Karstadt: Death of a legend (business model)
The German retail and travel conglomerate Arcandor AG formerly known as KarstadtQuelle AG filed on June 9th 2009 for insolvency. It claims that the financial crisis is the reason. It had asked the German government in May for state aid but the government refused. But is the financial crisis the real reason for the dire situation? I do not think so. The business models of its retail activities (Karstadt and Quelle) are just dead. The management did not innovate on its business model and that is the reason for failure.
Most writers and bloggers take the music industry as a prime example for an industry that failed to innovate its core business model. But there are many other industries where failure to innovate its core business lead to their decline. A sad prime example of missed innovation is Karstadt, a large department store chain in Germany and Quelle, a German mail order powerhouse.
The Karstadt case is typical for a corporation that business model is dated. Instead of rejuvenating its business model or finding new business ideas the old business model is defended and by consolidating the industry even reinforced.
The next lesson is that all activities at corporate level like selling non-core assets do not solve your problems of an ailing business model. The solution must be found on the business level not on a corporate level. If you cannot fix it, than sell or close it early. Success in business is not defined on corporate level but by its business model!
In May 2009, the CEO of Arcandor, Mr. Eich asked for “a state guarantee to temporarily bridge the gap of the currently non-functioning financial markets.” [update: link no longer available] Arcandor did not want to have any handouts nor a state participation in the company. It promised that it will repay the loan “to the last penny.” It claimed that the credit crunch is the main reason for its financial stress.
But is this really true?
The only constant in retailing is business model innovation
Retail markets in general are dynamic markets where new business models destroy old ones and create new fortunes. Zara, Aldi, H&M, IKEA or Carefour all reinvented their retail category and made their owners rich. But since the whole market did not grow as fast as the newcomers, the incumbents suffered losses in market shares and sales.
In Germany old dynasties like Hertie or Horten disappeared and where replaced by better retail concepts. In the UK, Woolworth, went into administration in the end of November 2008, leaving 807 holes (former shops) on British high streets.
The retail market is perfect example for Schumpeter’s creative destruction. While entrepreneurs with creative solutions gain in the markets old business models fail and disappear.
Now, the size of potential bankrupt Karstadt with alone 90 department stores in Germany and around 43.000 employees together with Quelle is unsettling, but who cried for all the shops Karstadt squeezed out of the market some decades ago? Where was the lobby for the all the mom-and-pop stores that disappeared already for ages?
And it is good that there was no lobby to protect the past. Karstadt and Quelle in their current state are the past of retailing.
Karstadt WAS a business innovator
Karstadt and Quelle are legends in Germany. The history of Karstadt dates back to the end of the 19th century when Rudolf Karstadt founded his first shop that he turned later into a chain of department stores. His dream was to offer everything for its retail customer under one roof. By 1931 Karstadt had 89 department stores in the German Reich.
Department stores are not a German invention. They first appeared approx. 1850 in France and the UK. Department stores offered a wide range of consumer’s personal and durable goods under one roof. The different product categories were organized in different departments from where the name department stores is derived. All prices were fixed so that the traditional pricing mechanism of bargaining was replaced. Department stores were a business model innovation.
The customers were fascinated by all the supply of goods they had never seen or even dreamed of. The department stores become cathedrals of consumptions that was reflected in their architecture like at Galeries Lafayette, a French department store (pictured above).
After World War II Karstadt became the place to be for the consumption-starved Germans. The department stores were the Germans’ window to the free and global world of consumption. Besides Karstadt Horten, Kaufhof and Hertie were the kings in retailing up to the beginning of the 1980s. Interesting is that behind all these companies entrepreneurs were the driving force at the beginning.
In the 1970s Karstadt branches out into the travel industry. The idea was to offer even more than just daily products and durables to its customers under one roof. Later it added also insurances and banking to its range of products. Karstadt become the supplier of almost everything to the German middle class. In 1977 it bought a share in Neckermann, a German mail order house. In 1984 it acquired the whole company.
The market share of the department stores was up to 12% in their heydays. But starting in the 1980s the slow and steady decline started. Today the market share is down to 3% and falling.
Consolidation instead of business innovation: Strategy in a saturated and stagnating market
When the market for department stores deteriorated, a typical behavior could be observed in saturated, stagnating or even declining markets. Instead of reinventing the business managers defended the traditional business model and optimized it. Their focus shifted towards process innovation particularly into more efficient purchasing.
