, the company’s focus was on their credit card operations more than it was on the merchandise! Proceeds from credit operations was the only reason the company was remaining profitable.
To further illustrate the difference in corporate business models, it is interesting to note that when Kohl’s brought their credit card in-house in 1995, it was never intended to be used as an additional profit center. To the contrary, Bill Kellogg, and later Larry Montgomery, stated that the primary mission of developing proprietary credit in the company was to get more customers in the door, establish greater customer loyalty, and gain market share. While Sears, prior to all their accounting scandals in their credit operations, was extolling the virtues of their credit cards as a profit center, Kohl’s has quietly and methodically raised proprietary credit as a percent to sales in excess of 35%, creating a profit that is less than 5% of the total company’s profit! Credit operations were used as a component of the fuel mixture to drive the top-revenue engine).
Rather than be offended by the big guy’s indifference toward us, we were quite happy that they were ignoring us. It was a great lesson for a small but fast-growing niche company to take huge market share in almost total silence. For several pivotal years, the major department stores seemed unwilling to acknowledge the impact we had when we entered one of their markets for the first time, in taking away market share. They were burying their heads in the sand. A foolish strategy, of course, and all the more remarkable as it was repeated time and time again in one market after another throughout the country.
Later, around late 1999, recognizing perhaps that they could no longer keep the false appearance of ‘looking’ like a retailer but actually, based on their business model, be a bank in disguise, Sear’s Martinez reversed his course and started to publicly proclaim Kohl’s as Enemy No. 1. They dabbled a bit, and copied the Kohl’s ‘stroller’ concept and started to consolidate their check-out registers. But, once again, it was really too late. Sears didn’t have the national brands. Private label, with the exception of dresses, kids and a couple of other categories, were weak. As it turned out, Martinez was out at Sears later that year, and about six months after the publication of his autobiography in 2001 Sears was back in pea soup.
Bob Mettler, who like Martinez had earlier jumped ship and ended up going to Macy’s West, where he was eventually promoted to CEO, no doubt felt the effect, yet again, when dozens of new Kohl’s stores opened in California. Mettler took Kohl’s more seriously the second time around.
Look, hindsight is 20/20, but that’s no excuse for how these wallowing giants allowed themselves to be so disastrously blind-sided. Any of these companies could have turned their companies around during this critical window of opportunity (say, from 1998-2001) had their CEO told their team: “Look guys, what we’re doing worked great in the 1970s and 1980s. It doesn’t work now. We need to make dramatic changes. Wherever we can, we need to copy the Kohl’s business model. We need to do it quickly.”
If you explore this a little more, one needs to understand that for the most part, national retailers are run by merchants with huge egos. Not financial guys, but merchants who always think they can always ‘merchandise’ themselves out of a jam. Or in the case of Sears, an ‘operator’ who thought that operational efficiency was going to save the day. So in a way it was the combination of us staying off the radar screen and the big guys just not getting it.
In a future section, we’ll discuss the more recent competitive threats from the national department stores facing Kohl’s. It can certainly now be argued that they are tweaking their own business models to more closely resemble the resounding winner.
The first major article on Kohl’s in USA TODAY was on October 14, 1999.
Titled “Thriving Kohl’s turns up pressure on competitors,” the article began with the proclamation: “Kohl’s Department Store is rapidly expanding beyond its Midwestern roots and snatching market share from national retailers in the process.”
That article marked a significant turning point. The company had finally hit the national media radar screen, and in a big way. The table was set for dozens of other articles in magazines, periodicals and newspapers across the country. Almost all of these stories began with basically the same banner: “Upstart ‘hybrid’ regional player takes on the national big boys.”
As far as we were all concerned, Kohl’s had begun to be recognized as a discount powerhouse that would alter the nation’s retail landscape. That was indeed good news. But in a way it was a mixed blessing. Hitting the big time also denoted a loss of innocence. Getting on the radar screen not only meant you were nationally prominent. It also placed you squarely in the gunsights of the big boys.
While this recognition certainly did not happen overnight, if you worked at Kohl’s during this time you could not help but feel a transformation taking place. We no longer had a ‘stealth’ capability as we expanded into so many states. By the time I left Kohl’s in 2000, we were effectively out in the open, with a lot less cover than we had enjoyed for so many years before.
Virent Energy Systems (part of Chapter 7: I'm An Angel?)
(Note: This post is my first entry to another ‘book’ of sorts (different than The Rise and Fall of Kohl’s Department Stores) that I will be periodically 'releasing’ on this blog, the result of years of writing about all kinds of things that I have experienced. This entry, on Virent Energy Systems, is part of a chapter titled 'I’m An Angel?’, about my years as an angel investor in early-stage, start-up companies.)
Based in Madison, Wisconsin, Virent Energy Systems started not unlike many technology transfer start-ups coming out of academia. In this case, Dr. Randy Cortright, a researcher with significant catalytic chemistry experience at the University of Wisconsin, spun out research through the Wisconsin Alumni Research Foundation(WARF) in creating this new venture, which began in 2003.
