Sean Iddings Resident guitarist and aspiring intelligent fanatic.

Action Speaks Louder Than Words

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In March 2006, the leader of an organization wrote the following in his letter to investors:

“My goal is to see [Company name] become a great company whose greatness is sustainable for generations to come.”

The company the leader oversaw was mature. The decline had already begun over a decade ago. Something new needed to be done to revitalize the company.

Based on the snippets the leader wrote below, ask yourself if this individual was the right person to lead.

How did the leader plan on spearheading a change back to greatness? The leader said:

“The most important aspect of beginning to create a new and winning culture is ensuring that we have the right people in place. We have worked hard attempting to identify the right people, and we now have an executive team that we believe has the capabilities and commitment to enable [Company] to become a great company.”

The leader believed one of the critical elements to having a lasting organization is to develop a culture of “testing and measuring, and openness to change.” His model was Jack Welch reinventing GE (General Electric) in the 1990s and looked to recreate a similar culture. Part of his duty was to raise important issues and “rely on the experience and ability of our talented management team to make those ideas come alive.”

This leader also wrote how he wanted to win with customers. He said:

“Our focus is on understanding our customers and figuring out how to provide them products and services that they value, so that we can build relationships with them and profitably serve them over the long term.”

Lastly, the leader talked about the importance of people in returning his company back to greatness:

“Ultimately, however, the success of a company is a function of its people. To be successful, we, like any company, needs to continue attractive associates and executives who are talented, hardworking, honest, ethical, commercial, and dedicated.”

Sounds good, right?

Things appeared to get better. In the following letter to shareholders, the leader added:

“Perhaps the most critical investment decision is the decision to invest in the people that make up a company. I have always believed that people should be paid for performance.”

The new incentive plan was centered around achieving lofty EBITDA targets. The leader said that it was “important to set goals that challenge and stretch us.”

Furthermore, the leader shortly after implemented a reorganization to drive decision-making down into the organization “to harness free-market forces to convert a centrally planned company into a more decentralized company.”

All of these decisions were rooted in the goal of increasing “the per-share value” of the company. And one way of doing that was “have fewer shares outstanding” so that “the returns to shareholders can be further magnified so long as we pay a reasonable price for the shares repurchased.”

This sounds like the leader was an intelligent fanatic business operator. He talked about culture, people, decentralization, incentives and capital allocation.

How did it all turn out?

Sales fell 66% over the next twelve years. The company lost a net $7 billion. The stock has crashed 99.6%. The company, Sears Holdings, filed for chapter 11 bankruptcy on Monday October, 15.

Eddie Lampert, Sears’ leader, largest shareholder and composer of the previous statements, failed to revitalize Sears. Granted turning around a business the size of Sears is next to impossible. Despite this, we believe Eddie Lampert’s actions didn’t agree with his words.

There are plenty of leaders who say the right things. However, these imposters do not have true deep fluency; they don’t walk the talk. They fail to execute because they don’t know how to.

As we wrote in The Most Valuable Investment Skill, it is possible to spot imposters. Simply observe the person improvise in the moment. An example I give in our online course is of an 11 year old guitarist. He copies Eddie Van Halen perfectly. But when the singer tries to improvise with him, in the moment, the kid is like a deer in headlights!

Let’s apply this exercise to Eddie Lampert. With enough digging these things could have been unearthed in real time.

Where Reality Doesn’t Meet Words - No Buy In

Grand visions are nice, but they need everyone to buy in. Otherwise, the vision is worthless, merely words on toilet paper.

Few Sears employees bought into Eddie Lampert’s vision. How could they? Lampert made it clear to all that he lived above the people in the company. Like Marquis de Mores, Lampert maintained his billionaire lifestyle. Ever since becoming chairman, and later CEO, Lampert has lived and worked from his $38 million estate in Indian Creek Island in Florida, off the coast of Miami. A vast majority of Sears employees, on the other hand, made minimum wage.

Lampert only visited Sears headquarters once a year for the shareholder meeting. The only way Sears executives could see Eddie was through a screen. One former Sears executive said, “We used to joke about who had to go upstairs to get fixed and see Oz.”

