Saks Appeal Goes Virtual
from Summer 2000
by Ann Reilly Dowd
From its premier position across from New York City`s Rockefeller Center, Saks Fifth Avenue stands like a monument to traditional luxury retailing. Shoppers from all over the world can find everything from a bejeweled violin-shaped Judith Lieber evening bag to the latest Armani suit or sybaritic scent from Tahiti. But are those same people about to hunker down in front of their computers and join the cyber-generation cruising the virtual aisles of e-tailing?
The Saks board thinks so. The 18 directors have signed off on a make-or-break $110 million gamble to transform Saks this summer from a purely brick-and-mortar operation to one that will also thrive on the Net. "I think of our venture as building a store, only the store has no walls, so it can be as big as the market demands," says R. Brad Martin, Saks chairman and chief executive and a former Tennessee legislator.
Most boards share this same conviction and know that they must find a way to move at least part of their business onto the Internet. Like Saks, they will have to manage their existing, traditional businesses while picking their way through unmapped virtual terrain that is already littered with casualties. But pick their way they must. The only certainty is that standing still is the most dangerous strategy of all. Yet the ways to ride the Internet are many. Should a company limit itself to business-to-business ventures or try business-to-consumer, too? How should it finance its move into the ether, via an IPO spinoff or with borrowed money?
Continually pulled, pushed, and led by the soft-spoken but persistent Martin, the Saks board wrestled with its cyber-strategy for 15 tense months: at board meetings, in one-on-one phone calls, and-a big clincher, as it turned out-during a weekend retreat in Tennessee`s Smoky Mountains.
In addition to the usual dilemmas, Saks` board members especially worried about the damage e-tailing might do to the company`s valuable brand-and to its weakened stock. Shareholders are still recovering from the 1998 deal in which Proffitt`s, a five-store family outfit turned megachain, topped off a 10-year acquisition binge by grabbing Saks and its high-profile name.
Breaking the cyberspace frontier is the logical next move for Martin, 48, whose career already has shattered a number of barriers. With the financial and electioneering support of his Kappa Alpha fraternity brothers, he won a seat in the Tennessee State House while still an undergraduate at Memphis State.
He went on to earn an MBA at Vanderbilt. After quitting politics in 1982, he became a successful real estate developer, building strip malls throughout Tennessee. By 1984, he had put together an investment group to buy Proffitt`s, a sleepy, family-run department store company based in Knoxville. He moved fast to build up the Proffitt`s chain, both by adding more eponymous outlets and by acquisition. Among the big-name chains he grabbbed: Carson Pirie Scott. The Saks purchase brought the number of stores to more than 350.
The board`s makeup changed as Martin added new companies. Among the directors shown on these pages, for example, Donald E. Hess, former chairman of Parisian, joined the board in 1996 when Martin bought that chain. Marguerite Sallee, chairman and CEO of Frontline Group, a workforce training firm, became a director the same year. Charles J. Philippin was on the Saks board and became part of the acquisition, though he has since retired.
In early July, C. Warren Neel, dean of the College of Business Administration at the University of Tennessee, and a director since 1987, became Tennessee`s interim commissioner of Finance and Administration. Both Governor Don Sundquist and Attorney General Paul G. Summers have given Neel permission to remain on the boards of Saks and the other companies for which he serves as a director, though he will In early July, C. Warren Neel, dean of the College of Business Administration at the University of Tennessee, and a director since 1987, became Tennessee`s interim commissioner of Finance and Administration. Both Governor Don Sundquist and Attorney General Paul G. Summers have given Neel permission to remain on the boards of Saks and the other companies for which he serves as a director, though he will take a leave of absence from the university.
Just as Martin once argued that Proffitt`s future lay in acquisitions, he now insists that Saks` online venture will ultimately lift both its earnings and stock. "The online business is a great growth opportunity," he says. "No one knows precisely how big the online luxury market will be. Estimates range from $15 billion to $20 billion by 2006. Who knows? But with Saks` brand power and vendor relationships, we think the market share opportunity is just enormous."
