SEARS: THE TURNAROUND IS ENDING; THE REVOLUTION HAS BEGUN ARTHUR MARTINEZ'S IDEA IS TO SELL SEARS' POWERHOUSE BRANDS--TO ANYBODY, ANYWHERE, ANY WAY HE CAN. INSTEAD OF WATCHING WAL-MART, HE WANTS SEARS TO BECOME MORE LIKE COCA-COLA, DISNEY, AND GENERAL ELECTRIC.
By PATRICIA SELLERS

(FORTUNE Magazine) – Is retailing a good business? You'd expect Sears Chief Executive Arthur Martinez to have a ready answer to the question. He's been in retailing, after all, for most of his career. He's the man who brought Sears back from its near-death experience five years ago. And Sears Roebuck, for goodness' sake, is almost a synonym for retailing. But at this particular moment in an interview with FORTUNE, the normally smooth-talking CEO falters. Martinez (say MAR-tin-ez) hems and haws, raises his eyes to the ceiling, crosses his arms in front of his barrel chest, and--finally--smiles and says: "The retailing business is middle of the pack at best."

That less-than-rousing reply explains a lot of things. First, it reveals how profoundly Martinez's thinking about his company and his business has changed over the past few years. It is also the key to understanding something he has not discussed publicly until today--how he plans to reinvent Sears. Again.

Two years ago, in a FORTUNE interview, Martinez defined Sears as "a moderate-price department store retailer." Now he says, "As we thought about it, we realized that's a very limiting definition." So he's changing the definition. Martinez's new plan is to transform Sears, the retailer, into a top-echelon consumer-brands and services company. To do so, he is rejecting all retail models of how to run a company. He is copying--unabashedly--key strategies of standout consumer companies like Coca-Cola, Walt Disney, General Electric, and General Motors' Saturn division.

The Sears he envisions will no longer revolve around the "Big Store," the traditional Sears department store. Instead, it will be built around the powerhouse brands that Sears owns--brands like Craftsman (America's leading tool line, with retail sales of $3.5 billion), Kenmore (the No. 1 appliance brand, $3.6 billion), DieHard, and Sears itself. Martinez, 57, believes that no other retailer and few other companies of any kind boast such strong brands. To get these brands to consumers, he'll open small stores--thousands of them--far from America's shopping malls. He will invest big money in outlets that won't even bear the Sears name. And he will build, he says, a $10 billion service operation--which isn't retailing at all.

If Martinez can make it happen and make it pay, Sears' transformation will be the stuff of future management texts--one of the most sweeping and surprising corporate makeovers ever. It will also be one hell of a third act in the Sears turnaround drama.

You may be familiar with the story so far. Act I begins in 1992. Arthur Martinez, the low-profile but charismatic vice chairman of tony Saks Fifth Avenue, trots into down-market, downtrodden Sears, which is in the process of losing $3.9 billion. As CEO of the Sears Merchandise Group, he is the first outsider ever to head the retailer. His assignment: Restore the health of the Sears stores while the old, embattled management pares the conglomerate to its rotten core. Sears unloads its financial-services businesses--Allstate insurance, Coldwell Banker real estate, the Dean Witter brokerage, the Discover credit card--and sells its famous headquarters, the 110-story Sears Tower. No time to waste, Martinez shuts 113 unprofitable "big stores" and cuts 50,000 jobs. He even terminates the Sears catalogue, the origin--and, some argued, the soul--of Sears.

Act II is a nervous time for Martinez. He is in charge of Sears' stores, and they are out of date, out of touch, and apparently out of ideas to win back shoppers from rivals like Wal-Mart and J.C. Penney. Many people wonder whether the company will even survive. Martinez decides that Sears doesn't have a clue as to who its target customer is. So he chooses one: the middle-American mom. He packs the aisles with women's apparel. He advertises "the softer side of Sears," promising that "We're not who you think we are."

