KMART'S LONG INVOLVEMENT IN FOOD IS POISED TO FADE

David Merrefield

Now that the dust kicked up by the announcement of the proposed $11-billion buy of Sears by Kmart is starting to settle, let's take a look at long-fomenting strategies involving the discounter and what they may mean for the supermarket industry.

At first glance, it might seem that Kmart-Sears bodes little for the food retailing business, but there's more going on than what appears on the surface. That's because Kmart has long been viewed by deal-makers as clay to be formed into a barrier that could hobble the march of Wal-Mart Stores across the land.

The first investor to divine the potential utility of Kmart was Ron Burkle, the principal of investment firm Yucaipa Cos. Burkle acquired equity positions in both Kmart and Fleming Cos. In early 2001, Burkle positioned Fleming to become the sole food supplier to Kmart's supercenters. Apparently, his method was to tightly unify the wholesaler and the retailer, forming a combination that could drive costs down enough to allow Kmart to approach Wal-Mart's food-price points. Indeed, many observers expected that, should that work, Fleming and Kmart would merge into a formidable supercenter operation.

Well, as we all know, the plan came to ruin in short order. By the end of that year, Burkle had exited most of his position in Fleming. That's because Kmart, which had dropped its high-low pricing tradition in favor of the cheaper everyday-low-price approach, was rapidly alienating customers and shedding sales volume. Not long thereafter, both Fleming and Kmart filed for bankruptcy.

Fleming eventually departed the full-line grocery wholesaling business, but Kmart's saga had just started. It emerged from bankruptcy quickly, attracting the attention of Edward S. Lampert, the principal of investment firm ESL Investments. Lampert acquired a large stake in Kmart and became its chairman. He also accumulated a big interest in Sears. Lampert forged the Kmart-Sears deal.

Most commentary about the Kmart-Sears deal has centered on its real-estate aspects. Certainly, that's a strong component, since both companies have ample holdings to swap or spin off. It's just as likely, though, that Lampert views Kmart-Sears as an operating business, not as a pure real-estate play. He has said as much, and such is more than possible. After all, moribund store locations are flooding the market, diminishing their value.

So Lampert may well be animated by a strategy similar to that tried earlier by investor Burkle. He may calculate that the combination of Kmart and Sears will prove useful in competing with Wal-Mart. Both Sears and Kmart have attractive store brands that, used together, could power broad-line retailing.

This brings us to the key issue for supermarket retailers: What place is food retailing to have in the future of Kmart-Sears? The complexity of combining the hard-line retailing assets of Kmart and Sears, along with the paucity of the controlling investor's food experience, suggest that neither store will depend much on full-line supermarket retailing. Or, the whole concept could fail. Either way, a small measure of competitive relief is ahead for the supermarket industry.