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KOHL’S HEADS WEST: LOCAL STORES BRACE FOR THE SHOCK WAVES

LOS ANGELES -- It's not an earthquake, but the heavy footsteps of Kohl's Corp. approaching across the Rockies that's causing trembling on California's retail shelves.<P>The Menomonee Falls, Wis.-based retailer, preparing to stage its biggest...

LOS ANGELES — It’s not an earthquake, but the heavy footsteps of Kohl’s Corp. approaching across the Rockies that’s causing trembling on California’s retail shelves.

The Menomonee Falls, Wis.-based retailer, preparing to stage its biggest expansion yet here next year, is expected to shake up the retail scene — and perhaps dislodge some established players. Forty Kohl’s doors are set to open in Southern California, Arizona and Nevada starting in the first quarter of 2003. Observers expect the retailer to deploy a strategy honed to a science over several years: Open all the doors over one or two days, leveraging a massive advertising and promotional push it begins months in advance. Already, paint is dry on a 650,000-square-foot, state-of-the-art distribution center on a former air force base in San Bernardino, Calif.

It’s that kind of tightly coordinated, take-no-prisoners approach to expansion that has retailers of all sorts cringing.

“If I was going to rate Kohl’s on a one to 10 scale, they would be an 11.5,” said Bruce Berton, director of accounting and consulting firm Stonefield Josephson. “They are going to give the retailers here a swift kick in their lethargic ways of doing business.”

“There’s no question this will have an impact on Robinsons-May, Mervyn’s and most of the department stores and mass merchants in the market,” said Linda Kristianses, an analyst with UBS Warburg. “Typically, the impact is several hundred basis points. Each company within the competitive circle usually loses 2 to 4 percent” on sales.

The 420-store chain is one of the industry’s hottest growth stories. Revenues swelled 21.7 percent to $7.49 billion last year, marking nine years of continuous sales growth. Following Kohl’s recent expansions into Houston (12 stores opened in March) and Boston (13 stores opened in April), department stores and discounters alike have had chunks bitten out of sales.

With the upcoming push into Southern California, analysts said one player is particularly vulnerable. Kohl’s, symbol KSS, could be the kiss of death for Target Corp.’s beleaguered Mervyn’s chain, analysts speculated. The moderate chain, with its slogan “Big Brands, Small Prices,” parallels Kohl’s in its strategy of offering national brands like Levi’s, LEI and Unionbay at prices lower than those of department stores. Mervyn’s, however, lacks Kohl’s aggressive pricing (Kohl’s marks down goods by 30 to 50 percent almost immediately after arriving in store, sources say), visually clean merchandising and financial muscle.

“Kohl’s is going smack dab into Mervyn’s market,” said Eric Beder, an analyst with Ladenburg Thalmann, reviewing a list of fast-growing suburbs with young families about an hour’s drive from Los Angeles reportedly scouted by Kohl’s management. Many of those locations will be within 10 miles of a Mervyn’s store, according to Beder. “By 2005, Kohl’s will be well established in all of Mervyn’s major markets, and I think it’s going to spell disaster for them.”

“They’re going in to win, and they’re proven winners,” observed one industry player, who asked for anonymity, of the Mervyn’s-Kohl’s contest.

In fact, Kohl’s has already trounced weaker regional players during expansions. In a research report Beder penned, he surmised that Kohl’s Northeast rollout “led almost directly to the liquidation of Bradlees,” a now-defunct regional department store that went bankrupt in 2000.

A Mervyn’s spokeswoman said the company, which has 124 stores in California, is “always eager to be challenged by the competition.”

Noting that California is Mervyn’s home state, U.S. Bancorp Piper Jaffray analyst Jeffrey Klinefelter predicted the chain will do “everything within their power to defend their market share.”

“I think you’ll see pretty substantial changes in terms of competitive improvement to Mervyn’s operation,” he said.

But to other industry observers, Mervyn’s looks dangerously like a lame duck concept. Mervyn’s has not expanded its store base in at least three years, while Kohl’s has opened 38 doors this spring alone. Mervyn’s has 48 doors in greater Los Angeles. Kohl’s is expected to plunk 30 of its 40 new doors in Southern California.

Mervyn’s parent Target “had this concept before Kohl’s did, but they decided to put no money into it,” Beder pointed out. “Mervyn’s has slightly shrunk — and it’s tough to attract great new management to a concept that’s not growing. Then, in Kohl’s, you have the best growth story in the country.”

In comparison, Target has 153 doors in California, with 78 in Los Angeles alone; Sears has 86 stores in the state, 22 in Los Angeles County, and Wal-Mart has 127 stores in the state.

Already, Kohl’s seems to have taken round one in its matchup with Mervyn’s. In Target Corp.’s April sales call, the company cited Kohl’s Houston rollout as the reason for Mervyn’s 4.2 percent decline in comp sales.

