Sears-Lands' End: The Seams May Show

Can Sears avoid cannibalizing the cataloger's business while not alienating its upscale clientele? This deal may not be a perfect fit

For decades, Sears, Roebuck & Co. has posted strong sales of car batteries, tools, and home appliances. But one product that has confounded management is apparel. Sears CEOs have come and gone, yet it has never been able to develop a clothing line that appeals to consumers the way core brands such as DieHard, Craftsman, and Kenmore do.

Now, Sears is trying again. In his boldest step yet since becoming CEO in 2000, Alan J. Lacy announced on May 13 that Sears would buy cataloger Lands' End for $1.86 billion and begin selling its casual and classically styled clothing in Sears stores.


  Wall Street analysts applauded, saying Lands' End's reputation for quality and value fits perfectly with what Sears stands for and that Lands' End's clothes would give Sears a truly softer side. Says UBS Warburg analyst Linda Kristiansen: "This acquisition significantly alters our previously negative view of the prospects for Sears' apparel business."

This acquisition is by no means risk-free, however. Sears is making a big bet the strategy will work -- paying a hefty 13 times Lands' End's earnings before interest, taxes, depreciation, and amortization. That's well above the multiple of 7 to 9 typically paid for apparel retailers.

And by selling Lands' End clothes in its stores, Sears runs the risk of cannibalizing $1.57 billion in annual catalog and Internet sales. Lands' End targets a higher-income customer -- a market it appears to have tapped out. While this creates opportunity for Sears to broaden the income range of its customer base, it faces the hurdle of not alienating Lands' End's consumers. "Net/net, [Sears] will be lucky to break even," predicts Marshal Cohen, co-president of market research firm NPD Fashion World.


  It's not as if Sears couldn't use an apparel line. Gross profit margins on clothing can be double those of hardline items such as appliances, where Sears commands four times the share of its nearest competitor. Clothing and other softlines like bedding account for about 40% of revenues in Sears stores, and it wants to boost those numbers. Clothing sales at existing stores have fallen for 17 months straight, erasing gains in Sears' stronger product categories.

Buying a brand that already enjoys consumer awareness is far easier than building an in-house apparel label to compete against entrenched national brands. And by being exclusive to Sears stores, the Lands' End clothing line will give it something unique to distinguish itself from competitors like Kohl's and Target. Those companies' gains in apparel sales have come in part at Sears' expense. "It allows you to compete on something other than price," says Lacy's predecessor, Arthur Martinez, now retired, who first began talks about a business combination with Lands' End back in 1998.

With 870 stores in every state, however, Sears is sure to take sales from Lands' End's catalog and Internet operations, says former Lands' End CEO Michael Smith. "You'll see a high cannibalization rate just for that reason," predicts Smith, who now heads Nordstrom's Internet operations.


  Both Sears and Lands' End have the bulk of their customer base in the 35-54 age range. But the largest percentage of those Lands' End customers have incomes of $100,000 and above, compared to $50,000 and below for Sears' shoppers, according to NPD. And with its narrower customer segment, Lands' End appears to have hit the outer limits of growth for now: Annual sales on its main catalog totaled $873 million last year, up just 1.3% from three years ago. Most of Lands' End's sales growth has been in its specialty catalogs, such as kids' clothing, where operating profits have fallen.

What must Lacy do? First, he must broaden Lands' End's appeal to the lower-income spectrum of Sears customers. History isn't on his side: Spiegel has struggled after trying to broaden the appeal of its Eddie Bauer unit, alienating its higher-end customers and losing the uniqueness of its merchandise.

Key to keeping both sets of customers will be Sears' marketing strategy, notes Bernstein Research analyst Emma Kozloff. But Sears has been inconsistent on this front.


  Its aspirational "softer side of Sears" campaign in the mid 1990s flopped after customers found the store's clothes didn't meet expectations. When Sears added the Benneton line of colorful knitwear in the late 1990s, it didn't foresee that the Italian company's controversial advertising could cause problems. Sears yanked the goods in 2000, after Benneton did a campaign sympathetic to death-row inmates.

The difference in price between Lands' End and Sears clothing could cause another problem. On average, Lands' End apparel costs $27 per item, vs. $13 at Sears, according to NPD. As Sears moves Lands' End pricing more in line with its own, the lower revenues might offset the incremental gains in sales. "They're going to end up giving away some of the volume they just bought," NPD's Cohen believes.

Lacy may have had little choice but to buy Lands' End. Still, executing this link-up may be trickier than he or Wall Street realizes.

By Robert Berner in Chicago

Edited by Douglas Harbrecht

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