THE SOURCE OF THE AMAZON (DOT COM)

 

Bradford Hudson

Essay

January 2, 2019

 

A few months ago, Sears declared bankruptcy. This represented an unhappy, but not unexpected, ending for an American retail pioneer. The full story offers a cautionary tale for executives in any industry who are contemplating strategic changes for older companies. Sears helped create the industry that eventually produced Amazon and if the company had made different strategic choices two decades ago, it could have become the leading online retailer today.

 

The Ascent

 

Richard Sears was working as a depot agent for the Wisconsin, Minnesota and Pacific Railway Company in 1886. A local jeweler refused to accept a shipment of watches, which Sears subsequently acquired and re-sold individually to his fellow railroad employees. This developed into a jewelry retail operation that distributed through mail order catalogs. Sears sold this business in 1889, but started another mail order jeweler with watch repairman Alvah Roebuck in 1893.

 

Sears, Roebuck and Company quickly expanded beyond jewelry to offer a variety of products at reasonable prices. By 1895, the company was publishing a catalog with several hundred pages. The astonishing range of products included almost every type of consumer product available in the marketplace, from clothing to groceries. Eventually consumers could purchase entire pre-fabricated houses from Sears, which were shipped by railroad in thousands of pieces and assembled at their destination by semi-skilled consumers. Sears subsequently expanded into physical retail stores in 1925 and within five years it was operating more than 300 units.

 

The financial success of Sears was indisputable for decades. Within two years of inception, its catalogs were producing annual revenue of nearly $1 million. At the turn of the twentieth century, the company was distributing more than six million catalogs per year and generating sales of about $10 million. Sears launched its initial public offering on the New York Stock Exchange in 1906, representing the first major offering by a retail company. By 1945, the company was producing revenues of $1 billion. A century after its founding, Sears was generating revenue of about $50 billion and was ranked ninth among the Fortune 500. Sears was a component of the Dow Jones Industrial Average from 1924 until 1999.

 

The success of Sears resulted from a perfect alignment between the company and its strategic environment. During the later stages of the Industrial Revolution, advances in technology and transportation enabled significant increases in the quality and availability of manufactured products, fueling the emergence of modern consumer demand. Companies experimented with new forms of distribution, especially retailers such as Macy and Wanamaker, who developed huge department stores in major cities. Similar advances in publishing and communications occurred during the second phase of the Information Revolution, which began centuries earlier with Gutenberg and accelerated with the invention of the telegraph.

 

As a railroad agent working in the expanding northwestern region, Richard Sears detected an opportunity. The expansion of supply and demand for consumer products was predominantly an urban phenomenon, which was removed both geographically and conceptually from the agricultural economy in rural America. He personally witnessed the unfulfilled needs and desires of farmers and residents of small towns, and quickly devised a solution through catalog marketing and railroad distribution. Sears was prescient. Surveys of midwestern farmers in 1920 revealed that almost 40% were using mail order catalogs from various companies.

 

During my childhood, the stores and catalogs of Sears were an important part of the shopping routine for our family. The high point of our year was the arrival of the Sears Christmas catalog, a special edition with gift suggestions ranging from clothing to billiard tables. This included more than 200 pages devoted to every imaginable toy or game. We would spend hours reviewing our possible largesse, circling and ranking our choices, and sharing our wish lists with parents and Santa Claus. The Sears Christmas catalog, which was later renamed the Wish Book, was a broad cultural phenomenon interlinked with the innocence and wonder of childhood.

 

The Decline

 

The year 1962 passed uneventfully for Sears, but in hindsight it represents an important milestone in its demise. Walmart, Target and Kmart were all started that year. Kmart was established as a division of Kresge, which was a pioneer in urban five-and-dime stores during the early twentieth century. Target was established as a division of Dayton department stores, which would merge with Hudson department stores a few years later. Walmart was established by Sam Walton, as the next iteration of his growing five-and-dime business. All three companies were pioneering the new ‘big box’ format, which was an attempt to capitalize on the shift in population toward the American suburbs and exurbs.