“By 2005, I question whether there’ll be a Mervyn’s here,” Stonefield Josephson’s Berton said.

Asked if they thought Target Corp. would sell Mervyn’s, several analysts said while it’s unlikely Target would be able to find a buyer for the chain, a more probable scenario would to sell it off as real estate chunks. “I bet you’d see Kohl’s pick certain sites up like gangbusters,” Berton said.

Analysts expect Kohl’s opening salvo to be a play for Mervyn’s family-oriented Latino customer base. During its Texas expansion, the company advertised in the Spanish-speaking media. Roughly one-third of Mervyn’s customers is Latino, according to a spokeswoman for the chain.

Mervyn’s has already begun tightening up its ties to the Latino community. The company recently inaugurated La Plaza, an in-store celebration of Mexican heritage. They’ve also started stocking Talavera pottery and other authentic Mexican home accessories as store exclusives.

“We’ve done research that community involvement is paramount to guests’ loyalty,” the Mervyn’s spokeswoman said. “They want to be shopping in a store that gives back to their community.”

Mervyn’s will also be sharpening its apparel assortment, the spokeswoman said, including signing an exclusive deal with a “very well known” children’s clothing label.

Mervyn’s isn’t the only retailer potentially vulnerable to Kohl’s advances.

“This is going to cause some dominoes to fall,” said Jack Kyser, chief economist for the Los Angeles Economic Development Corp. (LAECD) “It will exert pressure on almost everybody. Even Macy’s, Robinson’s May and Nordstrom will feel some sting.”

Kohl’s next expansion is likely to be into the Pacific Northwest, which is dominated by The Bon Marche division of Federated Department Stores. “Kohl’s is creating a shift of customers to off-mall shopping,” said Daniel Edelman, chairman and ceo of The Bon, based in Seattle, Wash. “Their locations are not in malls. But at Federated, we are really focused on simplifying the overall shopping experience for our customers. We’ve got some terrific ideas and initiatives. A Kohl’s format makes you look inward at how you operate.”

“Kohl’s is a dominant player, but the impact is more on department stores,” said John P. Derham Cato, president, vice chairman and ceo of Cato Corp., the Charlotte, N.C., fashion specialty chain. “Clearly, there is cross-shopping. However, we haven’t felt a significant effect.” When a Kohl’s moves into a Cato market, he noted, there might be a sales dip for about a week, but then business evens out.

Ira Kalish, chief economist for retail consultancy Retail Forward, said he thinks department stores and mall-based specialty stores like Clothestime, Miller’s Outpost and Gap are also uneasy about Kohl’s approach.

“Kohl’s has represented considerable competition to these players in other parts of the country,” Kalish said. “Part of the problem is people don’t enjoy going to malls as much as they used to, so I think any mall-based apparel or specialty store is going to be concerned.”

Kohl’s tends to siphon off mall traffic by opening up in “power centers,” large-scale strip malls with easy-access parking and massive anchors like Costco and Home Depot.

“We serve families with children, that’s our major focus,” said the Kohl’s spokeswoman. “We look for locations where mom can get in and out easily.”

She would not disclose any locations, but published reports and various industry sources list six Los Angeles county cities, four Orange County cities, five in Riverside-San Bernardino, two in Ventura County and five in San Diego County. Various estimates peg the Southern California expansion at 30 stores, with the remaining 10 in Phoenix and Las Vegas.

The retailer has tried to operate under the radar, but success attracts attention. When reports began leaking out last year that the retailer was plunking down millions for land parcels in shopping-center projects, communities began proactively contacting Kohl’s.

Jane McVey, director of economic development for Oceanside, Calif., said she solicited Kohl’s because she thought it would be a good fit for the community.

“They seem to have value-priced quality merchandise that would appeal to us,” she said. “We have a high degree of working women making family purchases for clothing, so I started leaving messages for the company because it seemed like it would be a really great fit.”

McVey confirmed the company has obtained permits to put a store in a new shopping center along a feeder highway that links the area’s two main interstates, I-15 and I-5.

The San Diego suburb also has Mervyn’s in town, which McVey said doe`s “pretty well.”

“A rapidly expanding retailer needs very solid business processes, and in the case of Kohl’s, you have that well-run, oiled machine,” said Lori Schafer, president and ceo of Marketmax, which just sold its “integrated merchandise planning solution” system, which does assortment and space planning, to Kohl’s.

“The biggest issue in opening stores in new markets is how to tailor the assortment to local consumer needs: micromarketing. Whether you go into Texas or Boston or California, you have to make sure you have a different product mix. There are a tremendous number of retailers that still need to do that.”

Schafer also said retailers must be sure they utilize systems they won’t outgrow, systems with “scalability,” meaning an ability to handle high volumes of data.

