Goal: Fixing the Achilles' Heel

By Edward Cone  |  Posted 2001-12-10 Email Print this article Print

When Chuck Conaway took over as the chief executive of Kmart, he gave himself two years to resuscitate the discount retailer, get the right products on its shelves and make it competitive again with the new kings of general merchandising, Wal-Mart and Tar

Goal: Fixing the Achilles' Heel

Which leads back to Sept. 6.

Conaway, the 40-year-old boy wonder brought in from drug chain CVS to revive Kmart's fortunes, has staked his two-year recovery plan on revamping the company's supply chain and inventory management systems. It's the biggest part of "achieving world-class execution," the No. 1 goal he established shortly after he was hired in May 2000.

He doesn't expect to completely fix the supply chain by this coming August. But, in a Nov. 27 conference with Wall Street analysts, Conaway said Kmart was "doing a phenomenal job of reinventing" its supply chain—and that should be evident by this time next year.

The revitalization from being able to put popular products on its shelves at competitive prices can come none too soon. In the quarter that ended Oct. 31, Kmart's sales actually dropped 2.2% from a year ago, to $8.0 billion. Even disregarding the writeoffs, the company reported a net loss of $127 million, while rivals were showing profits and sales gains.

How Kmart gets products onto shelves is not its only challenge. Conaway also is fighting to create a "customer-centric" culture and to market more effectively, besides pulling people into the store with Sunday circulars.

But he has told shareholders, employees, analysts and his board that the supply chain is his No. 1 priority .

"I believe the supply chain is really the Achilles' heel of Kmart," he said in September. "Just fixing the supply chain could really turbo-charge Kmart."

September's writeoff says a good portion of what the company spent in recent years on such technology is not deemed useful any more. If this is a final clearing of the decks to make way for new systems, Conaway's ambitious plan could be succeeding. But success is not yet visible to outsiders.

"They are not dead yet, but for Kmart to get back in the game would be one of the greatest miracle comebacks, ever," says Larry Schulsinger, retailing analyst with Management Ventures in Washington. "The world can exist with more than two large mass merchandisers, and Chuck is smart enough to figure out a way to do it. But if the story ended today, they have lost."

Fourteen months ago, Kmart placed a big bet on i2 Technologies as the strategic partner that would turn its perennially underperforming supply chain into an advantage. "This represents about a $50 million opportunity—just in the beginning—for i2, and there is a tremendous amount of more work we're going to do," Conaway enthused onstage at an Oct. 2000 i2 user conference.

The stakes are huge. Gary Busek, who studies retail technology as president of IHL Consulting Group, estimates Kmart could add $1.9 billion to its bottom line if it could match the inventory turnover rates achieved by Wal-Mart and Target.

The number of times a company turns over the inventory in its stores and distribution network each year is a particularly crucial metric in discount retail, which thrives on high volume. Last year, Wal-Mart turned its inventory 7.3 times; Target turned its 6.3 times; Kmart: 3.6 times. And chief financial officer John McDonald says turnover will be flat, at that same rate, again this year.

Ultimately, i2 is supposed to help Kmart achieve such basic retail goals as keeping the shelves sufficiently stocked so that customers can find what they need, but without stuffing stores with an excess of inventory that Kmart can't move.

Some of the ways i2 software can help is modeling demand for products—and what it means for keeping inventory in stock at each store and each distribution center. The software keeps track of the ability of key suppliers to fill orders, and the cost and speed of different means of transporting goods through the network.

After needs are analyzed, then instructions can be generated for executing orders, scheduling shipments, and recording the receipt of goods. If the analysis is correct and execution follows, costs of operating the network are lower and the company doesn't have to stock as much inventory either in distribution centers or in stores. That, in turn, means Kmart can lower prices and thereby raise sales and, hopefully, profits.

The Kmart partnership was a big deal for i2, based in Dallas. I2 claims to have delivered billions of dollars of value to its customers in the past few years. The market has grown skeptical, though, partly because of high-profile snafus involving an i2 manufacturing and distribution system at Nike, which led the shoe marketer to say it missed up to $100 million in sales. AMR Research supply chain analyst Bob Ferrari sees Kmart as one of a handful of make-or-break projects for Dallas-based i2, in this case to prove it can deliver hard financial results in a particular industry like retail.

The project would be organized as "a typical skunkworks" with a cross-functional team of 500 working in a remote location and told to keep at it until the new system was finished. Conaway spoke of emulating the kind of supply chain speed of execution achieved by i2's customers in high-tech manufacturing, such as Dell Computer. "We need to stop talking about days and start talking about hours. We have to get to that level of intensity to be world-class," he said.