One of the easiest ways to achieve savings in purchasing is to buy more from your suppliers so consolidation was name of the game. Horten was sold after several changes of ownership in 1994 to Kaufhof that is today part of the Metro Group. In the same year Hertie was sold to Karstadt. In 1999 Karstadt merged with Schickedanz Handelswerte, owner of the mail order business Quelle to form KarstadtQuelle. In 2001 it bought the clothing specialist SinnLeffers in Germany.
But Karstadt also tried to be innovative in its retail business. It started specialty store chains like Joy (young fashion), Papetik (stationery and gifts), Runners Point (sportswear and sports shoes) and Pico Bello (childrenswear). It also expanded its Karstadt sporting goods division Karstadt Sport in the 1980s. Already in 1995 it opened the internet sales platform myworld.de
Business innovation everywhere else
While the department stores were consolidating, the retail landscape changed fundamentally. New business models emerged. Business model innovation was on the agenda of many entrepreneurs.
Large shopping centers outside the inner city were built. Shopping centers had the depth of specialist shops AND the scope of a department store PLUS entertainment PLUS parking spots. And all that also under one roof. Department stores got stuck in the middle with a broad scope but with little depth of choice.
At the same time as the shopping centers flourished investment in refurbishment of the department stores was stalled due to lack of cash. So they became even more uninteresting for customers.
But not only shopping centers attacked the business model of department stores with even more under one roof but also new shopping systems.
Media Markt revolutionized the market for consumer electronics. Aldi entered the market from the discount side. IKEA become the biggest player in furniture. Zara, H&M and S’Olivier changed the retailing business in clothing forever. Instead of having 2 collections (summer and winter) per year for all sizes, they change their range of clothes every three to four weeks according to customer demand. Tchibo invented the weekly Tchibo world of goods, where every week you get a changing range of goods that is only available for a short period of time.
And the catalogue business of Quelle was under severe attack by the Internet attackers like Amazon.de.
No reason to go shopping at Karstadt
So, Karstadt’s mangers could have blamed the city authorities that allowed the construction of the shopping centers on the green field for their failure?
Well, yes but they also did not do their homework. Instead of finding a good reason for customers to go to Karstadt they were busy restructuring the holding company KarstadtQuelle AG aka Arcandor AG. They tried to do a little bit of cosmetic here and there.
The pity is that the managers never found an appealing answer to the first and most important questions of any business:
- Why should a customer do business with you?
- What is the value you offer your customer?
- Why are you different and better and does that matter to your customer?
All these questions are answered with the value proposition of the business model. For some stores they found an answer and value propositon, for the whole company they did not. Karstadt’s management just did not find a compelling reason for customers to shop there. And therefore Karstadt lost its deepest purpose of existence. If your customers don’t want you, there is no reason to exist further.
Corporate restructuring as the normal procedure
Karstadt’s management was busy, very busy indeed, but not with business innovation but with corporate restructuring.
After 9/11 management blamed the recession for the financial troubles of Karstadt. In 2004 after severe financial problems (sales fell by 12% in the second quarter on a year-to-year base) Karstadt started a large restructuring program in which non-core assets were sold and where employees accepted salary cuts in order to boost Karstadt. 5’500 jobs had to go. (See Der Spiegel for a recent history of KarstadtQuelle aka Arcandor in German).
In 2005 Mr. Middlehof, formerly CEO of Bertelsmann, became the CEO of KarstadtQuelle. He started a classical restructuring program at corporate level. He ordered a review of all corporate activities and sold further non-core assets like logistics to DHL, the media activities, the specialists shops like Runners Point and SinnLeffers and some small department stores. Karstadt’s core was defined as 90 department stores and 32 sporting goods stores.
In 2006 Karstadt sold its real estate of its department stores for € 4.5 billion and became tenant in its houses. That move allowed Karstadt to write off its debt and improve its equity ratio. That was the positive side, but the price for it was very high, too high in hindsight. In the past there were not cash-outs for rents. Now, Karstadt is a tenant in its former real estate and the rents are high so that the real estate investors can earn a return on their high purchasing price. The equation is simple: The more the purchaser pays for the real estate, the higher will be the rent. And that was bleeding Karstadt beside his old fashioned business model to death.
