KGB: Guy Russo

Kmart's managing director Guy Russo tells Business Spectator's Stephen Bartholomeusz:

– His complete overhaul of the retailer's product model over the past three years, as well as its supply chain, is really paying off

– How his time and experience at fast food giant McDonald's has been instrumental in the Kmart turnaround

– Why the main risk in cutting the number of product lines at Kmart has been running out of stock

– That a key condition of him taking on the top job at Kmart was having complete independence

– That Kmart is performing exceptionally well in the tough retail environment despite intense competition

– The revamped Kmart model has implications for the type of store space required, but that's not a problem

– That the internet is not a threat to Kmart and will only sharpen him up further to compete

Stephen Bartholomeusz: Guy, thanks for joining us.

Guy Russo: You're welcome.

SB: Can you tell me a little bit about the first impressions you got when you got to Kmart, which in my memory has always been dysfunctional and directionless. So when you got there, what did you see?

GR: I think it was just before I got there … obviously the first thing was that it was a business that potentially was considered to be closed down by Coles. That really interested me when Richard spoke to me about joining and they did a short evaluation to what to do with it. So, a business that was 40 years of age that turned over $4 billion that didn't know how to make a dollar really interested me. So, from that from the financial perspective really raised my curiosity levels. When I walked into the business it was bad. So lots of stock, very, very tired, no money spent on the business, very dedicated staff, very, very dedicated staff; and that really impressed me the most probably, as for all the troubles that they had all been through over the time, I mean I can't imagine working for anyone that finds out as an employee that you're going to be closed down a number of times. So impressed with their staff, but a very poor offer.

SB: How did you go about developing a game plan?

GR: I was nervous, to be honest with you, because I thought the four gentlemen that had been there before me obviously spent decades in the business and I'd spent none other than my amazing time at McDonald's, which has the best training in the world. So, I think game plan one was, I said, let's shut up and listen and really spend time on discovery. I thought the best thing I could do was just observe and tell all of the stakeholders that were in the business that I wouldn't be doing anything for the first period of time other than listening to what their views were.

SB: And you listened for six months I believe.

GR: Nearly. Yes, I'd say that. And it was confusing. The retail model, you know, full respect to those people that had been doing it for decades, you know, considerably longer than I have. It is already complex, nothing like the McDonald's model which, whilst it has its complexities, we always tried to take those complexities out. This is a very complex model, you know, for all of us that are in this space. So, listening and telling staff to, you know, shoot an email to me, or when I walk the shop floor to tell me what's really on their mind, and then travelling around overseas too to have a look at how the model maybe should be, because it was very confusing. Kmart I've always described as being a business that tried to be a Harrods in a Reject Shop. It tried to be all things to all people. It sold the high end luxury products, and sold the low end products.

SB: You ended up developing quite a radical model and taking 60 per cent of your SKUs out. Where did that come from? Is there a model overseas that you borrowed from?

GR: Yes.

SB: Where did that come from?

GR: I'd say to that it's not that radical. I think whilst it appears radical to what it was, it's this view of trying to … one of the things I had learned at McDonald's is knowing who you are and sticking to that and so one of the questions on my mind is what is a DDS? What is a Deep Discount Department Store? Walmart, Asda, Tesco and then eventually I found a company called Primark in the UK is probably what inspired me the most. Whilst I travelled around Australia and looked at retailers here, other than Target who was the strongest returns to shareholders and still are in this country, no one was really somebody that I thought we should aspire to or be inspired by. And those models did inspire me, and they worked on a similar model to what I've got now, which is maybe what Kmart had 30, 40 years ago.

SB: You've referred a couple of times to McDonald's.

GR: Yes.

SB: Are there learnings from the McDonald's approach to business that you've applied?

