Commentary: Attention Kmart: Find a Niche

By Joann Muller

Does America need Kmart (KM?) That's what really matters in the wake of the giant discount chain's bankruptcy filing on Jan. 22. Certainly, the opportunity for a swift financial makeover is a plus. By keeping creditors at bay, Kmart is free to close underperforming stores, walk away from bad leases, and trim debt. But what then? Unless Kmart Corp. can give consumers a good reason to shop at its stores, the once-mighty retailer will slide into oblivion.

There's little doubt that Kmart, based in Troy, Mich., will survive the largest-ever retail bankruptcy--at least for a while. But to thrive in the long run, it has to face some uncomfortable truths. First, it has to accept the reality that it has long since lost the battle with Wal-Mart Stores Inc. Its bigger competitor is both ubiquitous and light-years more efficient. Trying to compete on price last year was a colossal error. However much Kmart cuts prices, Wal-Mart (WMT ) can cut more. Kmart has to be more than a Wal-Mart wannabe if it wants to survive.

Second, a healthy Kmart very likely means a smaller Kmart. The discounter should close at least 250 of its 2114 stores. Five hundred would be even better. Then it needs to carve out a niche between Wal-Mart and Target Corp. (TGT ), the purveyor of cheap chic. Most of all it has to capitalize on its urban locations.

CEO Charles C. Conaway laid out his vision for Kmart soon after arriving in June, 2000. His plan: to make Kmart "the authority for moms, home, and kids." But grappling with Kmart's myriad operational problems, from logistics to technology, has left precious little time for bonding with moms. To make his fuzzy description of the new Kmart mean something, Conaway must pump new life into tired apparel lines, such as the Jaclyn Smith and Kathy Ireland labels, and add more exclusive brands like Martha Stewart Everyday.

Kmart's best hope for survival lies in a core group of several hundred stores in urban areas, far from any Wal-Mart and Target outlets. "Their urban locations provide a level of convenience that's potentially unmatched," says Sanford C. Bernstein & Co. analyst Emme P. Kozloff. "Wal-Mart and Target won't go into those areas." Plus, she adds, Kmart has very low-cost, long-term leases on those stores. Kmart hopes to dramatically boost sales and profits at its urban stores by adding a full assortment of groceries--including fresh meat, produce, and bakery products--tailored to each community's ethnic mix. If Kmart executes this play correctly, it stands a good chance of success.

But that's a big if. Kmart has been experimenting with food for a decade but has lacked the resources and the focus to make it work. Today it has just 124 supercenters, compared with 1,060 Wal-Mart supercenters. That's one reason Wal-Mart zoomed past Kmart in sales. Shoppers visit supercenters two or three times a week, compared with three times a month for a typical discount store.

Here again, Kmart has to avoid the temptation to try to out-Wal-Mart Wal-Mart. In a hopeful sign, Kmart is dusting off a strategy cooked up four years ago that it never implemented. Instead of rolling out 140,000-square-foot grocery-discount-store combos, it is converting smaller stores to the Super Kmart format. The strategy makes sense for urban stores where real estate prices are high. At $2.5 million to $5 million per store, the conversion is a bargain, compared with the cost of building a giant new outlet.

But it's a balancing act. To shoehorn a full grocery into an existing Kmart, the company has to pare back on general merchandise. The trick is doing it so customers don't notice anything is missing. Done correctly, sales can actually increase, says James Funk, a district manager in Michigan for Super Kmart. At one store in Bloomfield Hills, for instance, Funk cut the electronics department by more than 15%--and sales grew nearly threefold.

In neighborhoods starved for decent grocery stores, Kmart's urban supercenters could be a hit. But their success depends on flawless execution, something Kmart has not been known for. And it still has the rest of its stores to fix up. Clearly, Kmart has lots of work ahead before investors have something to feast on.

Muller covers Kmart from Detroit.

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