It's been more than a dozen years since Sears Holdings (NASDAQOTH:SHLDQ) was created through the takeover of Sears by Kmart. Unfortunately, the plan to bolster the ailing chains' profitability through greater scale didn't succeed for very long. Sears Holdings never recovered from the Great Recession, and in recent years, sales have been plunging as the company pays the price for years of underinvestment.
Last weekend, Sears Holdings unveiled its latest turnaround initiative, opening a small-format Kmart inside a Sears store in Brooklyn. It also plans to test small-format Sears stores inside some Kmart locations. Mixing the Sears and Kmart store formats in the same locations could help shore up sales, albeit at the cost of greater supply chain complexity. However, this project isn't likely to keep Sears alive in the face of its ongoing cash burn and massive liabilities.
Sears Holdings tries a new strategy
The new small-format Kmart that opened in Brooklyn takes up just 10,000 square feet on the lower floor of the Sears store there, versus nearly 100,000 square feet for a full-sized Kmart. It focuses on selling everyday household essentials like groceries, cleaning supplies, health products, and cosmetics.
The idea is to try bringing new product categories into Sears stores. The manager of the Kmart section said that customers had been coming into the Sears store looking for some of these products and had to be turned away previously, according to CNBC.
In addition to making more sales to people who were already coming to Sears, the addition of a Kmart with household basics could also help drive more customer traffic to the store, since these items need to be purchased relatively frequently.
Sears Holdings also plans to pilot Sears appliance shops in a few Kmart locations later this year. While Kmart already stocks a limited selection of entry-level appliances, the Sears shops are expected to carry a full range of appliances in order to appeal to a broader range of shoppers.
Echoes of J.C. Penney
There are clear parallels between Sears Holdings' initiative to add small-format Kmarts to some Sears stores (and vice-versa) and J.C. Penney's (NYSE:JCP) 2016 decision to (re)introduce appliance sections in many of its stores.
First, both moves were inspired by customers not finding items they were looking for. As noted above, customers were coming into the Sears in Brooklyn looking for household items that the store didn't sell. As for J.C. Penney, the company discovered that appliances were the No. 1 product category that consumers searched for on J.C. Penney's website but couldn't buy.
Second, Sears and J.C. Penney both want to find better uses for unproductive retail space. Both companies have seen a steep drop in sales per square foot over the past decade -- especially Sears -- making it harder to cover relatively fixed overhead costs. Bringing in new product categories and consolidating the rest of the merchandise can help to boost sales productivity.
It's too little, too late
Adding mini-Kmarts to Sears stores and Sears appliance sections to Kmart stores is something that Sears Holdings probably should have done years ago. However, given the depths of the company's current problems, this initiative won't be enough to save Sears.
Last quarter, comp sales fell 11.9% year over year and total revenue plunged 31.2%. This sales decline fully offset Sears Holdings' heroic cost-cutting efforts. As a result, the company is still burning cash at a horrific rate: an average of nearly $2 billion a year in recent years.
Sears has enough assets to pawn to stay alive for another year or so, but after that it is likely to face an impossible cash crunch. That doesn't leave much time to test and refine the store-in-store concept, let alone roll it out broadly. Furthermore, whereas the Brooklyn Sears store is in a densely populated urban area, most Sears locations are in suburban malls, where grab-and-go household products would be less likely to sell well.
J.C. Penney's move to add appliances to its stores created a significant new revenue stream, but it still didn't drive profit growth over the past two years. Similarly, Sears Holdings' efforts to add new product categories to its stores may shore up revenue without fundamentally altering the company's dreadful profitability.