Neiman Marcus, Nordstrom, and other competitors that have reached similar conclusions are already online, but Martin`s steely blue eyes narrow at the suggestion that Saks is late to e-tailing. "We were not willing to slap something together just to meet the timing of the Internet," he says. "That could have potentially negative effects on our brand. We approached this as an extension of our brand and a real, live business, not some Internet craze."
Martin`s curiosity about the Internet predates the acquisition of Saks. In the mid-`90s, he was nudging his board about the need to set up a business-to-business (B2B) technology program that would use the Internet to connect the thousands of suppliers that the Proffitt`s chain used. "There had to be opportunity for productivity improvements," says Martin, and the board agreed.
Martin also shared his "musings," as he puts it, on his far riskier dream of business-to-consumer e-tailing. "I was convinced that there was a long-term opportunity in online retail," he recalls, "but I was equally convinced that I really needed a brand to make it work." Proffitt`s, however profitable, wasn`t the brand he needed.
Saks was. To be sure, a series of different owners, a river of red ink, and various strategic setbacks had left the store chain bruised and battered. But like an aristocrat after a revolution, it still had its elite name, which Proffitt`s adopted soon after the deal.
The Saks pedigree represented the entrée to the Net that Martin needed. "Implicit in the 1998 acquisition was the idea that we could begin the development of an online retail strategy with a huge competitive advantage-that is, a great national brand with enormous international potential," he says.
Some of the board members weren`t so sure. "In 1998, we didn`t think e-commerce was something we should be seriously interested in," says Sallee. "We knew the Net was a powerful tool and that technology would play an increasingly important role in how to run a company. But we saw the Internet more as a B2B strategy. We were very skeptical about e-commerce. What surprises me is how quickly Brad led us to change our opinion."
In addition to his persistence, Martin proved adept at anticipating potential sticking points. At board meetings he was always prepared for tough questions and was ready to argue the pros and the cons of his own strategy. What he was doing, some board members acknowledge, was giving the board what management consultants like to call "ownership" of a particular plan.
Martin had other challenges. Among them: the integration of the wildly different cultures at Proffitt`s and Saks. Contrary to myth, the old-line southern retailer was known for its efficiencies, whereas its new northern partner seemed profligate and undisciplined. The odd coupling met particular delight south of the Mason-Dixon line: A New Orleans Times-Picayune cartoon pictured a Saks Fifth Avenue doorman calling out to a Yankee couple, "Y`all come back now, ya hear?"
To head the team that would put Saks` online strategy together, Martin turned to a surprising source of talent, the Pilot Corp., a family-owned national chain of truck stops and convenience stores based in Knoxville. What he really wanted was Bill Haslam, Pilot`s president and a son of the company`s founder, whose entrepreneurial ways had caught Martin`s famous blue eyes. At first Martin lured Haslam aboard to head the company`s strategic planning effort, which included putting together an overall view of how to get Saks online. Haslam grabbed the offer. It was, he says, "an exciting opportunity."
At the April 1999 board meeting, Haslam "laid out our plan for coming up with a plan. We were really just beginning to dip our feet in the water." He also made it clear that to move from vision to launch, everybody, including himself, needed to move fast. He asked for another month to complete his research, after which, he said, he`d want to assemble an e-commerce task force that would include strategic consultants and technology experts.
Some directors feared Saks was already behind the e-curve. "It was like this gnawing sore," says Saks president and inside board member James Coggin, who was focused on developing the company`s B2B strategy. "We worried that we`d waited too long, and that we might be so far behind that we couldn`t catch up. Earlier I wondered if this was just a fad. Now, I was worrying if we weren`t too late."
