Sears' Quiet E-Commerce Revolution

In the past few months, Sears Holdings has quietly added more than 250,000 music offerings, movies and video games to Sears.com. It has opened an online software boutique for downloading programs for taxes, graphics, finances and computer security . Later this spring, Sears plans to sell books online for the first time.

The expansion comes as the Hoffman Estates, Ill.-based retailer, struggling in its bricks-and-mortar business, took the significant step in January of breaking its Internet operations into a stand-alone business unit, hiring former Microsoft (Nasdaq: MSFT) shopping portal executive Jim Barr to run it.

A Rich Heritage

Sears Chairman Edward Lampert has been touting the role of the Internet in the company's future, leading some industry analysts to believe the recent moves have the makings of a key strategic decision: to turn Sears.com into an aggressive Web portal that would sell all kinds of products -- a competitor, in other words, for the likes of Amazon.com (Nasdaq: AMZN) .

"If you think about what the Big Book originally tried to do, it was to open up all this stuff to people living in the cabins in the Plains, and that's essentially what they're doing," said e-commerce guru Bill Bass, who ran Sears' online business before Lampert took control of Sears in 2005. Bass currently is cofounder and CEO of Fair Indigo, a fair-trade direct merchant of clothing. "When you think about the power of the Internet, that's what it's really good at."

Brand expert Jonathan Salem Baskin is one who sees the potential. He outlined his self-described radical idea for saving Sears on his blog, envisioning Sears.com as "a gateway to whatever is hot." He suggests Sears host branded boutiques from vendors around the world. Its 3,500-store base could shrink and function as a place Americans can go to pick up or exchange merchandise.

"Talk about a rich heritage," said Baskin, president of Baskin Associates, a Chicago-based brand consulting firm. "Like anything, it would take some commitment. Why couldn't Sears bring the world to me?"

Sears executives declined to discuss the firm's Internet strategy.

Traffic on the Upswing

At an estimated US$2.6 billion in sales, Sears ranks as the biggest mass merchant retailer online after Amazon.com and is the seventh-largest online store in the U.S., according to revenue estimates from online consultants and Internet Retailer's annual Top 500 guide. The estimate includes online operations of Sears' discount chain Kmart and direct merchant Lands' End (NYSE: LE) .

As for traffic , Sears does well there too.

The number of people who visited Sears.com and Kmart.com at least once in February -- an industry metric known as unique visitors -- rose 20 percent, to 14.7 million, from the same period last year. That makes Sears' Web business the second-fastest-growing site among mass merchants in 2007, after Costco Wholesale at 23 percent, according to Nielsen Online.

Sears.com alone drew 12.3 million visitors in February, up 28 percent from a year ago, making it the fastest-growing Web site among its peers, according to Nielsen. Amazon's traffic rose 17 percent in the same time frame.

When traffic from Kmart and Lands' End is added, Sears Holdings is drawing about 18 million people to its Web sites each month. Only Amazon at 47.7 million, Target at 22.6 million and Wal-Mart Stores (NYSE: WMT) at 21.3 million draw more people, according to Nielsen.

"Strategically, in the long run, Sears has to find a reason to exist," said Love Goel, a private equity investor who specializes in online retail as chairman and CEO of Minneapolis-based Growth Ventures Group. "They have a significant direct-to-consumer heritage. It is probably one of their strongest assets and the only silver lining in their business."

Driving Customers Into the Store

It is easy to imagine why Lampert, the Greenwich, Conn.-based hedge fund investor with the Goldman Sachs pedigree, might be enamored with Sears' Web business. It looks good on paper: low overhead, healthy profits, minimal capital requirements and double-digit sales growth, analysts said. It is also cheaper to experiment with new formats online than in a physical store, a bonus given Lampert's fondness testing and retesting new concepts before investing in them.

Further, Lampert already has signaled he would be willing to break down some of the traditional barriers that define a name-brand retailer. Instead of continuing to rely on exclusive products, Lampert has said he would consider selling Craftsman or Die-Hard products at outside retailers.

Why not rely on outside vendors to set up shops at Sears? The company already has arrangements with Teleflora to sell flowers and EchoStar Satellite's Dish Network to offer TV and Internet service.

"We're improving a lot of our online efforts, having a larger assortment in a lot of different areas," said Kirsten Whipple, a Sears spokesperson, declining to discuss strategy. "One of the main goals of our Web site is driving customers into the store."

This wouldn't be the first time Sears has looked to tap into its Big Book legacy. Previous Sears management has tried to revive Sears' direct-merchant heritage online. Six years after Sears shut down the Big Book in 1993, Sears.com debuted, one of the first traditional retailers to go online.

Executive Shuffle

Sears sold its hallmark tools and appliances first and then leaned heavily on Lands' End to move apparel online in 2004. When Sears bought Lands' End in 2002, the Wisconsin-based preppy direct merchant had been selling online for seven years.

Kmart, for its part, similarly showed early promise with BlueLight.com, an e-commerce company it formed in 1999 with a San Francisco venture capital group. BlueLight.com's assets were sold in Kmart's 2002 Chapter 11 bankruptcy reorganization, and the site's name was later changed to Kmart.com.

It hasn't helped that Sears' online business also has gone through four leaders in the past three years. While Sears and Kmart were regrouping, rival retailers caught up.

Today, J.C. Penney's online business generates roughly half the annual volume of Sears Holdings', but its conversion rate, or the rate at which it converts browsers to buyers, is among the best in the business at about 10 percent. Most department stores, including Sears, convert online customers at less than half that rate, according to industry sources.

At less than 1 percent of Sears' total annual sales of $50 billion, the online business isn't going to provide the panacea for Sears' chronic sales decline. Simply throwing millions of products online without direction will ultimately confuse and drive away shoppers.

However, as one of the few sources of growth at the company, Sears' Web business is getting Lampert's attention.

Parts of the puzzle Lampert, who rarely speaks publicly about Sears, held up the retailer's PartsDirect.com site in his Feb. 28 annual letter to shareholders as an example of the potential he sees for Sears' online future.

"In my view, PartsDirect.com clearly illustrates the power of the online selling channel as it combines access to both the product (carrying more than 7 million repair parts from 450 manufacturers) and information (more than 750,000 schematic diagrams of products and the parts of which they are comprised) necessary to help our customers replace worn-out parts on their own," Lampert said in the letter.

Creating a Collaborative Environment

As part of its focus on the Web, last year Sears turned loft space on the fourth floor of its State Street flagship in Chicago into a Web development center. About 100 technology workers try to figure out how to improve Sears' Web sites. Purple-speckled carpet and butter-yellow walls are meant to spark creativity, said Jeff Hamm, a director at the center.

"We created an energetic and collaborative environment," said Hamm, a 14-year Sears veteran.

Still, as Sears ventures beyond its familiar appliance and tool territory, it will face entrenched players, such as Amazon for books, iTunes for music, Blue Nile for jewelry and established portals that include Shopping.com and Buy.com .

"Ultimately it comes down to brand," said David Fry, founder and CEO of Fry, an e-commerce developer who created Kmart's Web site. "It has to be about what people think of when they hear the brand name. The biggest problem Sears has right now is perception in the marketplace. If they are able to improve that, it could work."