Leaving the Nest

Sears Hometown and Outlet Stores spins off from its parent company

There’s an old saying that what’s good for the goose is good for the gander. That seems to be the case for Sears and its newly separated Hometown and Outlet Stores.

“The decision was a long time in the making,” says W. Bruce Johnson, president and CEO of Sears Hometown and Outlet Stores (SHO), now publicly traded on NASDAQ. “But we’re a unique segment of the business and the separation was a positive move that’s enabled us to become more autonomous while still benefiting from a relationship with Sears Holdings.”

The company, which separated from Sears Holdings last October following a rights offering that gave the firm gross proceeds of about $346 million, operates four distinct formats. Outlet Stores, originally established in 1968 and averaging 32,000 sq. ft., are value-priced stores focusing on distressed, refurbished and marked out-of-stock merchandise in categories ranging from home appliances and lawn and garden to mattresses and apparel. In fiscal 2012, these stores generated sales of $600 million and $42 million in operating profits, with margins averaging about 29 percent.

Hometown Stores replaced the original catalog stores when the Sears catalog was discontinued in 1993. The format grew to more than 900 stores over the past 20 years and features hardlines including appliances, tools and lawn and garden. The stores average about 8,500 sq. ft. of selling space and are designed to serve customers in areas where there are no full-service big box stores.

Home Appliance Showrooms are located primarily in major metro areas and are a potential answer to the “showrooming” problem experienced by many retailers. These are customer-centric stores, many with a children’s play area, refreshments and personal service. The stores, averaging 5,000 sq. ft., do not carry a large stock since 50 percent of sales are through the company’s Online Solutions Center.

Hardware and Appliance Stores are more like a typical neighborhood hardware store with a deep assortment of Craftsman tools and power lawn and garden equipment, but they also sell appliances.

More opportunity for growth

Prior to the separation from Sears Holdings, these stores were already distinct operational units with their own executive staffs and independent marketing and promotional budgets. But those budgets required corporate sign off, Johnson says.

The spinoff of these businesses has to be viewed from two perspectives, he says. “From the Sears side, the rationale was twofold. Holdings is a big, complex company and these other businesses, while profitable and growing, were not really part of its core operation,” Johnson says. “Separating would enable the organization to focus on Kmart, Sears and online businesses. Additionally, since the transaction was structured as a rights offering, it generated a total of $550 million in total liquidity.

“As part of a bigger company, SHO did not get the time, attention or priority when it came to capital allocation because Sears Holdings had bigger initiatives,” says Johnson, who served as executive vice president of off-mall businesses and supply chain for Sears Holdings and interim president and CEO of Sears Holdings between 2008 and 2011. “We felt there was a better opportunity for unfettered and faster growth on our own so we wouldn’t have to deal with the constraints big companies are under when it comes to capital allocation, resources and new projects. But at the same time, we could retain a lot of important relationships with Sears.”

As for the danger of SHO’s growth cannibalizing sales at conventional Sears stores, “We’re in different locations,” Johnson says. “The Hometown and Outlet stores are smaller footprints and typically located in rural or small towns that can’t justify a big mall store. But we will continue to leverage a lot of Sears’ promotional activity like television by aligning with our promotional campaigns. We don’t have to, but we want to.”

Conversely, it doesn’t make sense for SHO to follow the same promotional calendar, particularly in the lawn and garden business. “Our profits are a bit different so our focus is as well,” he says. “We are into the power lawn and garden [business] but with a slightly different assortment than Sears, so marketing is different.

“The Outlet is a different business altogether,” Johnson says. “We’re talking about reconditioned products, overstocks, one-time buys which we sell at deep discounts. A number of factors differentiate our Outlet stores from competitors — product assortment, quality, service, brand recognition, loyalty programs, online and multi-channel capabilities and availability of retail-related services such as access to credit and delivery.”

Johnson says that at SHO, “We don’t even look at Sears as a major competitor ... Even when we are close, we tend to cater to different customers than those that go to department stores.

“For one thing, our geographic reach is much broader,” he says. “The Outlet stores can draw customers from 25 to 50 miles away. Additionally, there is an outlet-minded customer. They may want … a laundry pair or a second refrigerator for the basement and are looking for a great deal on a reconditioned model or something with a scratch or dent.”

Outlet stores also sell a lot of out-of-stock Sears apparel. “It’s not the biggest part of our business but a good adjunct, and one that enables us to have more of a transaction draw for customers,” Johnson says.

The company did test three outlet stores focused solely on apparel in Detroit, suburban Chicago and Georgia, but “came to the conclusion that the most profitable model was one that sold the full range of products including hardlines,” Johnson says.

Home Appliance Showrooms completely embrace the showrooming concept, according to Johnson, who notes that there are fewer than 100 units at this time. “It’s a small format … A lot of appliances are set up in vignettes, like kitchen vignettes featuring Kenmore or Whirlpool products,” he says. “There’s very little takeaway merchandise. You buy the product by ordering online for delivery through our logistics network. It’s the equivalent of buying online but with customer-assisted support coming from in-store sales people.”

SHO hardware and outlet stores also have ordering capability, Johnson says, “but these showrooms have been around for five or six years and are very much what you would think about building if you were competing with a pure online business. The difference is assisted selling and the customer’s ability to touch the merchandise and ask questions.”  

Mutually beneficial relations

SHO’s franchise model is something that Johnson believes will contribute significantly to the success of all its formats because it “allows us to leverage the entrepreneurial spirit of our franchisees to better serve customers. Individual store performance may vary but in the aggregate, local ownership makes a difference in performance.” In fact, on a comp-store basis, franchisees outperformed company-owned stores last year.

SHO’s franchise model is “a little different than Ace or True Value — it’s more like McDonald’s,” Johnson says. “The assortment, planogramming and inventory in the stores is ours and we pay a commission based on sales. Franchisees can’t buy their own products. We receive inventory from [Sears Holdings] in the form of discontinued or reconditioned product. But we are also able to provide our customers access to the full assortment and pricing available through Sears Holdings by leveraging those distribution centers.”

The Outlet stores also have inventory arrangements with third-party vendors, which “gives us the ability to source both new and reconditioned products,” he says.

SHO does plan to maintain company-owned stores, “but stores can transform from company-owned to franchises and vice versa,” Johnson says. Company-owned stores are used, in part, for training and development purposes and to test new merchandise assortments.

Despite the new company’s autonomy, Johnson says that a mutually beneficial relationship with Sears Holdings remains. “We buy services from Sears and have contracts that are part of our separation agreement. For instance, a lot of backend processing and accounts payable is done on Sears’ systems and we pay them for it.

“We have our own marketing and merchandising teams, but buying takes place within the Sears Holdings organization,” he says. “We provide them with our forecasts and they buy the products for us. That enables both our organizations to leverage scale.”

Johnson declined to discuss the specifics of future growth other than to say that the company plans to expand the store base for each format. “We’re currently focusing on domestic growth throughout the U.S. especially with our hardware stores and appliance showrooms,” he says.

This includes looking for Home Appliance Showrooms locations in regional power centers of metro areas underserved by Sears Holdings. “We are also looking for newer, refurbished strip centers in suburban markets with high home ownership for our Appliance and Hardware stores and refurbished strip centers in suburban and rural areas for our Hometown stores,” he says. “Development for Outlet stores is centered on vacant big box locations in regional strip and power centers that target bargain hunters across all income groups.”

Format changes will be gradual, Johnson says, as the company learns from “testing different merchandise assortments. We’ve seen positive results with expanded assortments in mattresses and tools over last year. In the Appliance and Hardware store format, we are very excited about preliminary results of our smaller-sized store pilot.”