Virent ‘s secret sauce involves the economical and energy-efficient conversion of plant-based sugars found in biomass into the fuels and chemicals that drive the world’s economy. The company, with the results from years of research and subsequent implementation, created an unconventional chemical pathway to renewably generate proven liquid fuels such as gasoline and diesel.
There were two global forces very much in Virent’s favor during the company’s early years. For starters, at a time when the post -9/11 United States was increasingly uncomfortable with it’s dependence on foreign oil, start-ups that potentially reduced that reliance were in the catbird’s seat; there was a lot of grant money out there, and Virent got millions of it from the Department of Energy, the Office of Naval Research, among others. In addition, with irrefutable evidence regarding the worsening problems associated with global warming, again Virent was in a sweet spot, in that demand was increasing for ‘green’ energy that is renewable, like versions of hydrocarbon chemicals but especially hydrogen and propylene glycol.
Virent’s process was not only green, but also cost-effective and produced more net energy than existing methods, and played in a huge marketplace.
What’s interesting about this company from the perspective of an angel investor like myself is how quickly and relatively easy the company ramped up and took institutional money to fund their growth. In mid-2006, the private equity investment arms of energy and energy-related players Cargill and Honda made major multi-million dollar investments, as did local Wisconsin VC’s. In early 2007, only three years after the company’s true launch as a start-up, a major financing round was pitched nationally to institutional players, resulting in a $21 million Series-B equity financing round in August, 2007. In addition, in May, 2007, Virent announced a major collaboration with Shell Hydrogen. Virent now has 55 employees, in a 26,000 square foot facility.
As someone who came in one of the early ‘seed’ rounds, you’d think I’d be doing cartwheels with all this momentum, no?
Pleased, yes. But doing cartwheels? No, or at least not yet. I invested my money in 2003, as an early angel. Three years later, with some of the best tailwinds a start-up could every get in this world, the mid-2006 $7.5 million VC round was priced in two traunches – the first $3.75 million was invested at a pre-money valuation of $10 million, and the next $3.75 million to be invested would be at a pre-money valuation of $20 million. The most recent round in August, 2007, has a pre-money of $70 million. Whew, sounds terrific, right?
Not so fast. Here’s the possible rub. Actually there are two.
Translating the above into actual share prices, while I’m hesitant to publish exact numbers at this point in time, I am concerned that the per share price has not truly risen 'appropriately’ in relation to all of the traction that the company has experienced. To add, when you take into consideration all of the VC bells and whistles (the convenants, add-ons and crap that dilute the existing investors), new employee stock options, etc., the most recent actual share price is in a range that, in my view, should be considerably higher.
Despite all this incredible traction over the four years leading up to this major VC funding, my investment on paper suggests that the early angels of this deal will not get the ten-bagger that one should expect for an exit that in all likelihood will be 'large.’ To me, that is a disappointment. Your reaction may be that I’m a greedy SOB. But you need to understand the numbers associated with angel investing. Because so many investments in startups go down the drain, or are treading water with no real exit in sight, it becomes critical that when a startup is truly successful, the early angels hit a huge, out of the park, run around the bases a few times homerun, to make up for all of the other losers. Otherwise, if you don’t score big with your occasional winner, your internal rate of return (IRR) for this part of your overall portfolio(i.e., angel investing) will be less than 20%. So why take all of that risk, and have to deal with all of the angst associated with all of the unavoidable losers that are part of the package? Why not just put the money somewhere else?
I am concerned that the events at Virent set the stage for the unthinkable: that a start-up that had genuine success from the beginning and no real cashflow problems might have a huge exit in the form of an IPO or acquisition, but the angel investors who wrote their checks early when there was lots of risk and no company revenues, don’t get the necessary 10-bagger to offset all of the dogs that one gets when you play in this early-stage venture game.
The other rub (and it’s only a slight one) involves the very bright CEO of Virent, Eric Apfelbach, and the approach he has taken toward raising capital. Eric had extensive experience raising funding for growing companies; when he was at Alfalight, a private high power laser company, he raised $49 million in three venture rounds. On the one hand, Eric has the skill sets to go out there and get institutional money; the company has been extremely fortunate to have him in this role. My gosh, he has gone out and gotten over $30 million in VC funding for Virent. That’s very impressive.
I could turn out to be wrong, but I think Eric was too quick to shut down the angel channel of funding, and jumped too quickly to the VC rounds. As a result, I’m not sure he really strongly embraced the idea that the early supporters of the company –the angels—were deserving of appropriate rewards if Virent succeeded in the early years. This is really key when you are thinking about making an investment in a start-up: does the CEO really appreciate the value of angel money? Do they really understand the metrics of playing in this space and the returns that are necessary for the small percentage of startups that succeed?
That’s really the rub, not that Eric isn’t running the company great, or setting things up nicely for some sort of successful ‘exit.’ I’ve just always had this hunch that Eric viewed himself as a VC-friendly CEO, and not necessarily an angel-friendly CEO. They are two very different kinds of managers.
