SUPER KMART ON THE MARCH

ELLIOT ZWIEBACH

TROY, Mich. -- Super Kmart Centers are about to emerge from a self-imposed hibernation. After several years of static store growth while Kmart Corp. here addressed more pressing corporate issues, the company is about to become more aggressive in rolling out its supercenter format, Laurence L. Anderson, president of the Super Kmart division, told SN.

"The Super K's have always operated successfully," he said. "They turned profitable in 1996, improved profits dramatically in 1997 and have continued to do well this year. The problem was that the parent company simply ran out of money. "But now that Kmart's finances have improved with the rollout of the Big K format, the company has enough cash to accelerate the growth of supercenters, and we're planning to hit the growth cycle again." According to Anderson, Kmart's plans for Super Kmart Centers include the following:

* Opening 12 supercenters next year, with plans for 25 locations a year in subsequent years.

* Introducing a new 140,000-square-foot prototype at two stores this month.

* Developing a 110,000- to 115,000-square-foot prototype that will be tested in 1999 and, if it proves successful, converting hundreds of urban-based Kmart stores to supercenters.

* Switching to self-distribution once it can achieve critical mass in some marketing areas. Kmart opened its first supercenter in Medina, Ohio, in July 1991. It opened its 100th store last week in Virginia Beach, Va. -- its first prototype of 140,000 square feet -- with another new-prototype store due to open Wednesday in Detroit, and a more traditional 180,000-square-foot unit also scheduled to open Wednesday, in Southgate, Mich., a Detroit suburb.

"We're very excited about the new size," Anderson told SN, "because 140,000 square feet is the prototype of choice going forward." In the new prototype, food covers about 40,000 square feet, or about 30% of floor space, compared with 65,000 square feet, or 40%, at the larger stores.

The new model also shifts perishables -- including produce, service bakery and service deli -- from the back of the store to the periphery, adjacent to meat and seafood, "for better labor efficiency," Anderson said.

In addition, the prototype incorporates a wall of values up front, opposite the produce department, that will be visual as the customer enters the store, "for a strong price/value impression," he said; it also features a seasonal display area near the front that ties in food and nonfood.

Most grocery assortments in the smaller prototype are condensed, Anderson noted. "We've practiced more category management in our decision-making in both food and nonfood, and going forward, we intend to utilize what we're learning to a greater extent." The new prototype will still feature what Anderson termed Kmart's strongest nonfood departments across the front -- ladies apparel, Martha Stewart home furnishings and a seasonal display area.

Given the ability to condense supercenters down to 140,000 square feet, Anderson said, Kmart is now asking itself "if we can take the box down to 110,000 or 115,000 square feet. And if we can, then what category assortments would we impact?

"If we can develop a prototype and reconform supercenters to that smaller size, we see tremendous opportunities to go back and convert hundreds of existing Kmart stores in urban locations to supercenters to backfill what we already have."

The company is still working on developing the smaller prototype, Anderson said, "and although we have no specific location yet at which we want to test it, it will be tested in 1999. In fact, we hope to test the smaller prototype at several locations next year."

Kmart will have more opportunities for testing as it begins a more aggressive expansion program. "We're planning to hit the growth cycle again because Kmart now has the cash to accelerate the growth of supercenters," Anderson told SN.

He said Kmart is budgeted to open 12 new supercenters in 1999, "with seven or eight locations already tied down. But I think we'd have to go like mad from a real-estate standpoint to get to 12," he said.

"But after next year, we're looking at opening 25 or more a year for the next few years." This represents a major strategic and financial shift for Kmart after an erratic store-opening program. Since opening its first supercenter in 1991, the company opened three in 1992, 15 in 1993, 48 in 1994, 20 in 1995, nine in 1996 and three in 1997.

"Early on, the idea of Super K was very exciting, and the company had plans to roll out hundreds of them in a relatively short time," Anderson said. "But just as acceleration reached its peak in 1994, Super Kmart encountered some internal problems as it outgrew its infrastructure -- at the same time the parent company was becoming troubled on other fronts."

Shortly before Floyd Hall was hired in 1995 as Kmart chairman, president and chief executive officer to tackle the corporation's problems, Ron Floto left Kash n' Karry Food Stores, Tampa, Fla., to join Super Kmart to deal with the division's issues, Anderson pointed out.

"Ron and his team did a nice job improving store conditions and establishing cost controls for labor, advertising, markdown expenditures and gross profits, and by the end of 1996 the stores were profitable. But by that time Floyd had to curtail capital for growth because the company was on the verge of bankruptcy," he said.

Floto left Super Kmart in May 1997 to join an overseas firm, and Anderson was named to succeed him three months later as president of Super Kmart and executive vice president of the parent company, following a 23-year career with Supervalu, Minneapolis.