At the same time, the more cautious directors couldn`t take their eyes off the dead and wounded who`d already tried life online-or the amount of money that had been spilled on the battlefield. "We realized that there were a lot of failures out there," says Neel, the business school dean. "We all knew people with B2C ventures whose burn rate on capital looked like they would never make money. So we wanted to think very seriously about what assets we had that could make us different. We didn`t want to launch into a bottomless financial pit."
Still, all the directors finally agreed that the greatest danger Saks faced was delay. They told Martin what he wanted to hear: Develop an e-tailing plan.
Over the next two months, Martin, Haslam, and Coggin, accompanied by some of Saks` bright up and comers, crisscrossed the country to learn all they could about setting up an online store. They visited Microsoft, IBM, and Cisco Systems, among others, and slowly put their plan together. "It was like trying to drink from a fire hose of information blasting from everywhere," recalls Haslam. "With so much going on in e-commerce that`s new and exciting, and with everyone believing their idea would work, the greatest difficulty was separating what applied specifically to us."
In June, at their traditional annual planning session at the Inn at Blackberry Farm, a Smoky Mountain resort, the board members got their first detailed look at where Martin wanted to take Saks. He laid out a twofold strategy. First, he said, he wanted Saks to be the world`s premier online retailer of cosmetics. Later, he wanted to add all the types of goods sold on the first floor of Saks, such as accessories, cosmetics, and gifts.
Martin told the board that high-end e-tailing would produce big margins for the company, arguing that Saksfifthavenue.com would be "a real, live value-creating economic business and one with a very compelling economic model." Then he asked for the money he needed: $35 million for the first year and an additional $75 million over the next four.
The price tag put a damper on the board`s enthusiasm, and Martin quickly warned against delay. "The consumer has moved online faster than anyone dared dream or anticipate," he said. "We need to get going. With your permission, we need to go fast."
At the resort, the directors mulled over what he had said, over elaborate meals and fine wines, during hikes through the mountains, and in individual conversations that lasted late into the night. The big question was how to make an e-tail venture work. Neel urged that the online store ensure the preservation of Proffitt`s traditional, small-town values of integrity and trust, as well as its valuable long-standing relationships with vendors. Sallee spoke up for the busy working woman, pushing for "a virtual store with my own closet and personal shopper who could show me how to put things together-all those service elements that are the hallmark of Saks."
Neel says some issues were discussed "in vivid color," and by the end of the retreat, there were still "more questions than answers." Would people really buy luxury goods online? Would they buy perfume but not Gucci shoes or St. John`s Knits? Would online sales cannibalize store sales? Would Martin`s e-economics really work? How would Saks finance the venture? How would Wall Street react-would the battered stock revive, or drop further? Was Saks already too late? Whatever the questions, Martin had made a sale. The board backed his plans to launch an e-tail site.
Haslam admits that putting a strategy together was far more challenging than he ever thought. "It`s like you`re racing down a road with no lines," he says. To help draw some of those lines, he sought the counsel of various outsiders who had traveled some of the roads he wanted to follow. He chose McKinsey & Co., the consulting firm, to help refine the overarching strategy; Wit Capital to find other partners; Goldman Sachs to find potential investors; and USWeb as the technology partner.
Such expertise was essential. But it was Haslam`s decision to launch a series of focus groups that helped steer Saks away from what might have been a disastrous marketing decision. Martin`s earlier plan, aired at the retreat, had been to have an online first floor, offering cosmetics, accessories, and gifts. But the focus groups-representing Saks regulars, along with folks who spend more than $2,000 a year on luxury goods in New York, Chicago, and San Francisco-wanted much more. They asked for all seven floors of a traditional Saks store-designer clothing, for example-and all the services they had come to expect when they made a personal visit. Even Martin says he was "shocked to learn that people wanted to buy designer clothes online," but the findings convinced the board what kind of site it should have. As board member Hess puts it: "The plan is to ultimately duplicate Saks Fifth Avenue online."
