Blue Light blues

Jan 17th 2002 | NEW YORK 
From The Economist print edition

The perils of trying to out-Wal-Mart Wal-Mart

THE latest special offer available at Kmart seems to be its own shares. These fell to a 36-year low this week, leaving the second-largest American discount chain, which sold goods worth $37 billion last year, balancing borrowings of $4.7 billion on a market capitalisation of a mere $784m. No wonder the rating agencies have rushed to downgrade Kmart's debt deep into junk territory. The retailer is talking to its banks about drawing down its remaining, dwindling, credit lines amid rumours of an imminent Chapter 11 bankruptcy filing.

Kmart has been struggling to restructure itself for the best part of a decade, in response to the success of competitors such as Target and Wal-Mart, the industry leader. However, it is the most recent reorganisation under Chuck Conaway, its chief executive, that has landed the company in its current mess. Mr Conaway, who arrived with great fanfare from CVS, a drug-store chain, 20 months ago, has worked hard to overhaul inventory management. But he has also allowed Kmart to get caught between two contradictory pricing strategies.

The company has traditionally specialised in promotional retailing: using newspaper supplements and advertising circulars to tout loss-leaders, such as its famous “Blue Light” specials, in order to draw in the crowds. Although this worked well for years, it also put a strain on merchandising and distribution systems, because orders for particular items came in sudden waves. (This explains why Kmart's shelves are fully stocked only 86% of the time, compared with almost all the time at Wal-Mart.) Promotions also forced costs up at Kmart's suppliers, as they could not reliably predict manufacturing runs. This meant that Kmart could never consistently better Wal-Mart's prices.

Mr Conaway has tried to wean the company away from this strategy. Rashly, however, Kmart cut its ad circulars too sharply in the second half of last year, losing customers in droves. At the same time, it cut prices on 38,000 items and promoted them with expensive television spots, again under the Blue Light tag. But this did not chime with younger shoppers who had no memory of the original campaign.

Worse, even though shoppers did not respond, Wal-Mart did. It used its greater efficiency and economies of scale to fight back on pricing. The outcome was a 1% drop in Kmart's same-store sales in December, and an 8% increase for Wal-Mart.

Under the circumstances, a Chapter 11 filing looks increasingly appealing. This would give Kmart some respite from its bankers and suppliers. Most importantly, it would make it easier for the company to wriggle out of leases on poorly performing stores and warehouses. Kmart admits to having some 250 “opportunity stores” (translation: lame ducks) among its 2,100-strong chain. Analysts think that the number of closures might have to be higher than that. 

The result might be a healthier, if much smaller, Kmart with a shot at becoming profitable once more. But it will take all of Mr Conaway's skills—and a lot of understanding from his bankers—to stop the lights at Kmart, including the blue ones, being switched off for good.