November 17, 2004

Sears, Kmart Merger to Create Huge Retail IT Operation

By Evan Schuman, eWEEK

Updated: The new retailer will be the nation's third largest with $55 billion in projected annual revenues and almost 3,500 stores.

When Kmart and Sears announced on Wednesday their plans to merge and create the nation's third-largest retailer, it shook the retail technology world.

Although it will take months for the two retail leaders to merge their almost 3,500 stores with a projected $55 billion in annual revenue, the combined operation will have the ability to significantly influence retail technology trends.

The only two retailers that will be larger will be Wal-Mart and Home Depot.

Before the merger, though, neither retailer had been a dominant force in any segment of retail technology. Analysts suggest that is not likely to change soon, as the combined company will have its hands full just maintaining operations.

"We have not viewed either organization as being lead IT organizations," said Stephen Smith, a vice president and research director at Gartner. With some mergers, "one side has got a great IT organization and it will tremendously help the other. I don't think that's the case for either company here."

Although the combined entity would certainly have the size and number of stores to dominant retail IT trends, that's not likely to happen for quite some time, if at all, Smith said. "Historically, mergers and consolidations tend to slow down deployments and operational efforts," he said.

Ideally, IT mergers can help a company develop a strong competitive advantage, whether it's from improved time to market, better customer insights or developing a more efficient supply chain to lower prices. But with the Sears and Kmart merger, it's more likely the two will be so occupied with integrating the two without losing sales or inventory data that they won't have the time or the wherewithal for much else.

"They are going to spend a lot of time trying to figure out how to get to a single platform and to just make the engine run. They are going to be appropriately focused on keeping both operations running. It is not going to allow them to drive or even pursue competitive advantage" for quite some time, Smith said.

Another analyst, Frost & Sullivan IT research director Rufus Connell, agreed.

"In my opinion, they will spend the better part of a year to get everything integrated. When you're behind in a race, you need to be driving faster than the competition, not stopping to bolt the engine back onto the transmission," Connell said. "Sears and Kmart will have to overcome huge challenges not to fall even farther behind Wal-Mart in terms of efficiencies."

Frost's Connell said the pair's integration struggle logically extends from challenges they have faced individually.

"Both Sears and Kmart have been hurting for some time now," he said. "The reason they've been having trouble is that Wal-Mart has been outcompeting them from an inventory and information-management perspective.

"Wal-Mart has built a lower cost structure, a more efficient infrastructure. Now, Kmart and Sears will be faced with a huge integration challenge."

In a brief written report, AMR Research's Scott Langdoc echoed Connell's concerns, but was more blunt: "Kmart has been trying to establish a new approach to IT after some spectacular project failures and bankruptcy disruptions, while Sears has aggressively embarked on a number of initiatives in store systems, replenishment, merchandise planning, and markdown price optimization."

The AMR Research Vice President added that the timing of this announcement is critical. "The merger comes at a critical time in the ongoing retail technology initiatives of Sears and Kmart," Langdoc wrote. "Assessing the options for synergy in technology while not slowing down IT investments will be difficult."

Company executives quickly pointed to potential operational efficiencies, which will invariably translate into layoffs. But which technologies of the two will be favored is the $55 billion question.

"The combination of the two companies is conservatively estimated to generate $500 million of annualized cost and revenue synergies to be fully realized by the end of the third year after closing," said a statement issued by the two retailers. "The combined company will also benefit from improved operational efficiency in areas such as procurement, marketing, information technology and supply chain management."

At a news conference Wednesday morning, executives stressed that while independent competition could have made sense, the businesses needed to cut costs so more dollars can be reinvested.

"We need to have a very low-cost structure to compete," said Edward Lampert, the current chairman of Kmart who will be the chairman of Sears Holdings, which will own both businesses.

It was not disclosed who will be managing the IT integration nor the roles that current Kmart CIO Karen Austin and current Sears CIO Gerald F. Kelly Jr. will perform.

The timing of the announcement is drawing notice among analysts. To have two consumer retail chains announce a merger in mid-to-late November is not ideal for the retailers, Smith said.

"It does put both of their seasons at risk," he said. It is especially dangerous because of the message it sends to employees and the probability that some of the best talent will leave and go to work elsewhere, quite possibly with the direct competition.

"If you're working at a company that has just announced that there are several hundred millions dollars' worth of synergies to be had, what are you thinking about?"

Under the terms of the agreement, which was unanimously approved by both companies' boards of directors, Kmart shareholders will receive one share of new Sears Holdings common stock for each Kmart share.

Sears Roebuck shareholders will have the right to elect $50 in cash or 0.5 share of Sears Holdings (valued at $50.61 based on Tuesday's closing price of Kmart shares) for each Sears Roebuck share.

Executives stressed that the Kmart brand will continue, but executives discussed the potential for many Kmart stores becoming Sears stores and very little potential for the reverse. But that was officially attributed more to store location than brand strength.

Editor's Note: This story was updated to include more analyst comments.