GR: This piece about learning who you are, I think, was one of the pieces that was the first part, is that we are a high volume, low price retailer. That's not who we were, and sticking to that knitting. McDonald's, you know, could have played in anywhere they wanted to as far as food is concerned. I mean they had the kitchen equipment to do it, but they were proud about being a hamburger joint and stuck to it. And so, we're only into maybe step four of a 10 step plan. What I'm proud, and our team now understand, is we sell everyday items whether it be everyday items for your home, and that's what we buy, and that's what we want to sell. And then on the pricing piece we want to be at the lowest prices that we possibly can. And again there is nobody in Australia that does low price well. Primark just blow my mind away. I mean they had nearly everything under $10, from dresses and jeans to kids' clothing, socks and shoes and ladies' intimates, men's intimates and, you know, that journey we're clearly on now is being low priced … lower prices everyday and finding items that you need for everyday for use around home.

SB: When you go from something like a 100,000 SKUs down to whatever it is, 40,000 SKUs, that presumably makes radical changes to the way you buy, the whole supply chain issue and then in store. Can you describe what you've had to do to get to where you are?

GR: What I've got to say to you is I have no idea how they did the 120,000 SKUs, no idea. That product came in on a Saturday and Sunday. It had to be ready in the store by Tuesday, in a catalogue that came out on Thursday, put on sale by Friday. We'd run out of the product on the weekend and then we'd start that over again on the Monday. The new model is so much easier; a 120,000 SKUs down to 50. Those 50 we love and cherish every item that now comes into the store. We have the 70,000 items that we deleted that mainly were unprofitable too. This was about trying to be all things to all people. I mean we tried to fight Barbeques Galore by having every barbeque that there was absolutely available, and the high end barbeques and the high end clothing sold at Kmart, but when it was radically discounted. So, removing those items improved profitability in one respect, but two it allows all of the buyers now to have a passion for, if it's in the kitchen department, you know, they are focusing on the basics that people use in the kitchen area. So, you know, it's no big surprise that we're looking at plates that are white and we sell them for a dollar. And we're no more complex than that. If you want Villaroy and Boch, you know, go to David Jones. If you want knives and forks, we sell a set of a dozen for a few dollars. Or there's this cast iron pot that is worth hundreds of dollars in other retailers that we just… we used to sell at $29 and we just dropped it down to $25, and the quality is outstanding.

SB: When you focus on a much smaller group of stock items, do you see risks in that because you've got to sell a lot of them to make any money?

GR: Sure.

SB: How do you choose the ones that you're going to focus on?

GR: That's a secret. What we actually ask our buyers to do is to pretend they're running a little camera in the home … in the part of the home that they're buying for. So, if it's in the kitchen, just imagine a camera running 24/7 in that area and watch what mum and dad touch every day. And if they're touching knives and forks, I want to have knives and forks in Kmart at the lowest price. If they're touching dinnerware, it's normally as I mentioned before the white set; it's even in boardrooms there they use the white teacup or coffee cup. And then if it's in the drawers, it's fry pans or the, as I said before, the cook pots that we had before. So, look at those items they're using every day and then stock in those. So, in the bedroom it's sheets, you know, and if you want the high end sheets, you know, with 1200 thread count, go to David Jones. But if you want sheets that are under $10, and they're probably white as well with a couple of other choices in colour, then come into Kmart and they'll be under $20. So, that little camera idea is a very, very important one to watch the products that customers are using and touching, you know. And on the body it's jeans, it's underwear, it's t-shirts. They're being used every day, straight after kids come out of school, uniform off and they're in a t-shirt. Well, Kmart will have that for $4. The biggest bottom part of the body in clothing is jeans. We don't have a big range of jeans, but we proudly sell them at $8.50. And if you want a high-end range of jeans with high quality, my staff will tell you where Jeanswest is and that you'll probably pay ten times the price for it, or Levi's.

SB: The consequences of mistakes in buying are presumably elevated with your strategy?

GR: As in too hard to choose, you mean?

SB: No. If you make a mistake, as you're going for such high volumes, that your consequences are going to be greater than they'd normally be.

GR: Oh, right. Yes. The consequences have been the reverse. We run out. We have run out. In three years we've sold about 80 million more items over the last three years, 80 million more with 20 million more people walking in through the doors than they did three years ago. Our problem is that we've run out. I can think of two products where we over ordered on. I actually know the products pretty well. It was one of the $10 jeans that we over ordered by a year and some ladies' underwear which we had three pairs of underwear for $3, we ordered 12 months' worth of that. We've now moved them down to $1.50; three items for $1.50. The other 50,000 items, my biggest frustration is running out because when I source direct, which is the way we get our prices down to the consumer, if I run out, I've got a 12-week lead time before I can fill back up, so that is my complication. It's a nice problem to have. I mean, I was just talking to my general managers this morning saying I reckon there's about 15 per cent of our items that we just don't have available because we've run out.