That’s why it’s so darn important that pre-money valuations in the early ‘seed’ rounds be low enough to insure that angels get appropriately rewarded. It’s also very important to understand where your CEO is on ‘protecting’ and rewarding the angels. Some CEO’s get it, and understand just how big the upside needs to be with a start-up that’s really successful. Others don’t. In those cases, you’re setting yourself up for VC cramdown or ‘takeover’ rounds, and a corporate atmosphere where angels soon get blown off.
Eric, if you are ever reading this before Virent’s exit:
If it turns out that Virent’s exit is Big (like an IPO or an acquisition from a multi-billion dollar company) and doesn’t provide the early angels at least a ten-bagger, well, that sucks. And it’s not right.
If it turns out that Virent’s exit is Big and does provide the kind of big return to the early guys that they deserve, then I apologize, and I owe you an incredible dinner in Madison at the restaurant of your choice!
Chapter Nine - The Smaller Box
Around 1998 or so, under the stewardship of former Wal-Mart executive Pat Peery and under Larry Montgomery’s persistent nudging, Kohl’s Real Estate department was starting to get itself organized. In earlier years, Real Estate had essentially been the domain of Bill Kellogg, and in all candor it ran loosy goosy. Now there was the emergence of a far more formalized process for reviewing real estate opportunities.
Part of this more formalized approach was the creation of a spreadsheet that identified the potential number of Kohl’s that could be built in all the cities throughout the United States, based on population, demographics, family incomes, and other criteria. This spreadsheet was tweaked over and over again, as new data from newly-opened markets came in, as well as changes is acquisition strategies played out. For example, take over 13 former Bradlee stores in Boston, and that meant a delay in opening a new city in Arkansas or Florida.
Pat and his team also took a very hard look at the expansion of not only his former employer, Wal-Mart, but also Target, which along with Kohl’s was on an expansion tear throughout the 1990s. As an interesting sidebar, during much of the 1990s the signing of Target in a new real estate development was extremely influential in whether Kohl’s went ahead in opening in that complex, not unlike Pizza Hut coming in right after McDonald’s opened at a location in the 1970s. Almost every time, Target paid a premium, got the best pad on the site, and got top billing on the column signing/monument at the entrance to the shopping center. Our real estate team had a genuine respect for Target’s real estate group, and tried to gather as much information on them as we possibly could in developing our big-picture real estate strategy.
The question was often asked: How many Kohl’s stores can America support? While things were always in a state of review and re-review, it’s fair to say that in 2000 the company worked with a general number of around 1000 stores, assuming sales footage growth of about 15% a year.
As Larry Montgomery and his management team looked further out, it became apparent that the time was approaching that within five years the company was going to hit a saturation point of sorts. The company had always had a model of 20% increase in sales, fueled by a 3-5% comp store sales increase, and the rest in new store openings. Well, do the quick math and see that as your base of stores gets larger, the number of stores you have to open going forward gets much, much larger as well. Looking back, I think it caught management a bit by surprise. I remember when I left in April, 2000 we had fewer new stores planned for the years 2002, 2003 and 2004 than actually ended up being built. The numbers had to be revised upward, basically to make the math work.
In 2000, the idea of building a smaller store, to the tune of 50,000-55,000 square feet vs. the standard 86,000 now seen throughout the country, started to gain some steam. An initiative was launched to further develop the concept: it would have to involve going into smaller markets, cutting back on assortments, and other adjustments. Strategically, the smaller box could then become a major part of Kohl’s expansion at the end of this decade, after the current prototype started to hit the wall in terms of markets that could support those larger stores.
While very much part of the company’s real estate strategy, it was kept extremely confidential outside the company. In fact, there was very little build-up leading up to the opening of four smaller model stores in the Fall of 2002. While Kohl’s had earlier announced that stores indeed were going to be built in those markets, they did not indicate that they would be in the smaller format.
In an October, 2002 interview, Kohl’s President Kevin Mansell, when asked about the launch of the first four smaller format stores, said, “It’s a test. That’s all it is.” Six months later, at a fiscal year-end March, 2003 conference call with investors and analysts, Mansell had to be prodded to even comment on how the four stores were performing. His answer was a short: “We’re pleased with them so far” with no elaboration.
While Kevin certainly didn’t mean to deceive anyone, don’t believe it for a second that it’s “just a test…that’s all there is”!
To begin with, as mentioned earlier, Kohl’s always tests something new before they go ahead with it. They are incredibly slow to change. So to that extent, the first four stores were indeed a test. But once the test is proven to be right, or tweaked to make it right, Kohl’s will make the move. That may take a few years. But when they’re ready, it will become a deliberate, major part of the expansion. Fast forward to 2007, this has certainly been the case.
Consider all the additional stores that can be now added to Real Estate’s spreadsheet, as a result of the new smaller box concept. It extends new store growth of the life cycle of the company, whatever it ends up being, by five or six more years.
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.