 

Sears responded to the same population trends by taking anchor positions in new suburban malls, alongside more prestigious department stores such as Macy’s and Wanamaker’s. The occupancy costs for malls were closer to traditional urban locations, while the strip mall locations favored by the discount retailers were much less expensive. Without realizing the full implications at the time, Sears was now straddling between two strategic positions, a higher end retailer in terms of cost versus a lower end retailer in terms of brand prestige and pricing power.

 

This period also coincided with an increasing emphasis by Sears on real estate ownership and financial engineering. A variety of companies were embracing principles of finance that had previously been limited to Wall Street firms, and economic results became increasingly decoupled from operational choices based on consumer preferences. One of the related techniques was conglomerate diversification, which involved acquiring business units in industries that were potentially unrelated, so that operating companies were transformed into larger holding companies. These conglomerates owned portfolios of diversified business units, which could offset each other in terms of seasonality and risk. Strategic management became a process of manipulating financial levers and managing cashflows in corporate headquarters distant from operational units.

 

Sears acquired the Wall Street investment broker Dean Witter Reynolds and the consumer real estate broker Coldwell Banker in 1981. Sears had always extended credit to consumers for retail purchases from their own stores and catalogs, but they broadened this principle by introducing the Discover Card in 1985, which was a full-service credit card intended to compete with Mastercard and Visa.

 

Meanwhile the core retail business at Sears was suffering from neglect. The corporate buyers were failing to keep pace with fashion and changing demand patterns, the store interiors and merchandising equipment were outdated and deteriorating, and the company was no longer regarded as a preferred employer. At the same time, discount big box retailers such as Walmart and Target were upgrading their product lines and moving aggressively to build new units in growing suburban markets.

 

Walmart and Kmart surpassed Sears in 1990 to become the two largest retailers by sales. That year Walmart sales increased 26 percent, while Sears achieved an anemic one percent gain. Rationalization and denial were the reactions of Sears and its supporters. A Sears spokesperson stated that “Comparing Sears to Walmart and Kmart is a little like comparing apples and oranges. Sears is in the general merchandising business. They`re in the discount business. We compete directly against them in only about 30 percent of our product line.” An investment analyst contended that “To an investor, profitability and return on equity are more important measures of a company`s success” than its industry rank.

 

Sears did make some changes in response to the increasing competitive pressure, including the addition of name brands and more stylish merchandise in its stores, attempting to compete against more upscale department stores such as Macy’s and Wanamaker’s. The latter seemed to be the relevant competitors, because they shared anchor status in the same shopping malls, but Sears executives failed to realize that the more significant competitors were the discounters. These included Home Depot, which outflanked Sears in its previously successful hardware and appliance unit, and subsequently replaced Sears within the Dow Jones index.

 

Sears announced a net loss of about $4 billion in 1992 and never really recovered thereafter. If the period from 1970 to 1990 was devoted to financial engineering on the upside, the past two decades have been characterized by financial manipulation on the downside. A private equity investor orchestrated the merger of Sears and Kmart in 2004. He subsequently pursued a strategy to cut costs and sell assets, including real estate and powerful brands such as Craftsman and Kenmore. The company was pursuing profit as a goal in itself, rather than as a measure of effectiveness in generating revenue. The network of stores was reduced from about 3,500 in 2004 to about 700 in 2018. Only a financier would believe that suppressing capacity is a viable solution to a fundamental weakness in demand.

 

When my family visited Sears two years ago, it was my first venture into one of their stores in decades. We did so reluctantly, after searching every other store in the mall for a particular shoe brand that my children preferred. The experience was stunning and offered a distinct contrast to my memory of Sears during childhood. The store was dark and dirty, the shelves were sparse and messy, the departments were unstaffed, and the products were poor quality and unfashionable. From a consumer viewpoint, this was clearly a company in a death spiral.

 

Revenues at Sears declined from about $50 billion in 2004 to less than $20 billion last year. The company declared a net loss of about $2 billion in 2016 and accumulated over $10 billion in losses during the past decade. Even considering the vast number of store closures, revenues continued to weaken due to continuing declines in comparable same store sales.

 

Sears declared bankruptcy in October 2018. It was little noticed that this news coincided almost exactly with the 125th anniversary of the incorporation of Sears, Roebuck & Company in September 1893.