Leaders set the tone. By not taking the effort to meet with Sears executives in person, Lampert was telling those below him to do the same.

Additionally, Sears employees all agreed Lampert was out of touch with reality. If the guy didn’t meet with his corporate executives, we can safely assume he rarely visited stores in person. The reality was stores were in shambles, employees had low morale and customers were angry.

One former vice president said, “You walk in and you are embarrassed as an employee when the ceilings are leaking and the floors are cracked.”

In some stores, employees hung bedsheets to shield shoppers from sections that stood empty. An employee for a Sears in Ohio said that his store had broken walls, escalators and frequent roof leaks.

Where Reality Doesn’t Meet Words - Incentives

Eddie Lampert was correct that incentives are important. Incentives drive the world. However, not all incentives work.

As we wrote in our case study on “Perverse Incentives”:

Perverse incentives are like a covert spy, they look, sound and seem like great ideas. Yet in reality, they will compound your problems manifold.

It comes down to what you prize, quantify, and pay for is what you tend to get.

Eddie Lampert got exactly what he prized, quantified and paid for.

Let’s look at the decentralization of Sears into more than 30 autonomous units in 2008. On the surface it sounded like a great idea. Each unit had its own president, chief marketing officer, board, and separately measured profit and loss. The company was now 30 smaller companies. Driving decision making down closest to the customer should lead to better listening, understanding and reaction to customers, right?

Not always. Only with the right buy in, culture and incentives does decentralization work.

Sears executive bonuses were based on individual unit performance. That seems all well and good, but it often leads to zero-sum games. Sears executives have chosen to boost their own division’s short-term profit at the expense of others. The culture also led many of the units to hoard best practices hurting the company as a whole.

For example, Kenmore, Sears’s valuable appliance brand, was its own business unit. Kenmore executives found that they could make more money selling other products, so they gave outside brands better shelf space. This, along with other missteps, has decreased the overall Kenmore brand’s value significantly. Fifteen years ago, Sears valued Kenmore at $2 billion. Eddie Lampert offered to buy Kenmore for just $400 million August 2018.

In Sears’s transformation, the company was to become more “asset-lite”. In other words, Lampert’s vision was to invest heavily into e-commerce and reward customers for shopping stores with the Shop Your Way program, introduced in 2009. Store employees were required to meet ambitious quotas for new rewards program sign-ups. Instead of rewarding customers, it backfired.

A former Kmart assistant manager stated Shop Your Way was “confusing and poorly executed, killed profits, slowed down customer service, and featured targeted advertising that was completely off base.”

The former manager further elaborated:

“Items scanned per minute decreased from 18 to five items per minute because the program was littered with exclusions and confusion. Several items didn’t ring as advertised or generate the points as expected. This resulted in long lines and angry customers. Abandoned carts meant utilizing payroll to return those items back to stock.”

Humans naturally have an inclination to work for mutual benefit of the whole. As social beings, we like to cooperate and collaborate towards a shared goal. If incentives promote the opposite, then people will work against each other and destroy an organization from within.

Identifying the Real Mccoy

Eddie Lampert has been phenomenally successful at investing. Unfortunately, he got himself in a difficult position of turning around a massive company where he lacked similar abilities.

Saying the right things doesn’t necessarily indicate fluency and ability. True deep fluency comes from years of experience, apprenticeship and thought. A long track record in the appropriate field helps, but it is not always available.

How do you test if someone is the real deal? Simply observe the person improvise in the moment. Make sure that they do what they say and say what they do.

Sources

https://www.businessinsider.com/sears-workers-reveal-bad-workplace-2016-6

https://searsholdings.com/invest/chairmans-letters/february-2011

https://www.businessinsider.com/sears-failing-stores-closing-edward-lampert-bankruptcy-chances-2017-1

https://www.bloomberg.com/news/articles/2013-07-11/at-sears-eddie-lamperts-warring-divisions-model-adds-to-the-troubles

https://www.vanityfair.com/news/2018/03/the-strange-odyssey-of-hedge-fund-king-eddie-lampert-sears-kmart

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