ECON 550- Case Study 2: Analysis of Risk, Uncertainty and Managing Incentives

ECON 550- Case Study 2: Analysis of Risk, Uncertainty and Managing Incentives

Life is full of risks and uncertainty. No one can with 100% accuracy predict when or if something is going to happen. However, through the use of tools like math, more specifically statistics, companies and other entities can predict within a reasonable range a particular outcome. With that in mind they can strategize based on that prediction in hopes to come out ahead of their competition. The company I’ll be covering had an amazing start when it first began, but failed to adapt to the changing times and invest properly. This company is named Sears.

You may have heard of Sears going into bankruptcy over the past few months. If not, here’s a brief history of the company. Sears began as Sears-Roebuck after the namesake of it’s two founders Richard Sears and Alvah Roebuck (Howard, 2017). They began in 1888 with a mail order catalog that they sent all over the country. Sears sold mass produced appliances like washing machines (Isidore, 2018). Not only that, but during the Jim Crow era, the Sears catalog allowed African Americans access to goods and fairer prices that local white owned stores often took advantage of (Charlton, 2018). Over the years, Sears created the insurance company we know today as Allstate and the credit card company Discover. They of course dabbled all major appliances, clothing and jewelry. Their all encompassing reach to try and fulfill every customer need is a lot like Amazon if you think about it. However, unlike Amazon they failed in their endeavor of evolution.

In the past year, Sears has filed for bankruptcy and to avoid a total shutdown of the company CEO Eddie Lampert infused the company with $5.2 billion dollars from his hedge fund company, ESL Investments, in order to keep the company afloat. In keeping it on life support, he managed to keep 400 stores open which equates to roughly 45,000 jobs (Siegel, 2019). Lampert has plans to revitalize Sears and Kmart, but to what extent? Bankruptcy doesn’t happen overnight. So how did this company get here?

With the advent of the internet and the more people buying just about everything online, Sears was faced with many challenges that they simply left unchecked. Mark Cohen, who was the Chief Executive Officer of Sears Canada believed that at the end of the day it came down leadership. The individuals that stepped in to save Sears as retail sales began to plummet only implemented cost cutting measures as way to stop the hemorrhaging. With an organization as large as Sears more approaches needed to taken besides just cutting costs and trying to save as much money as possible. Cohen also believed that leadership did not have a well defined plan in order to carry the company forward. At the end of the day, an organization has to have direction. Something everyone can focus in on that allows the company to grow. Without an operating strategy how can any company be effective?

I would recommend going back to the drawing board. Gather all leadership, poll every employee and survey the customers to find out what they think Sears is what its strengths and weaknesses are. Analyze all this data and see where it takes you. This can help build trust with employees showing that they really are part of the process of making this century old company a better place to work and serve customers. Asking your customers for this kind of help can tell you what customers are looking for in regards to value and what they believe is important to them in products and service. Doing this can help give leadership insight on how to proceed. Coupled with this information, Sears needs a new and aggressive marketing mix. It needs to address what the products, prices, promotions and places are going to be (Kotler, 2016). The

Four P’s of any marketing projects must be addressed. At this point in Sears life cycle, the idea needs to be very different than anything its ever done so again going back to the beginning and figuring out what to focus on is paramount.

Another option would be to completely reorganize the structure of the company. Perhaps change the model in how they interact with customers. Sears began as a company that specialized in selling large appliances and handy man equipment. Over time, the company branched out to many other industries and tried to incorporate that into everyday operations. The only other business that does this with regularity are companies like Costco, BJ’s and Sam’s Club. I think a move like this would benefit Sears in the long run however they would still need to distinguish themselves from the formerly mentioned competition.

Perhaps specializing in installation of appliances and holding workshops on how to use certain power tools. While doing these workshops they could stream/upload them to YouTube and other social media expanding their presence. Let’s face it, when it comes to big retailers younger millenials have absolutely no idea who Sears is. This method, along with a very big push to marketing other channels will Additionally, give viewers and attendees as a special discount for using participation or simply viewing the video. Pertaining to appliances, offer free installation and delivery to all those that have a membership. Customers that buy their private label, Kenmore, also get the free installation plus free installation kits which I recently found out are sold separately at every retailer.

An adverse selection problem occurs when a party or seller in this case has more information about the product or service being sold to the client or customer (Froeb, 2018). Sears is currently trying to sell their flagship appliances to customers. However, Sears also closed down their product testing laboratory back in 2005, so they know that the standard that they had before is not what it once was. Continuing to sell these products to customers not having fully tested these products puts their customers at a disadvantage that could lead to some harm consequences and even further lawsuits. Sears response to this could reopening the testing lab and investing more research, safety and efficiency. This would prove to their customers that they still have the best appliances on the market and that their customer really do come first. However, what they actually ended up doing was allowing Amazon to sell their products. This move in itself isn’t a terrible move, but Sears has to share a percentage of their profits with Amazon in doing so.

A moral hazard occurs when an organization enters into an agreement with another but provides incorrect information to bolster its standing (Froeb, 2018). In Sears case, the employees entered into an agreement with the company the promise of having their pensions/401k’s paid out in the event the company goes under. Sears so far has not honored that agreement citing slumped sales and store closures. While that information isn’t misleading, what employees find odd is Sears paying executives million dollar bonuses when they aren’t even guaranteed a paycheck at the moment (Isidore, 2018).

