Case Study: Kmart Bankruptcy and Department Store Operations

Walmart dominates the competitive department store market, but does it have better cost performance than its competitors? Why did Kmart go bankrupt while other retailers such as Target Corporation flourished?

Walmart has maintained a consistent relationship between cost of sales; and sales, administrative, and selling costs; to sales, even as sales have grown from $50 billion to $250 billion. 95.3% of each additional sales dollar has gone to these costs.

Target Corporation also has maintained a consistent relationship between these costs and sales, but only 87.8% of each additional sales dollar has gone to these costs.

Kmart had a similarly consistent relationship for cost of sales through 2000, although the sales, general, and administrative relationship had some variability. Unfortunately, 103.7% of each additional sales dollar went to these costs. This means income actually declined as sales grew from $28 billion to $37 billion per year.

When sales declined in 2001 and 2002, costs of sales did not decrease as much as expected given the prior relationship. Kmart entered bankruptcy in early 2002 and emerged in quarter 2 of 2003. Sales rebounded in 2003, and cost of sales was a little better than would be expected.

Comparing cost of sales performance for these three competitors, Target has the best marginal rate at 65.3%, while Kmart is highest at 96.4% (through 2000). However, Kmart has the lowest total cost of sales for sales levels below $24 billion. Target has the lowest cost for higher sales levels

For selling, general, and administrative costs, Kmart has the lowest marginal rate, while Target has the highest. Walmart, however, has the lowest total cost up to sales levels of $54 billion. Kmart has the lowest total cost above that sales level.

Combining these two costs and subtracting them from sales (this does not equal operating income due to some other charges), the poor Kmart performance becomes clear. They are very profitable at low sales levels, but profitability declines as sales increase. They begin losing money around $50 billion in sales.

Target, on the other hand, is more profitable than Walmart at sales levels above $17 billion. Thanks to its high 12.2% of each additional sales dollar that goes towards operating income. Although Walmart has been very successful with revenue growth, Target has performed better with cost control. Kmart will have to produce significantly different cost performance to survive.