The focus groups also revealed the critical importance of being able to customize content and the need for Saks to integrate the online store with the physical one so that customers could make returns and get alterations. For weeks, it seemed that no sooner were Haslam and his team about to settle on one kind of online store than the information changed and they had to start the thinking process anew. "Fortunately," he says, "the board recognized this is a work in progress."
Martin and Haslam quickly understood that Saks Direct, the e-operation and catalog business that Haslam would be heading, would need its own management and marketing team. The sky-high valuations of dot-coms ended any thoughts of simply buying such a group. Ultimately, says Haslam, "we decided not to buy or rent but to build our own."
The back-office operation-the picking, packing, shipping, and customer inquiry part of the business that retailers call fulfillment-was no less important. After investigating various outsourcing possibilities, Saks decided to keep this in-house, too. Its catalog companies and sister retailer, Bullocks, had a first-rate fulfillment center in Aberdeen, Maryland. The company would rely on that.
As Saks` management was putting its e-strategy together-and as Coggin continued working on the B2B side of the business-the board was busy getting computer savvy. As recently as 1998, outside directors weren`t even on the company`s e-mail. Within a year, warp speed e-missives were zooming between Martin, top management, and board members.
At home, directors were doing their own online due diligence, checking out what various websites had to offer, and at board meetings they happily strutted their newfound knowledge. At one meeting, the types of questions that bounced around the table included: "It takes too many clicks to get to the shopping cart on XYZ`s site." "The search engine on ABC doesn`t do sizes." "Have you seen the Volvo site? You can design your own car. Could we let customers design their own clothes?" "Would that slow down the site? And what would it cost?" Says Neel: "The board was very engaged in detailed discussions of the look and feel of the site because of our concern not just about financials, but about image and brand integrity." Brand integrity always had been high on the board`s list of priorities. "It`s our biggest advantage-and what we struggle with most," Haslam says. "Our board gave us a lot of leeway to make mistakes. But one thing it made clear: Don`t do anything to hurt the brand."
Though none of the board will say as much, a close second priority has been Saks` stock. The share price did well in Martin`s early years. But despite a brief rally earlier this year, it has been in free fall since the Saks deal was announced. Earnings are picking up. In the fiscal year ending January 29, Saks earned $189.6 million on revenues of $6.4 billion. In 1999, it lost $896,000 on sales of $5.9 million.
Martin has always made clear to the board that the online payoff would take several years. In the first year, he says, revenues are likely to be no more than $20 million, versus $35 million in start-up costs. Thus, like other boards eyeing the Internet, Saks` directors have to figure out how to finance an online venture. Board members have considered various choices, including spinning off the business as an IPO or into a partnership with venture capitalists. "The decision rests on two factors," says Martin, who has been visiting with unidentified Silicon Valley VCs to explore his options. "One, what`s our estimated cost of capital for funding internally versus externally? And two, what does a prospective investor bring to the venture other than capital? Are there alliances or people or strategic value that could be added by having another investor?"
Even if the board keeps Saksfifthavenue.com in-house for now, as seems likely, Martin has been careful to open up the operation so that investors can see how it`s doing. Among the numbers to be disclosed: total sales and pretax earnings or (initially, more likely) losses. Later, the company may also release net profit or loss figures.
Meanwhile, Martin is hoping that the online operation will encourage investors to look at the parent company-and its stock-in a friendlier light. "If I`m right about the economic and return-on-investment characteristics of the online business," he says, "it should be ascribed a higher multiple than the traditional retail business because the growth and return characteristics can be very, very attractive."
Dress rehearsals are always highly charged, as evidenced by the weeks leading up to the July launch of Saks` site. While store employees fussed over some 10,000 different luxury items and the various services that would back and fine-tune them, the Saks board was deep in its own e-assignment. At the February meeting, Haslam asked for volunteers to test the site before it went live on the Internet, and all hands shot up. One thing`s for sure: As Saks launches into cyberspace, its board will be watching-and clicking.
