Rivals Are Expected to Benefit From Fallout

Kmart Corp.’s model of selling a broad array of goods at value prices--once a winning strategy--in recent years has become vulnerable to newer, tougher and more innovative retailers that each have picked off segments of Kmart’s target customers.

Those competitors now stand to gain even more from Kmart’s troubles, analysts said Tuesday.

Consumers, however, could see higher prices as competitors face less pricing pressure from a consolidated and repositioned Kmart, they said.

Although the discount sellers are likely to gain the most from Kmart closures and reorganization, the opportunities to pick off pieces of Kmart’s business stretch across the retail industry, analysts said.

“Kmart is just squeezed in the middle. There just isn’t a way for them to differentiate,” said Jeffrey Klinefelter, an analyst with U.S. Bancorp Piper Jaffray. “The market is not that complicated. The deep-value customer simply has a number of options that they didn’t have before, and those options get better and better.”

Bad news at Kmart quickly became good news for its two biggest competitors, Target Corp. and Wal-Mart Stores Inc., both of which saw stock gains Tuesday after Kmart’s bankruptcy filing.

Target and Wal-Mart stand to gain the most from Kmart’s troubles.

Wal-Mart founder Sam Walton reportedly developed the model for his stores by visiting Kmart stores and noting all the things they did wrong.

Beyond his attempts to improve upon the look and feel of Kmart stores, Walton worked to beat his competitor at the discount game Kmart helped invent. In order to offer the most consistently low prices available anywhere, Wal-Mart stores quickly outpaced Kmart in new technology, store operations, and eventually, size and buying power. All of that solidified its abilities to promise customers unmatched value.

“That means no one can beat Wal-Mart on price,” one competitor said. “No one. It’s suicide to try.”

Still, Kmart tried to compete for the discount mantle, kicking off the second quarter of last year with new promotions and lower costs. Wal-Mart, with its bigger buying muscle and higher-tech operations, moved in to match prices and lower them further, keeping the pressure on Kmart but cramping its own margins in the process.

Shelly Hale, a retail analyst with Banc of America Securities in San Francisco, estimates that Wal-Mart has lost 1.2 percentage points off its gross profit margin “in large degree because of [Kmart’s] pricing action.” Kmart’s bankruptcy is likely to ease that pressure, Hale said.

“Kmart has been very promotional in its pricing--in some cases irrational,” Hale said Tuesday in a note to clients. “The irrational pricing environment should improve, benefiting [Wal-Mart] and all other discounters.”

Target also stands to benefit further from Kmart’s troubles.

In surveying the competitive landscape in the early 1990s, the company--then called Dayton-Hudson Corp.--determined that its Target stores would have to focus on more than just value pricing.

To that end, Target stores were positioned as a “mass with class” chain, offering high-style goods at lower prices than department stores.

Target brought in known brands, such as Mossimo, and developed other names, always with fashion as a focus. Target took architect and designer Michael Graves, who had designed home goods for Italian fine goods manufacturer Alessi, and turned him into a household name, using Graves’ designs and lower-cost materials to create more affordable, but still fashionable, housewares.

By the time Kmart responded, landing a prize contract with Martha Stewart, Target had secured its position as the fashionable discounter of choice.

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