It worked--and much faster than anyone dreamed possible. The "dinosaur" (as FORTUNE tagged Sears--along with IBM and General Motors--in a 1993 cover story) turned into a cash cow. Sears earned $1.3 billion on revenues of $38.2 billion last year. The profits didn't come just from cost cutting, either. The stores have consistently gained market share from competitors in virtually every category of merchandise. Martinez rose to CEO in 1995, and Sears' reputation ascended too. In FORTUNE's survey of the most admired companies, Sears was once the least admired in the category of innovation--dead last among hundreds of companies. This year, Sears was rated the most innovative general-merchandise retailer.

The greatest testament to the turnaround is the stock price. Since Martinez arrived at Sears, the shares have outperformed the big-brand companies that he's trying to emulate, including Coca-Cola and Disney (assuming investors held on to Sears shares that became Allstate and Dean Witter shares when those businesses were spun off as separate companies). Sears stock has beat the other "dinosaurs," IBM and GM, as well (see chart).

"Only now," Martinez says, "have we earned the right to think about growth."

Sears still has its problems. Store profit margins are mediocre. Customer satisfaction lags Wal-Mart's and Nordstrom's levels. Sears' international business is floundering. A chain of furniture stores is a loser. But these are minor compared with Sears' big problem. The company is still stuck in retailing--which Martinez is so ambivalent about. "I want to go beyond the tyranny of bricks and mortar," he says. Tyranny, Arthur? "Yeah, the store is the tyranny of retailing. You're making 20-year, 40-year asset decisions. For all practical purposes, it's a forever kind of decision."

Not that Martinez is giving up on department stores. He's got 821 of them in shopping malls across America, and he intends to invest heavily enough to keep them fresh looking. He explains, "That's Job No. 1, as Ford would say. If we ever got into a situation again where the full-line stores aren't healthy, it would be deadly. It would undercut our entire growth program."

That growth plan is radically different from anything Sears has done before--so radical, in fact, that it seems to be a reversal of what Martinez has accomplished so far. Consider: The guy who revived the Big Store now says the store of the future is a small box. (Of 380 new Sears units scheduled to open this year, just 22 are department stores; 358 are freestanding specialty outlets.) And Martinez's reputation, remember, has ridden thus far on "the softer side of Sears"; the new specialty stores sell only heavy-duty stuff like tools and auto parts. Call it "the harder side of Sears."

The apparent contradictions surprise even Martinez. Two years ago, he says, he had "no idea" that small stores and service would become Sears' new growth vehicles. But his change of mindset doesn't faze him. "A hallmark of great companies is an ability to recognize the game has changed and to adapt," he says.

So, where did all this new thinking come from? And how is Martinez able to impose it on Sears' sprawling bureaucracy?

Back inside his office 30 miles northwest of Chicago, the CEO is describing the challenge of moving Sears from turnaround to "transformation." He says, "A turnaround is a financial recovery. A transformation is much more. It's all about changing the structure and the approach to the business, and reeducating our people to feel comfortable outside a command-and-control environment. It involves getting them used to risk taking and innovation. And getting the very best out of our people."

Sometimes Martinez sounds as if he's merely skimmed off the best of the last decade's pop management trends: a swing from cost cutting to a "we need to grow" mentality. A shift to selling services. A resurgence of brands. A focus on long-term value creation. Martinez is newly hot on ever popular EVA, a measurement of capital efficiency that Coca-Cola management, among others, says is the real thing that drives a stock. But Martinez, unlike many CEOs who talk this talk, has actually made these things work. And he has the results to show for it.

His success, in part, is innate: He's the kind of guy who sets a goal and reaches it. The only child of a Brooklyn fish wholesaler, Martinez graduated from high school at age 16. He used an ROTC loan to put himself through college, did his army tour, and went on to Harvard Business School. And he's not shy. By sheer force of will, for instance, Martinez recently persuaded Disney CEO Michael Eisner to speak at Sears' annual gathering of its top 200 managers in Phoenix. "You gotta understand, I don't do these kinds of things," says Eisner, who had never met Martinez before the Sears boss invited him. "Arthur got me there. He wrote me. He called me. I went because he seemed to be a man on a mission." So impressed is Eisner with Sears' revival that he jokes he may be miscast as Martinez's role model. "I think I'm gonna watch what Arthur does and copy him from now on," Eisner says.