If one is really interested in changing how the company operates it needs to revamp its image. Many companies already get a bad wrap because we these executives and shareholders receive gross amounts of money for whatever the reason may be, but to go through near bankruptcy procedures and give executives millions of dollars that could be reinvested into the company just looks irresponsible and careless. My advice would be not to give these bonuses but redirect them back into the company so that it can be used for the new marketing project or training for employees that can help them with customer interactions. Even using these as a payout to employees that are no longer with the company would’ve been a better use because you are still showing your employees how much you value them.

This leads into the principle-agent problem. The principle-agent relationship occurs when one party does the work while the other receives the benefit of said work (Wong, 2014). Every company has this relationship with their employees. Employees are hired to literally run the company while executives make decisions on direction, but ultimately are compensated far more than those that do the actual work. The problem with this is that employees are undervalued and can be ‘easily’ replaced should they leave for any reason.

As with the moral hazard, the executives are more concerned with being paid their very generous bonuses than the actual employees or the company for that matter. They aren’t showing employees or customers that they are valued, thus more poor decisions are being made. One would think that considering the dire circumstance of Sears that annual bonuses would be toward the bottom of any relevant list of things that need to be done. Unfortunately, it seems as though the more important things are bonuses and continued bad decisions. That leadership piece that Cohen touched on earlier still isn’t being serviced properly. The framework for addressing their problems has not been met so they are doomed to continue making such choices.

The tools that Sears is currently using to justify their current actions is by selling off pieces of the corporation for as much profit as possible. For example, they sold off Kenmore, Craftsman tools and Diehard batteries in an attempt to keep their doors open, but in doing so I believe hurt their brand more than anything (Isidore, 2018). These are brands that people recognize so it may have been a better strategy to double down on them and show the world why those brands are still important. Customers still want quality products and that’s what Sears was known for and that foundation that can be built upon again.

Like many other companies, Sears organizational structure is that of a functionally organized firm. A functionally organized firm is one that numerous departments that conduct different tasks, but all working towards that same goal. (Froeb, 2018). This set up allows employees to become specialists at what they tasked to do which can be a good or bad thing. On the one hand, this person or group of people are so proficient and knowledgeable at their specific job that it enhances the overall product or service. On the other, this department can become complacent because this is all they do thus hurting organization. Not quite sure where the disconnect is within the company as it’s troubles were never internal at least not from a department point of view.

The best suggestion I can think of out with the old and in with the new. Starting with the CEO. Eddie Lampert has been the CEO of Sears for far too long and the situation has not gotten any better under his leadership. His ideas just aren’t working. Part of being a good leader is recognizing that your best laid plan just isn’t that good. The only common denominator between Sears current situation and Eddie’s arrival is him. You need to remove the ego and pride from the situation and ask yourself do you really want this business to continue on or not? From there replace other top executives that have been there ten plus years and get some fresh blood in the mix. This creates new ideas and experiences that could very well have a much better shot of allowing Sears to thrive again as opposed to remaining on life support.

Sears has a very unique opportunity to rise from that ashes as it were regain some of that former glory. However, it needs to capitalize on better management and returning to some of their core concepts about why they want to be in business and what do they hope to accomplish by doing so. Embrace new ideas and people and don’t be like Blockbuster or Toys R Us and think that because you have been around for so long that people just love you and won’t let you fold. As we’ve seen even those once popular companies failed because they didn’t adapt to changes in times and trends.

REFERENCES

1. Howard, V. (2017). The Rise and Fall of Sears. The Smithsonian. Retrieved from: https://www.smithsonianmag.com/history/rise-and-fall-sears-180964181/

2. Siegel, R. (2019). Sears Survives Bankruptcy Auction and Will Keep 400 Stores Open. Denver Post. Retrieved from: https://www.denverpost.com/2019/01/19/sears-survivesbankruptcy/

3. Wong, P. (2014). Sgency theory: Which of these relationships are agency?. Retrieved from: https://www.youtube.com/watch?v=cpu0dw9VY2E

4. Cohen, M. (2018). Sears: A Case Study in Business Failure. Columbia Business School. Retrieved from: https://www8.gsb.columbia.edu/articles/ideas-work/sears-case-studybusiness-failure

5. Isidore, C. (2018). Here’s What’s Killing Sears. CNN Business. Retrieved from:

https://money.cnn.com/2018/02/12/news/companies/sears-downfall/index.html

6. Isidore, C. (2018). Bankrupt Sears wants to give executives up to $25 million in bonuses. CNN Business. Retrieved from: https://www.cnn.com/2018/11/16/business/searsexecutive-bonuses/index.html

7. Kotler, P., Keller, K. (2016). A Framework for Marketing Management: Sixth Edition.

Pearson Education, Limited.

8. Charlton, L. (2018). Back When Sears Made Black Customers a Priority. The New York Times. Retrieved from: https://www.nytimes.com/2018/10/20/us/sears-jim-crow-racismcatalog.html

9. Froeb, L. M., McCann, B. T., Shor, M., & Ward, M. R. (2018). Managerial economics: A problem solving approach (5th ed.). Boston, MA: Cengage Learning.