Besides speeding up supply chain processes, Conaway said he was looking to i2 to help Kmart with "micromerchandising" efforts that would allow it, for example, to make sure that a store in an area with a large Hispanic population adjusts its mix of merchandise to appeal to that population. "Great companies are going to have to look to a local customer like they're actually a member of that community," he said.

Now individuals close to both companies say the implementation has stalled. Kmart is not commenting. Yet, even John West, who until recently served as chief technology officer at i2, admits it's not proceeding as fast as planned.

At the project's peak, individuals close to the project say the supply-chain revamp kept about 100 staff members from Deloitte Consulting customizing i2 software so that it would precisely track the movement of goods to Kmart's 2,100 stores across North America. Now, only a handful are left.

For its part, i2 says it has "multiple" applications live at Kmart. But West would name only one—a remotely hosted service called FreightMatrix, which Kmart is using for inbound transportation planning and sourcing. The slow pace may result in part from a possible absence of leadership. Randy Allen, the CIO whom Conaway hired away from Deloitte just a year ago, was reassigned in August to become executive vice president, strategic initiatives and chief diversity officer. No replacement has been named.

Allen was Kmart's fifth CIO in seven years. In contrast, when Randy Mott left the CIO's post at Wal-Mart in early 2000, he had been at the company since 1978 and taken over its top IT job in 1994. Successor Kevin Turner has been with the company since 1985 and served as assistant CIO since 1998.

Conaway's intense push comes even as Kmart's financial performance weakens. Lone among the major discount chains, Kmart reported a loss last year, of $244 million on revenue of $37 billion. By comparison, Target reported a $1.3 billion profit on nearly identical revenue of $36.9 billion. Wal-Mart, which has blown by Kmart in size and success, earned $6.3 billion on sales of $191.3 billion.

This fall, the stress of war and recession have actually boosted sales for competitors. But not for Kmart. Its sales dropped 4.4% in October at stores open at least a year. Same-store sales improved 6.7% for Wal-Mart and 2% for Target.

On those reduced sales, Conaway also is making it tougher to squeeze out a profit. He has mandated price cuts on 38,000 of the 95,000 products that Kmart stocks in its stores. He wants to cut prices on another 12,000, to stay competitive with Wal-Mart, the most efficient player.

This strategy aims to let Kmart cut back on the use of newspaper circulars and sales to draw customers to stores. But when Conaway reported Kmart's third quarter loss of $224 million on Nov. 27, he said "there's no doubt we made a huge mistake by cutting too much advertising too fast." Although "regular sales" not associated with any promotion rose 12% in the period, it wasn't enough to make up for the loss of traffic associated with advertised promotions.

Beyond that, the price cutting is meant to be a "pay as you go" program, meaning greater operating efficiency pays for the lost revenue. That's where the supply chain overhaul comes in.

On Nov. 27, Conaway said he expects changes that will provide real-time data throughout the supply chain to be completed by July 2002. He also reported progress with the integration of separate systems for distributing "hard" goods such as appliances and "soft" goods such as apparel. The updated system will allow any product to find the most efficient route to its destination, cutting lead times by 14 days.

Conaway said it has cut back the number of its suppliers by 25%; and, that a change in how it pays for supplies resulted in some invoices being dropped. The upshot? There may be other "bumps in the road" to come. "That's the reality of the massive change we're going through," he said.

Still, where last year a congested distribution system forced Kmart to choose between shipping toothpaste or Christmas trees during the holidays, now shipping capacity has been expanded from 900 to 2,000 trucks per day, Conaway said. At the same time, replenishment systems are being tuned so that bulky items such as pillows can be held at Kmart's distribution centers, rather than taking up space in the backs of stores, he said. Further, where last year 60% of the merchandise was being allocated to stores by central planners, today 60% is pulled to the stores in response to sales, he said.

But Conaway and other Kmart executives, while upbeat and insisting their initiatives are "on track," refused repeated requests to discuss the overhaul of its supply chain, in detail. Kmart Director of Corporate Communications Jack Ferry would say only that it's a "work in progress."

Senior Writer and author of the Know It All blog

Ed Cone has worked as a contributing editor at Wired, a staff writer at Forbes, a senior writer for Ziff Davis with Baseline and Interactive Week, and as a freelancer based in Paris and then North Carolina for a wide variety of magazines and papers including the International Herald Tribune, Texas Monthly, and Playboy. He writes an opinion column in his hometown paper, the Greensboro News & Record, and publishes the semi-popular EdCone.com weblog. He lives in North Carolina with his wife, Lisa, two kids, and a dog.

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