SB: You've presumably had to create an entirely new sourcing structure since you took on that new strategy. What have you done?

GR: We had another part of Kmart, which already existed, was our sourcing company that it was over 50 years of age. So somebody else had already developed it and thought of it and they never used it. It had less 50 staff based in Hong Kong. Unfortunately, there are no factories in Hong Kong, so I'm not sure how that worked. Maybe people that made the decision preferred to live in Hong Kong instead of China. We now have over 300 staff living in Bangladesh, India and all the way through China, and their goal is find the lowest cost factory that you can, and normally they're the factories that already source to Walmart or Asda or Tesco. And then two very, very important things. When you find them, quality is absolutely paramount of the product that we buy from those factories, and ethical sourcing is very, very important. If I found any factory that were not making sure that their employment practices were globally accepted by not only themselves but Australia, we would terminate immediately or more importantly we would do an inspection before we started and not use them. So, the challenges I've got to see there in finding local staff, ensuring they are all quality, acceptably from a quality point of view and ethical sourcing, but that's a challenge that we had to install into our process of wanting to achieve lowest price. Then we cut out all the middlemen, not overnight, but over the three years all of those people that we were buying from who bought from those countries we just had to go and find those factories because they weren't going to write them down on the back of an envelope for me and say here's where I bought the jeans from, but my staff do that every day, you know, 365 days a year and still to this day they're finding factories that big retailers around the world are using that we just jump onto that order if you like.

SB: The changes have proven themselves to be very disruptive, not just to your competitors but to the suppliers as well. What's your relationship like with some of those bigger local suppliers?

GR: Well, some of them aren't with us anymore and I am partly apologetic for that, but the other part is I'm very, very focused. You know, I'm a Wesfarmers employee and Wesfarmers are very, very focused on returns to shareholders and making sure that we serve customers and look after the communities that we operate in. So, why I'm not apologetic is that this model was nearly closed down. There was nobody that was going to be around under Wesfarmers' ownership if this model didn't have a return, a satisfactory return. So, we've saved a business that could have had 26,000 more people unemployed. So, I owed it to them and to the two odd million people that visited us every week to make sure that we could, if you like, earn the right to play in this retail space, which we all love shopping, but in a way that was profitable so that way the new owners could hold their head up high, as they always want to, for a business that did what they're meant to do, and that's make money, employ people and look after customers.

SB: Apart from disrupting some of your competitors and suppliers, you've also disrupted some of Wesfarmers' brands including Target. I know that your colleagues within the Wesfarmers' brand are fascinated by what you're doing and trying to understand whether there are things that they can learn from it. Also, there's a bit of chagrin there that you actually have met your targets. When you have those discussions internally, are the discussions about kind of brand conflict within the portfolio?

GR: Richard uses, and Wesfarmers, their philosophy is you've got independence and I love it. I had one or two criteria in joining this job and one was independence. I like to be hired and fired under my results, you know, and to be able to truly affect the people that were under my responsibility I needed autonomy and I didn't need any crossover happening. That's how McDonald's operated as well. So, the chats that we have when we're in the wider group are normally about long-term benefits to shareholders for Wesfarmers. We never get together in regards to talk about how we could do something or collaborated with each other on anything, I mean other than maybe real estate. You don't want Target and Kmart negotiating on a piece of real estate that could end up just benefitting the landlord. I have a high admiration for Target. And that's really simple. My criteria for admiration is on returns. They are the highest returning retailer in general merchandise and apparel in Australia, and have been for that decade prior to the Wesfarmers' ownership. There's no doubt that with a resurgence of Kmart I don't think it was Target that was going to hurt so much, but as I watched all of the retailers that are in my space that serve apparel and general merchandise, DJs, Myer and Big W and a lot of the others, they've all talked about a downward turn in their business models. And then they blame the outside. At Kmart for me anyone internally is forbidden to talk about what goes on on the outside of their four walls because we can make a huge difference by looking after customers, for the people that visit us every day. And I truly believe the success has been about focusing on all Australians that could buy at a retailer versus just trying to focus on a small segment. I never go after anybody; I go after everybody.

