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Inside the Decline of Sears, the Amazon of the 20th Century

The Wall Street Journal logo The Wall Street Journal 10/31/2017 Suzanne Kapner
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Shoppers hunting for this holiday season’s hot toy, the L.O.L. Surprise, may have trouble finding it at Sears or Kmart stores. Worried about the financial health of the retail chains, the company that makes the toy, a ball that children unwrap to reveal small dolls, has reduced shipments to Sears Holdings Corp.

“We cut their credit line and shortened payment terms,” said Isaac Larian, chief executive of toy maker MGA Entertainment Inc. “If they pay one day late, we will cut them off.”

Sears once dominated American retailing and helped build famous brands, including Whirlpool appliances, Craftsman tools, Schwinn bicycles and Allstate insurance. Now, bleeding cash and losing shoppers, the 124-year-old company is scrambling to keep suppliers—the lifeblood of any retail chain—from bolting.

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To guarantee shipments from LG Electronics Inc. and Samsung Electronics Co., Sears is paying them cash up front for some goods, said people familiar with the matter. Levi Strauss & Co. has stopped supplying women’s jeans to the chain, said another person. At Clorox Co., “We have certainly adjusted our payment terms,” said CEO Benno Dorer.

A monthslong feud between Sears and Whirlpool Corp. burst into the open last week when the sides couldn’t agree on terms to keep their century-old partnership going. Earlier in 2017, Sears sued two longtime manufacturers of its Craftsman tools to keep them shipping merchandise to stores.

The supplier turmoil is the sharpest sign yet of Sears’s decline. It has lost more than $10.4 billion since 2011. Annual sales over that period have collapsed to $22.14 billion from $41.57 billion as the company has spun off divisions, closed hundreds of stores and attracted fewer shoppers to its 1,250 remaining Sears and Kmart locations.

Employee ranks, above 300,000 a decade ago, have dropped by more than half. This year Sears lost state tax breaks when the number of employees at its Hoffman Estates, Ill., headquarters fell below a 4,250 threshold. Sears is looking to lease out part of its headquarters space, and some amenities that once dotted the six-building campus, including a bank branch and optical shop, have closed.

Though Sears is slashing costs, credit analysts say it needs to raise about $1.5 billion a year to fund its operations. On Monday, S&P Global Ratings downgraded Sears’s debt further into junk territory, on concerns the company could have trouble repaying or refinancing $1 billion in loans coming due next year.

Analysts say Sears still has assets to sell to keep it afloat. And as long as it continues to pay on time, suppliers are unlikely to abandon it. Many say they want Sears to stay in business but have taken the harder position on payment terms to protect themselves.

A Sears spokesman said the company has taken a number of steps “to remain a viable competitor,” including closing unprofitable stores, negotiating “with vendors to reduce their risk in doing business with us,” investing in its customer-loyalty program and reducing costs.

The spokesman, Chris Brathwaite, added that “inaccurate assertions and negative speculation about Sears and its future” have “had a very detrimental impact on the company through mere repetition.” He didn’t reply to specific questions, including about MGA, LG, Samsung and Levi Strauss.

At the center of the storm is Edward S. Lampert, the 55-year-old financier who rescued Kmart from bankruptcy and then combined it with Sears, Roebuck & Co. in 2005. Partly through his hedge fund, ESL Investments Inc., in which he is the primary investor, the money manager turned CEO is also Sears’s largest shareholder, with 54%. Through ESL, he also oversees a big creditor, holding just under half Sears’s $3.5 billion or so in long-term debt.

Sears has been selling real estate and brands to raise cash and Mr. Lampert has pumped in money through short-term loans from his hedge fund.

In weekly management meetings, Mr. Lampert pushes executives to drive harder bargains with suppliers, arguing that the vendors need Sears as much as it needs them, people familiar with the matter said. In one recent meeting, he said Kmart’s grocery team wasn’t delivering low-enough prices, and threatened to bring in professional negotiators, according to a person who was present.

“There have been examples of parties we do business with trying to take advantage of negative rumors about Sears to make themselves a better deal—a deal that is unilaterally in their interest,” Mr. Lampert, who declined to be interviewed, wrote in a May blog post. “In such a case, we will not simply roll over and be taken advantage of.”

Sears no longer has the clout to play hardball. In 2002, it accounted for a fifth of Whirlpool’s revenue. That was down to 3% of Whirlpool’s sales in a recent tally.

In the negotiations this year, Whirlpool wanted to reduce its exposure even further by lowering the amount of goods it ships to Sears and raising prices, according to people familiar with the discussions. When the sides couldn’t agree, Whirlpool executives told their Sears counterparts in May they would stop shipping products. In October, Sears notified employees it would no longer carry Whirlpool, Maytag and other brands made by the manufacturer, according to an internal Sears memo.

“To be honest, it’s not a whole lot” of business, Whirlpool CEO Marc Bitzer told analysts.

Electrolux AB, the European appliance maker, was once so beholden to its largest customer it paid for Sears executives to fly business class to Asia on factory visits, even though its own executives flew coach, a person familiar with the arrangement said. In recent years, Electrolux has minimized its exposure to Sears by courting other chains, such as Home Depot Inc. and Lowe’s Cos., the person said.

“There is a significant sort of reshaping of the North American retail landscape, and that requires us to focus a lot on the right channels,” Electrolux CEO Jonas Samuelson told analysts in April.