But the main reason Martinez has been able to change Sears is that he changed the people. Most of the senior executives are Martinez recruits, and most had had no prior experience in retailing. Executive vice president Gus Pagonis, for example, is a three-star general who masterminded the supply chain in the Gulf war. He is Sears' logistics chief. Tony Rucci, the administrative boss and Sears' unofficial minister of culture, came from Baxter International, a medical-products company.

"We used to be so inbred, it's a wonder we all didn't have one eye in the middle of our foreheads," says executive vice president Bill Salter, a 32-year Sears veteran. Survivors like Salter tend to be broad-minded, blunt-speaking mavericks. "A number of us who are still here are almost ashamed we didn't figure out how to fix Sears ourselves," he says. "But our experiences were all the same: retailing. The most important thing Arthur has done is bring in specialists in their fields."

Case in point: marketing honcho John Costello. An alumnus of Procter & Gamble, Pepsi, and Nielsen Marketing Research, where he was president, the 49-year-old Costello is Martinez's brand evangelist. A brand, he preaches, signifies a relationship with the customer. It is a company's most valuable asset. It's also the main differentiator, the best defense against price competition, and the key to customer loyalty. "Competitors can copy your features and benefits, but they can't steal your brand," Costello says. Before Martinez arrived, Sears viewed all its brands--Kenmore, Craftsman, DieHard, Weatherbeater (paints), and the Sears brand--"as tools to sell more merchandise instead of as assets we need to invest in," Costello says.

Martinez and Costello got intrigued with Disney as they were casting about for a compelling, explicit way to extend Sears' brands. "The retail models are lousy," the CEO says. Not only are most retailers poor brand managers. These companies typically grow by putting up more and more stores. When their look-alike units have sprouted in every major market across America--wham!--the companies hit the wall on growth. It happened to Kmart. It happened to Wal-Mart. Now it is happening to the superstores that sell office supplies and computers. "These concepts have matured in less than a decade," Martinez says. "It took the department stores 50 years to mature."

Unlike the retailers, Disney found the secret of renewal. "Here was a consumer business whose brand franchise had weakened," Martinez says. Eisner joined Disney as CEO from the outside 13 years ago. He has invested heavily in Disney's brands, from Mickey Mouse to Quasimodo, and in the core of the company, animation. Eisner has extended the brands into big-budget movies, TV, all sorts of theme parks, merchandise, even retail stores.

Martinez says he foresees a similar growth strategy for Sears. Might you call that diversification? "Don't use the D-word!" Martinez says. "It's a word I reject. It implies moving into unrelated businesses." The D-word almost D-stroyed Sears a few years ago, of course, when Sears' previous managers got distracted by a hodgepodge of misfit businesses, notably financial services. Think of those executives as peripheral visionaries. Martinez, in contrast, seems to be focused on Sears' core brand strengths. The Disney model of brand extension, he says, "is based on deep and imbedded customer relationships."

Thus Sears is doing lots of research. This year alone, the company will survey some two million consumers. "We ask the customer, 'Where does Sears have authority to compete?'" Martinez says. "We expand into areas only where the customer permits us."

Customers "permit" Sears to sell them hardware, appliances, lawn and garden supplies, automotive gear, and electronics. So, Sears' off-the-mall specialty stores sell this heavy-duty stuff. "It is ironic, considering all the emphasis we've placed on apparel," Martinez says. "People ask me, 'Gee, are you abandoning your apparel strategy?' Absolutely not. But we're still building 'the softer side of Sears.' It's not ready to be treated as a brand like Craftsman and Kenmore, and I'm not sure it will ever be."

Craftsman is Sears' sturdiest brand. And the best vehicle for moving it beyond the traditional retail box is Sears' freestanding hardware stores. In fact, this business is a veritable minilab of the new and emerging Sears.

Sears tried the hardware-store idea about a decade ago, but abandoned it--in part because the department store folks disapproved. Martinez, though, thinks the small hardware store is Sears' most exciting retail format. "It's an elegant concept," he says, "because it's a flanking strategy around arguably the best-managed retailer, Home Depot." Not that Martinez expects Sears' small (20,000-square-foot) hardware outlets to hammer Home Depot. He simply wants to win over a few million shoppers that the Depot doesn't satisfy. "Our customers, particularly female customers, are often put off by the very thing that the category-killer retailers stand for: incredible selection," he says. "There's some evidence that these stores have gotten too big, too overwhelming, and too confusing to shop. Too frightening."