SB: The environment as we all know has been really, really difficult in retail because of price deflation, intense competition and consumers being very conservative about their saving patterns. Is that a good environment for a Kmart?

GR: I think we're in the best environment or from my perspective that anyone could ever wish for, if you put the customer first. If you put the customer first on any model that you do and, you know, it's our responsibility to make sure our costs base is right, but all these big retailers turn over a couple of billion dollars a year in turnover. If you can't work out how to make money out of that, I think that's a problem internally not externally. So, the environment in my mind is fine. When I talk to landlords there are more people visiting shopping centres today than there were a year ago, so it's a matter of if you've got your proposition right, which I believe Kmart has nearly got that right about focusing on everyday items, you've got your pricing model right and to me we'll never have that exactly right. We're going to drop 300 prices in the next few months. We dropped 50,000 pieces a year ago and now we're on, let's do it again. I think that the retail environment is customers will buy if you offer the right package of service and quality and price.

SB: The price being particularly important in today's environment.

GR: I think price is king. But I don't think there's ever a time that price isn't king. I admire my old employer as I go past so many billboards where they still proudly show the 30 cent cone. It was 20 years ago they sold that product for 30 cents. And I don't see McDonald's complaining about a tough retail environment. Sales are still going up. Profits are still going up. So, they're focused on price and they try to work out how to back out costs all the time. I think that's a responsibility of a CEO and his team; always try to find an ethical way of reducing the costs of doing business.

SB: The change in the model to this lower number of SKUs and the higher volumes. Does that have implications for the type of space you need because Kmart traditionally has had big spaces?

GR: Yeah, they have. We re-evaluated our spacing, you know, right at the beginning of this and there are, you know, a dozen odd stores that are oversized, not a lot them. So, we've got about 180 in the fleet and again the benefit of being part of a bigger chain or Wesfarmers is that, you know, it's easier to pick up the phone and call Ian McLeod, who's also getting into the space of apparel, which I think is a great thing for Coles, and asking him if he wants the extra space. That way the Coles customer gets a bigger … a better deal in not only buying the amazing low prices that he's setting for his consumers on fruit and vegies and everyday needs in the kitchen, but now they're also getting into the space of everyday needs for clothing which I think is an outstanding thing.

SB: One of the big discussion points in retail, and it's reasonably recent, has been the internet and its impact on their models and internet sales are 5 per cent of total sales, but they're growing at twenty per cent. Does the internet have any impact on you and is there any opportunity for you?

GR: It impacts me on the view that it makes me even more determined to do the right thing by the model I'm in. I think it's competition and so I take competition as there's another challenge to drop your prices even lower, to make sure you've got the products that customers want and use every day and deliver. So I see the internet like all the retailers that surround me in any retail, in any shopping centre, and they're probably the best competitor that I've got now, looking at the way they price. But I can guarantee that it would be a lot cheaper still to buy at Kmart than to buy something on the internet. It would cost you more for the taxi fare to even get there or the courier to drop the product off.

SB: And there's no opportunity for you there?

GR: There might be. There's so much more opportunity for me to make sure I've got my stock available for consumers. There's so much more opportunity for friendly and faster service at the store. And there's still a lot more opportunity to drop prices even further for that customer that wants to go outside of his four walls at home and enjoy a great shopping experience. I think the internet is a little bit like the, you know, when I was in fast food when they had deliveries available for people, you know, and McDonald's food is not one of those products that works well on delivery, so it sharpened them up to make sure that they delivered better at point of distribution, which is their stores. This whole internet thing will just sharpen me up further. Maybe in a few years' time I'll have a look at it, but I've still got so much more opportunity to get those jeans down even cheaper, to get that crockery down even cheaper, and plates and things that people need, whether it be in the garage or in the tool shed or in their home office and, you know, deliver on those things.

SB: Thank you very much indeed, Guy.

GR: You're welcome.