 

The Tipping Point

 

The financial loss in 1992 was a significant negative milestone for Sears, representing its first year without profit since the Great Depression. However, the subsequent strategic response by Sears signifies the actual tipping point. Sears announced in January 1993 that it would discontinue its general catalog later that year.

 

Some observers believed the decision was perfectly sensible. The catalogs generated sales of more than $3 billion, but the catalog unit had been unprofitable for two decades, producing annual losses as high as $100 million per year. The chief executive of Sears remarked that the decision “gets us out of a number of unprofitable businesses and frees up the playing field for us to move forward.” An investment analyst asserted “this is without a doubt good medicine for the company.” And The New York Times suggested this was “a big step toward making Sears nimble enough to compete in today's lean retail environment.”

 

In my estimation, however, the decision was utter madness and indicative of the strategic myopia and poor judgment endemic at Sears. At that exact moment, the mail order catalog industry was at its zenith.

 

The idea of a merchandise catalog printed on paper with products delivered by mail was nothing new, but several key developments fueled a renaissance circa 1980. The first was expanded shipping options, resulting from the founding of FedEx and a decision by the Interstate Commerce Commission expanding opportunities for delivery companies such as UPS. The second was a significant decrease in the cost of operating toll-free 800 numbers, following the breakup of AT&T and deregulation of long-distance phone service. The third was a renaissance in physical retailing and the rise of specialty stores that focused on a limited range of goods. Companies such as American Eagle, Gap, Urban Outfitters and Victoria’s Secret were all founded during the decade (more or less) prior to 1980. The fourth was the buying power of baby boomers, who entered adulthood between 1964 and 1982.

 

More than 5,000 companies were publishing catalogs in the United States during 1982, with the average household receiving about 40 per year. Within a decade, the catalog industry was mailing more than 10 billion catalogs annually. More than 100 million Americans were spending more than $50 billion through catalogs.

 

The problem with the Sears catalog in 1993 was not the generic nature of catalog sales or the demand for products delivered at home, but rather the specific approach that Sears was taking to its catalog business. Sears could not find an effective and plausible strategic position in the increasingly competitive catalog landscape. This is especially surprising given that Sears was the most prominent among pioneers in the industry. Anyone who knew anything about the history of Sears could grasp the irony as they admitted defeat in the catalog wars exactly 100 years after their incorporation as a mail order catalog company.

 

A Lost Opportunity

 

One year later in 1994, a former investment banker turned digital entrepreneur started an online bookstore called Amazon. Within two years, the company had achieved revenues of about $16 million, but also an astounding net loss of about $6 million. At that time, the combined sales of all companies through online distribution was a mere $8 billion per year. The entire sector seemed inconsequential compared to the Sears annual revenue of $38 billion and net income of $1.2 billion in 1996, of which about $27 billion and $800 million respectively derived from traditional retail operations.

 

However, insightful investors had faith in the growth potential of the digital economy and Amazon was able to conduct a successful public offering on NASDAQ in 1997. The company grew quickly thereafter from a quirky digital bookseller to a vast broadline retailer, surviving the dot.com crash circa 2000. A decade later, the strategic context had reversed. Amazon surpassed Sears in revenue during 2011, with Amazon achieving sales of $48 billion that year compared to $41 billion for Sears.

 

Hopefully it is clear to readers that Amazon filled the same market space created by the pioneering catalog retailer a century earlier. Sears is the source of the proverbial Amazon or at least its digital namesake. During the interim, computers replaced typewriters and telephones. Websites replaced paper catalogs and order forms. FedEx and UPS replaced the Railway Express Agency and the United States Postal Service. But basic human behavior and related consumer needs did not change at all. Consumers were still buying products from retailers. And they were still buying goods remotely that were delivered to their homes. They just weren’t buying those items from Sears.

 

For Sears shareholders and enthusiasts, the story actually gets worse. Much worse. Sears missed an opportunity to become Amazon, not just in terms of historical analogies, but quite literally in terms of its evolving operations.

 

Three decades ago, Sears joined with AT&T and IBM to establish a technology company, which launched an online platform called Prodigy in 1988. This was a dialup service connecting users to a proprietary computer network resembling the modern internet, during the era before the world wide web and the Netscape browser. Prodigy allowed users to send and receive email, participate in chatrooms, access a variety of content including news, conduct banking transactions and trade investment shares, and make airline and hotel reservations.