In March, Super Kmart added Frank Yanek -- a former Supervalu executive who had spent most of his career with Safeway, Pleasanton, Calif. -- as vice president for food operations; David Marsico, who has been with Kmart for 26 years and with Super Kmart since the first supercenter opened, continues as vice president for nonfood operations. According to Anderson, Super Kmart's profit levels "improved dramatically" last year, and the division has continued to show improved earnings and sales growth this year, though he declined to be specific.

Observers estimate Kmart's supercenters account for sales of approximately $4.3 billion a year, or about $43 million per store (including all food and nonfood).

By comparison, Wal-Mart Supercenters, with about 550 units, will do about $32 billion this year, or about $60 million per store; and Super Target, with 18 stores, will do volume estimated at $800 million this year, or $44 million per store.

The strength of Super Kmarts has always been one-stop shopping, Stephen Long, a securities analyst with Prudential Securities, Atlanta, told SN. "The format gives Kmart customers the opportunity to put apparel in the same shopping cart as milk and eggs. "It's pretty easy to drive the top line by offering consumables alongside general merchandise, as Wal-Mart has found out with its supercenters, and obviously Kmart did not want to be left in the dust."

The knock on Kmart supercenters, some observers pointed out, has been that it has opened stores scattered all over the country rather than concentrating growth in a few areas.

Don Spindel, a securities analyst with A.G. Edwards & Sons, St. Louis, said one of the major differences between Super Kmart Centers and Wal-Mart Supercenters is the location of the stores: urban vs. rural. "Kmart has focused on metropolitan areas, while Wal-Mart has not," he said. "But while Wal-Mart has clustered stores, Kmart has not, and that has seemed like a less efficient strategy."

Super Kmarts are spread across 21 states, with nearly two-thirds (59 of the 100 stores) located in six states: Texas, with 15; Ohio, with 14; North Carolina, nine; California, eight; Illinois, seven; and Michigan, six, pending the scheduled addition of two more later this week.

The rest are located in Colorado, Louisiana, Tennessee and Virginia (four each); Georgia, Indiana, Mississippi, New York and Pennsylvania (three each); Arizona, Connecticut, Nevada and South Carolina (two each); and Nebraska and West Virginia (one each). According to Anderson, "We have some concentration of stores in Detroit, Chicago, Cleveland and Los Angeles, but a lot of our expansion will be designed to backfill areas with the aim of building critical mass.

"Self-distribution for the supercenters certainly makes economic sense," he said, "and once we have critical mass, the economics of procurement and advertising will allow us to pursue self-distribution, either by acquiring existing facilities or building new ones." Anderson declined to say how long it might take for Super Kmart to achieve sufficient critical mass to begin self-distributing, "but if we get the smaller prototype working efficiently, it would be sooner rather than later," he said.

Super Kmart currently buys food from various wholesalers, primarily Supervalu, Minneapolis, and Fleming Cos., Oklahoma City.

"We have a nice relationship with our existing wholesale suppliers, but we'd be better off with our own distribution, which requires critical mass," Anderson said.

Long, of Prudential Securities, said Super Kmart will have to find a way to deliver product more cost-effectively than using third parties for distribution. "Its locations are pretty spotty now, and if it wants to expand nationally, it needs to focus on where to put new stores and the distribution logistics it will take to do that kind of expansion," he said. "That may not require Kmart to build or acquire a logistics operation -- it could involve forming some kind of alliance with a supermarket to handle distribution for the supercenters.

"But continuing to rely on third parties for distribution means the company will never be as efficient as it should be," Long told SN. Kmart has reportedly been trying to secure self-distribution by pursuing a merger with an existing retailer or wholesaler, according to industry speculation that it was Kmart's Hall who initially brought Albertson's and American Stores Co. together in hopes of effecting a three-way merger with Kmart to provide a means for national distribution of food products.

Anderson declined to confirm those reports or to discuss any negotiations Kmart may have had with other companies.

However, he said Hall is willing to consider "whatever makes sense for our company going forward, and in the event there is an opportunity to merge with a national food distributor or retailer that gave us self-distribution in a logical fashion, we would be open to that."

Kmart Corp. self-distributes all nonfood through 14 hardlines and four softlines distribution centers; it also distributes food to the Pantry food sections of its Big K stores through 11 of the 14 hardlines centers, with the other three scheduled to come on-line by the end of the year, Anderson said.

"But we could not utilize Kmart's existing distribution centers because they run efficiently now, and they're not compatible for doing what we would need because it's a different kind of distribution -- they distribute on a flow basis, which is much more automated, whereas foods are distributed on a pick-to-order basis."