Yes, Bernie Marcus is watching. The CEO of Home Depot, the king of big-box hardware retailers, once viewed Sears as a dying company. ("Sears and IBM believed their own bullshit," he told FORTUNE.) Today Marcus says Sears is his fiercest competitor.

That's because Martinez is stocking Sears' hardware stores with new and fresh management talent. Last year, for instance, he discovered a chain of hardware stores in California that were more productive and more profitable than his own. So, he bought the company, Orchard Supply Hardware Stores. "This is our potential Saturn," Martinez says. The CEO's view is that Orchard, like GM's quasi-independent small-car company, is a model of innovation, customer friendliness, and healthy corporate culture. He wants the Orchard organization to pollinate the rest of Sears.

New hardware boss Gary Crittenden is chief pollinator. A 43-year-old Harvard MBA, Crittenden joined Sears as chief of strategy just one year ago after he helped the retailer Melville with its restructuring. A smooth decision-maker much like Martinez, he is already being pegged as the CEO's eventual successor. "Both Gary and Arthur look at 100 dots on the wall and say, 'I'm going to focus on this one,'" says one Sears executive. Crittenden took charge of hardware in January. Within a month he chose his senior team. Nine of the 12 come from Orchard. Like Martinez, Crittenden is a relentless change agent. He prefers the Orchard name, so "Orchard" is what all Sears Hardware Stores will likely become. This summer he'll uproot the Sears hardware group and move permanently into Orchard headquarters in San Jose.

Another small-store innovation that flouts the old rules is Sears' fastest-growing retail format: "dealer stores." These outlets sell tractors and TVs in outposts like Eagle Pass, Texas, and Thief River Falls, Minnesota. Actually, the concept was born out of failure in 1993, when Martinez closed Sears' 2,200 catalogue outlets in rural areas. "Our problem wasn't our inability to generate revenues. It was our inability to make money," Martinez says about the catalogue stores. "We wanted to find a capital-efficient way to keep the Sears brand in small-town America."

The tiny (5,000-square-foot) dealer stores require almost no capital investment from the company--just $10,000 or so for a big, blue Sears sign over the front door. Reason is, Sears doesn't own or operate the outlets. Entrepreneurs do. Sears supplies the merchandise (a limited line of tools, appliances, electronics), contributes quite a bit of advertising, controls the pricing, and monitors the quality. The local proprietors supply the bulk of the capital and the sweat equity. They earn commissions on the goods they sell. These owners are not franchisees, since they pay Sears no fees. The dealer-store concept is unique. "It's collaborative," says Martinez.

The dealer stores show the value of "getting beyond the tyranny of bricks and mortar," as the CEO says. Vice president Steve Titus, 44, who heads the business, says his career at Sears was going nowhere for years, probably because he advocated renegade ideas like opening specialty stores away from the malls. In Martinez's Sears, Titus is a hero. This year at the Phoenix meeting, Martinez gave Titus his annual "Chairman's Award," for providing customers "the most compelling place to shop."

Titus' winning strategy has been to locate the dealer stores right across the road from Wal-Mart--that's right, the retailer that once almost killed Sears. The dealer stores compete quite nicely by offering higher-quality merchandise and higher-touch service than Wal-Mart. A folksy, small-town son of Hannibal, Missouri, Titus explains, "The key is finding owners who really like people. The best owners have sincerity off the charts, and if they told a lie, they'd fall over." Today Sears has 472 dealer stores. Martinez expects the chain to double in size in three years.

Sears' most promising growth vehicle is Sears Home Services, and it requires no physical building at all--just thousands of service workers with thousands of trucks to carry them to customers' homes. This new division encompasses a jumble of offerings, from appliance repair to pest control, that Martinez believes can earn higher returns than Sears' stores.