 

Prodigy was instantly popular, at least as a niche technology product, attracting one-half million subscribers within a year and becoming the second largest online service provider in the United States. Prodigy subsequently became the first company to offer full access to the world wide web and host consumer web pages. By 1995, the company had two million subscribers and generated annual revenue of $243 million.

 

Most importantly for our story here, Prodigy offered electronic commerce for retail goods from inception, including online access to selected items from the Sears catalog inventory. In other words, a few insightful executives correctly perceived the opportunity in digital commerce and Sears had a fully functional online retail operation before Amazon even existed.

 

Then Sears did something inexplicable. As part of a further round of strategic refocusing, Sears divested its ownership interest in Prodigy during 1996. The company launched its own website the same year, but this initially provided information only. Sears.com did not sell any products online for another year and did not offer a broad line of products until it was re-launched in 2000. By then, its digital moment had passed.

 

Lessons Learned
 

It is easy and reasonable to conclude in hindsight that Sears should not have closed its catalog operations at the height of the specialty catalog trend, should not have divested its interest in Prodigy at the dawn of the digital era, and should not have missed the opportunity to combine its catalog unit with Prodigy to preempt a nascent Amazon.

 

It is quite another matter to argue that Sears should have known better at the time these decisions were being made. Indeed, if all of us had correctly grasped the opportunity in Amazon at the moment of its inception and later its initial public offering, we would be much wealthier today. And yet, that is exactly what I am asserting. Sears executives should have known better, not because they could have accurately predicted the future, but because they could have remembered and honored their past.

 

I distinctly recollect the exact place and moment in which the astonishing news about the Sears catalog discontinuation reached me. The profound nature of this strategic error was felt so acutely that it burned the news into my memory with all the accompanying stimuli, including the visual appearance of my physical surroundings. This was not due to any special gift of clairvoyance, but rather because of my tendency to view marketing as an omni-temporal phenomenon involving the past, present and future simultaneously.

 

If Sears executives had been more respectful of their corporate heritage, they would have been more reluctant to discontinue the catalog unit. This represented the core of the Sears historical narrative, which was even more clear at the height of the renaissance in specialty catalogs than it is today. The solution was to renew the catalog through digital technologies, not abandon it entirely.

 

At a more conceptual level, these executives would have been reminded of the underlying consumer need that the catalog originally fulfilled. Sears provided a wide range of relevant quality goods at reasonable prices and delivered these items to the point of consumption in an efficient and convenient manner. This consumer need has not changed over the past century. Nowhere in the original mission or strategy of Sears was the goal of manipulating financial statements to conjure profit from inferior operations selling undesirable goods. That consumer need has never existed. Not then and not now. 

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About the Research

 

Sources for this article included historical and recent annual reports from Sears Roebuck and Sears Holdings, information and documents available at the Sears Archives online website, data from the National Bureau of Economic Research and the Direct Marketing Association, historical newspaper and media reports (including New York Times, Wall Street Journal, Chicago Tribune, and Fortune), current media analysis (including Bloomberg, Forbes, and Smithsonian), case studies distributed by Harvard Business School, and historical ephemera in the personal collection of the author.

 

About the Author

 

Bradford Hudson is President of Brand Heritage Institute and Editor of Brand Heritage Review. He holds a concurrent full-time appointment as Associate Professor of the Practice of Marketing in the Carroll School of Management at Boston College.

 

Professor Hudson earned a doctoral degree (Ph.D.) in Business History from Boston University, a master’s degree in services marketing from Cornell University, an undergraduate degree in political science from the University of Pennsylvania, and a certificate in strategy from Harvard Business School. He is a former Fulbright Scholar to Canada, where held the Fulbright Visiting Research Chair at the University of Guelph.

 

Prior to his academic career, Professor Hudson served in a variety of executive and consulting positions. His clients with historic brands included AT&T, Bank of Boston, Cadbury Schweppes, Cunard, Harley-Davidson, and Nestlé. As a teenager, he worked at the department store Jordan Marsh, which eventually became part of the Macy’s system.

 

Citation

Hudson, B. (2019) The Source of the Amazon (Dot Com). Brand Heritage Review, Volume 1, Number 1.

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