Several developers contacted for this story declined to comment, citing confidentiality agreements.

When asked for reaction to Kohl’s arrival here, most retailers offered carefully worded statements about staying focused on their own game.

“Yes, we’re following the story of Kohl’s. Our reaction to any competition is to be aware of what they do, but to stay focused on being the best Gottschalks we can be,” responded ceo Jim Famalette of the Fresno, Calif.-based chain. The 98-year-old regional retailer has 86 stores, 39 of which are in California. The company announced June 7 it will close two stores, one in Idaho and one in Washington State, to “focus on those markets where we can leverage our marketing and distribution costs,” Famalette said. Although Gottschalks carries a smattering of higher-end junior brands, like Tommy Hilfiger and Calvin Klein, it overlaps with Kohl’s in reaping most of its volume from moderate labels like Unionbay, LEI and Mudd.

Wet Seal spokesman Steve Strickland said its Midwestern customers list Kohl’s as a place they shop.

“Kohl’s shows up on the younger end of our demographic,” he said. “As far as direct competition, I think they sku more basic than we do.” Wet Seal caters to tweens through young contemporary customers with its Zutopia, Wet Seal and Arden B chains.

Strickland said although he expects Kohl’s to “carve out its share of the market,” he believes Wet Seal’s three concepts can hold their own. “As long as there is a new, exciting player getting people out of the house and spending, we’re happy. This could be a boost to California retailing in general.”

J.C. Penney, with the 80 stores in California representing one of its largest national clusters, said simply it is proceeding with its five-year recovery plan.

“J.C. Penney has historically lost business to Kohl’s,” noted U.S. Bancorp’s Klinefelter.

Industry insiders said most retailers dread Kohl’s arrival, especially as word leaks out around the industry that the planned promotional effort includes radio, television, newspaper, gift-card mailer and couponing campaigns.

“If there’s anybody that’s really happy about this, it would be the print media,” observed LAECD’s Kyser. “Because they’ll get the first blast of the ad campaign and then the full response from everyone else trying to protect their business.”

The company spent 3.6 percent of sales on advertising last year, roughly $270 million. Next year, it will start advertising on national network TV, a pricy but often effective move for chains with stores coast-to-coast. Kohl’s currently advertises nationally on cable television, which drives traffic to its e-commerce site.

Not only television stations and metropolitan newspapers with Sunday sections, but vendors are also privately cheering the retailers’ arrival.

“Whenever you talk to an apparel company about Kohl’s, their eyes light up,” said Jennifer Black, an analyst with Wells Fargo Van Kasper. “If you’re stuck in department stores, it’s just a massive consolidation. You’ve got nowhere to go. People think Kohl’s is a savior.”

Connie Maynard, vice president of junior sales for Unionbay, called Kohl’s “a great partner.”

Unionbay has sold to Kohl’s since 1992; today, the retailer is one of the Seattle-based brand’s top three accounts. Maynard said she’s been meeting with Kohl’s for several months, hashing out merchandising details for the rollout. She declined to give specifics. Analysts note that Kohl’s generally has not changed its merchandising strategy from region to region.

Maynard described Kohl’s management as “information seekers.”

“They’ll pick our brains and grab as much as they can,” she said. “Then they’ll sort through it and see what’s most important and what applies to them as merchants.”

Philip Byer, president of Byer California, a supplier to Kohl’s, said the retailer has been “very proactive in contacting their suppliers to make sure their logistical needs are met and the company’s infrastructure is equipped to handle the expansion of business.”

For its part, Kohl’s has also established a hub here. Goods for all Western stores will move out of the San Bernardino distribution center, slated to be operational by November, according to John Magness, senior vice president with Hillwood Investments. Hillwood is developing the industrial park, dubbed AllianceCalifornia, that houses Kohl’s distribution center as its anchor tenant.

Magness pointed out tenants of AllianceCalifornia can obtain foreign trade zone status, though Kohl’s to date has not exercised the option.

“We’re considered as a sub zone of the Port of Long Beach,” Magness said. That means containers can travel in bond by railroad the 70 miles between the port and AllianceCalifornia.

“So you don’t have to pay any tariff until goods exit the warehouse — basically, until you’ve sold it,” Magness said.

With its move into one of the nation’s most prized retail territories, Kohl’s days of operating under the radar are long gone.

“I’ve got a ringside seat,” said Kyser of the upcoming battle for retail market share in California. Kyser lives in Downey, Calif., where Kohl’s is reported to have inked a deal for space in a new strip mall. The site is just a stone’s throw from the Stonewood Mall, a classic regional mall with a Sears, J.C. Penney, Robinsons-May and Mervyn’s in it. “I’m going to watch this very closely to see how it plays out.”