Jane Thompson is the home-services chief. Martinez says he followed Michael Eisner's management credo--Move by instinct--when he assigned her to head the business. A onetime Procter & Gamble marketer and McKinsey consultant, Thompson, 45, joined Sears in 1988. She appears to be the company's most agile and ambitious survivor. The day Martinez arrived in 1992, Thompson, then a corporate planner, popped her head in his office and invited him to dinner. Martinez accepted. "So, I hear you want to run a business," he said to Thompson first off over drinks that evening. She did. Soon after, Martinez appointed her head of the Sears Credit group, which generates about half the company's total profits. She promoted the Sears card in new ways and substantially increased its market share and earnings.

Last year Thompson told Martinez she'd like to run Sears' $4-billion-a-year tire and auto-parts empire. Martinez said no. He wanted her to get her fingernails dirty in home services instead. "Jane had no experience in the business, but I knew she would come at it from a marketplace perspective," Martinez says. "We have plenty of operators at Sears. We don't have enough people who think about the business from the outside in."

Her challenge is to take an orphan operation and transform it into a highly profitable $10 billion business--by 2000, her target. Sears already brings in $3 billion a year in revenues by calling on customers at home--to install their dishwashers, reface their kitchen cabinets, even put roofs on their homes. Trouble is, Sears uses a lot of licensees. Service is inconsistent. Marketing is lousy.

"We're creating a central source for a houseful of services," Thompson explains. She came up with an umbrella brand name, Sears Home Central. And a single phone number for customers to call: 1-800-4-MY-HOME. And a big-budget ad campaign that promotes--what else--"the service side of Sears." The advertising spreads the word that Sears will repair any of your appliances--it doesn't matter whether you bought them at Sears. Thompson says she has chosen to compete in ten different categories of services. Add 'em up, and this is a $160 billion market. And Sears is already the leader, with a brand name consumers trust and only a 2% share. "As the population ages, spending on home services increases," Thompson says. "We have a great growth vehicle, with no particular competitor to take us on."

The biggest challenge at Sears, however, is not coming up with growth plans and strategies. It is directing 300,000 people to step together--and step lively--as the company reaches in so many new directions. Martinez admits it. "The risk is always executional," he says. Back in Phoenix, where the theme of Sears' conference was "Working in Concert," Martinez invited Steven Kerr, General Electric's chief learning officer, to speak to the Sears executives about "boundarylessness." This is CEO Jack Welch's clunky but descriptive term for collaboration across GE's dozens of business units. To transform, Martinez believes, Sears needs to emulate GE. Everybody in the company must shake their not-invented-here fear and snatch the best ideas.

Finally, Martinez needs to focus the organization on shareholder value. Early on, he ditched Sears' longtime compensation program; it rewarded executives for hitting sales and profit goals on their own particular businesses. Martinez based bonuses on key measures like customer satisfaction and employee morale, which he thinks are as important as financial targets. He also required his senior managers to buy Sears stock equal to three times their annual salary (five times for himself). There's no doubt that getting Sears' stock up is Martinez's ultimate goal. At headquarters, electronic monitors flash Sears' share price at every turn.

Inside his sixth-floor office--many miles from that old black colossus, the Sears Tower--Martinez is discussing the issues that worry investors. Sears has an unprofitable chain of furniture stores called HomeLife. Asked whether he might quit the business, he says, "I won't say I will. But if we can't see it contributing to value, we're not going to keep the patient on life support." Sears' international operation (department stores in Mexico and Canada) has been losing money for years. Martinez says, "Expanding internationally is 11th on my top ten priority list." Also, Sears' credit business has investors fretting, since loan losses have been rising across the card industry. Martinez says the credit operation is rock solid and conservatively managed, and Wall Street analysts agree. In general, Martinez believes that Sears' turnaround has impressed Wall Street more than Main Street. "The customer isn't convinced yet," he says. "Our opportunity for improvement is enormous."

His new friend, Michael Eisner, says that recovering from failure is often easier than building from success. Martinez certainly knows this. Though he isn't as sweaty-palmed as he was in 1992, he says he is heeding the lesson of Sears' bungled history: Don't rest a moment, because every strategy ultimately fails. "Today's peacock is tomorrow's feather duster," Martinez tells the people at Sears. A paperweight on his desk, bearing those words, reminds him of that bitter truth every day.