“We see no viable path for Sears to succeed as a retailer,” said Bill Dreher, a financial analyst with Susquehanna Financial Group LLC, one of the few who still follow the company on Wall Street. “I’m concerned that the vendors are starting to lose patience, because that is what put Kmart in bankruptcy in 2002.”

To keep products flowing, Sears is paying vendors in one month, on average, compared with two months for Target Corp., Mr. Dreher said. The shorter payment terms tie up working capital and cash, forcing Sears to borrow more and making it harder for the retailer to carry the right levels of merchandise at the right time of year.

There might have been no Sears at all if Richard Sears, a 19th-century railway agent, hadn’t received a shipment of watches from a local jeweler who didn’t want them. He sold them to station agents up and down the line and then teamed up with Alvah Roebuck, a watchmaker. The two formed Sears, Roebuck in 1893.

Thanks to Mr. Sears’s flair for copy writing, their new mail-order company was soon selling all manner of goods to rural America, including a “Stradivarius model” violin for $6.10, men’s suits for $9.95 and $1,000 kit houses, making luxuries once the province of the city rich available to a wide swath of the population.

Sears was one of the earliest and biggest customers of Schwinn bicycles, and in the 1920s it bailed out the appliance maker that became Whirlpool.

As rural people began moving to cities, Sears began opening large stores, which by the arrival of the post-World War II boom were filled with washing machines, lawn mowers, television sets and other accouterments of middle-class life.

By the end of the ’60s, Sears’s annual sales were just shy of 1% of the nation’s gross domestic product with the breadth of an Amazon.com Inc. In 1973 the company opened a 110-story Chicago tower, then the world’s tallest. It operated Sears Auto Centers, owned the Kenmore, Craftsman and DieHard-battery brands, and had a financial-services unit that by the ’80s included Allstate Insurance Co., the Dean Witter brokerage, Coldwell Banker real estate and Discover credit card. Sears no long owns any but the auto centers, Kenmore and DieHard.

Sears was an early internet mover, forming the Prodigy online service with International Business Machines Corp. “The issue really isn’t success or failure,” Sears then-chairman Edward Brennan said in 1989, according to the “The Attention Merchants,” a book about media and marketing. “It’s really a question of how big a success we’re going to be.”

Beneath that bravado, Sears was already in decline, facing growing competition from discount chains such as Wal-Mart Stores Inc. and Target and big-box retailers such as Home Depot. Wal-Mart passed Sears as the country’s largest retailer by sales in 1990.

Mr. Lampert, who had started his hedge fund in 1988 at age 25, took control of Kmart in 2003 out of bankruptcy and used its stock to acquire Sears two years later. He had some early success when he unloaded high-cost real estate, raised prices and reduced marketing costs, a counterintuitive strategy that boosted profits, according to a former senior executive. That led him to believe he could run a chain better than traditional retail executives, the person said.

His unconventional approach included minimal investment on store upgrades. Instead, Sears has spent $6 billion repurchasing shares since 2005, at prices as high as $180 a share. The stock now hovers around $6, down 90% in five years. The result is stores sometimes missing chunks of flooring and with empty shelves.

“The stores are creepy,” said shopper Chris Angelos, with few customers, a limited selection and whole sections closed off in the cavernous location near her home in Gurnee, Ill. The 69-year-old said she shops there anyway because it lets her avoid crowds and park near the front door.

In a 2007 letter to investors, Mr. Lampert explained his strategy this way: “Unless we believe we will receive an adequate return on investment, we will not spend money on capital expenditures to build new stores or upgrade our existing base simply because our competitors do.”

Ten years later, after breaking off pieces such as Craftsman and the Canadian division, which filed for bankruptcy in June and is being liquidated, Mr. Lampert is undeterred. In October his hedge fund lent Sears another $140 million, bringing its total borrowings from ESL to roughly $1.6 billion.

“People have often asked me why I am still committed to the company and why I continue to invest a significant amount of my own money in its ‘transformation,’” Mr. Lampert wrote in a May blog post. “The answer is that I firmly believe we will succeed.”

Mr. Lampert keeps his own counsel. He doesn’t go to Sears headquarters more than a couple of times a year, people who have worked with him say. Instead, executives make quarterly treks to Florida, where Mr. Lampert lives on the exclusive Indian Creek Island in a $42 million home.

The CEO—who was kidnapped for money in 2003 and held in a Days Inn motel room in Connecticut for 28 hours—rarely visits stores and has urged executives to adopt a similar policy, arguing they can collect more data more quickly by connecting with store managers over videoconferences, former executives say.

Over the past few years, middlemen known as factors have stopped providing vendors with insurance on payments for their shipments to Sears. Many suppliers, even large ones that don’t use factors, have pushed to shorten payment terms to reduce their risk, according to analysts, suppliers and consultants.

When LG’s contract came up for review in 2015, the two companies worked out new terms over nine months of tense negotiations. Under the final deal, Sears would pay the South Korean company cash upfront before receiving some goods, according to people familiar with the situation. In return, Sears gets a small discount.

The toy maker MGA, when it renegotiated its contract last year, cut in half the amount of time Sears has to pay, to 30 days.

“We want them to stay in business,” said Mr. Larian, the supplier’s CEO. “But not at risk to MGA.”

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