Shop Your Way: Just Another Way Sears Holdings Can Go Broke

Loyalty program is causing retailer to hemorrhage profits.

Jun 3, 2014 at 10:01AM

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The idea is sound: reward your most loyal customers by giving them discounts for spending more at your store. Shop Your Way is Sears' (NASDAQ:SHLD) increasingly popular loyalty program that, having started from nothing just a couple of years ago, now accounts for three quarters of the retailer's eligible sales. Although it can make Sears "sticky" for consumers and perhaps reverse the long, steady decline in which Sears is mired, it needs to do so quickly before it breaks the bank. 

Like many such programs, Shop Your Way awards members points for purchases they make at Sears stores, Kmart, and through its website. Sales made at Sears Canada and through third-party merchants at Sears Marketplace are excluded. Like an airline's frequent flyer program, members can redeem those points for merchandise, so the more they spend the more they save.

And therein lies the problem, as they can also eat away at margins. In the first quarter, Sears gross margins tumbled $328 million to $1.8 billion, and though a good portion of the decline was due to Lampert spinning off Lands' End, the Shop Your Way program contributed to the impaired margin rate, which declined by 220 basis points. It was a similar situation in the prior quarter as well, where the Sears Hometown & Outlets spinoff bore the biggest responsibility for declining margins, Shop Your Way had a hand in the 170 basis point drop at Kmart and the 260 basis point decline at Sears. 

Yet Sears Holding also carries the burden of having two promotional models, the Shop Your Way program and traditional discounting, which ultimately is what the loyalty program amounts to. Lampert admits it's going to cost the retailer points, but he sees the value of additional investments in the program paying off further down the road.

As it stands now though, because sales remain in free fall, the more people that sign up for the program the faster it erodes profits, which it really can't afford to give away at this point. Losses widened to $442 million in the first quarter from $292 million in the same period in 2013 as same store sales fell for yet another quarter, a years' long skein that shows no sign of abating.

In essence, loyalty program members will become bigger fish in a quickly drying out pond. Moreover, a recent study by McKinsey & Co. found that despite their general growth and popularity, loyalty programs actually destroy value for their owners. Companies with them grew no faster than -- and sometimes slower than -- those without loyalty programs.

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Source: Sears Holdings SEC filings

Now perhaps without the program things would have been even worse for the retailer, but considering sales are still declining even as membership rises, it's actually not unreasonable to assume spending patterns haven't changed all that much. And because margins are increasingly contracting, they're just getting more stuff they otherwise might have paid for, although Sears says its most engaged customers spend 75% more than the average member. 

Yet because only the scantest of information is given on Shop Your Way, it's hard to know just how much everyone's actually spending, and whether it's more or less than they were before the program. Certainly it's a delicate balance and Sears needs something to staunch the bleeding, but Shop Your Way could be the cure that's worse than the disease. Or at least hastens its spread.

The term "loyalty program" is really a misnomer, since it should really be providing a vast database of information about a customers spending habits. The retailer must put that information into use then to enhance the relationship between it and the customer. If all a retailer is doing is rewarding existing behavior -- rather than increased positive behavior, such as shopping more often or spending more -- then all the company is doing is reducing its profit per customer.

This seems to be the path Sears Holding is on. My worry is that road leads it at last to the brink.

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Rich Duprey has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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