Death would have been postponed if the proceedings of the real estate deal would have been invested in rejuvenating the business model but management decided to use the cash to expand its travel activities. At the end of 2006 KarstadtQuelle AG became the sole proprietor of Thomas Cook, a travel group, for € 800 million.
In 2007 Thomas Cook merged with Mytravel, Europe’s 3rd largest tour operator to form Thomas Cook Plc. Travel became by far the major activity of KarstadtQuelle AG. To show the change of business activities KarstadtQuelle AG was renamed to Arcandor AG. In the same year HSE24 is acquired to develop further expertise in teleshopping.
Do you win customers on the corporate level?
From a corporate perspective all these activities made sense. Arcandor became less dependent on its retail activities and had some very interesting assets in its portfolio.
So did the performance of Arcandor improve? Well, no. For the business year 2007/2008 they lost € 746 million.
Did this solve the problems with the business model of Karstadt and Quelle? Nope! Still, nobody in management could give one good reason why to go shopping at Karstadt department stores or order via catalog from Quelle.
Corporate strategies are great from a shareholder point of view but competition is on business level, in this case on the level of department stores and mail order. And nobody in Karstadt or Quelle has found an answer why should I shop with them.
And if you find no answers to this, why should you exist?
Patrick, I very much like your take on this topic. It nicely illustrates that the “old” field of corporate strategies has to be replaced or at least complemented by the new field of “new” business model strategies.
Thumbs up for this well researched, detailed, and relevant blogpost.
Alex, how about putting a short post about my article on your site? Looking forward to your book.
I fully agree with your opinion. Karstadt was more a shopping-culture or a feeling where you celebrated a big shopping day. Times are changing and in my eyes the people are experiencing a kind of consumption-overload and shop in a faster and well-directed way. I think some centers in special (regional) areas can survive, or they might spin the “exclusive” centers off. The “galeria”-concept of Kaufhof probably works for them …
hindsight is easier than foresight. I would like to know what could have been the rescue for Karstadt and Quelle from your point of view. No, I have to correct myself I would rather like to know what is the great innovation idea for other mail-order houses when there is a competitor like amazon waiting for you.
In my opinion Arcandor has waited for too long. As far as I know, some of the businesses were very succesful, like HSE24 and Thomas Cook. The company missed to see that the future is about excelling at spezialized business fields rather than selling everything to everyone. I think, other retailers might be a little bit better prepared but need to work on exactly this topic.
Interesting to read that Karstadt implemented ‘myworld.de’ already in 1995. Sad at the same time, that it never had relevance in the customers’ minds. What went wrong?
Thanks for your comments. @Bettina, your are right that with hindsights it is easy to see what went wrong.
But even with foresight we can see certain characteristics in the field of strategizing. First, we are overconfindet about our future and our ability to predict the future. We believe that with market resarch (about past behavior) we can foresee the future. You find an interesting article by Charles Roxburgh from McKinsey at https://www.mckinseyquarterly.com/ghost.aspx?ID=/Strategy/Strategic_Thinking/Hidden_flaws_in_strategy_1288 Another great article about innovation killers in our resource allocation in firms you find with Clayton Christensen http://www.ascendcfo.com/pdfFiles/HBR-How%20Financial%20Tools%20Destroy%20Your%20Capacity%20to%20Do%20New%20Things.pdf
I really much agree on your point that the main reason for Quelle’s decline was to have missed the chance of innovation. But, I think for being innovative, you have to be aware of the need for innovation and therefore you have to have some slack time to distance yourself from the daily business. In my opinion, there have been some seriouse operational flaws that blocked the Quelle management from innovation or from being able to ask the three central questions. Only to name a few of the flaws: First of all Arcandor did not achieve to build synergies among buying departments timely, secondly they stopped to increase their marketing spendings after the phenomenal jubilee season 2002 and thirdly they had constant quarrels in the top management.
But how to prevent an organisation from getting lost in operational problems to keep the overview and the chance to be innovative??
I think that the article is correct in the main part. According to the book “What would Google do?” by Jeff Jarvis ‘middlemen are doomed’. If you fail to concentrate on your customer and are not able to attract him you will fail for sure.
Innovation is essentiell and Karstadt failed at this point (not only with the business model).
Malls face strong competition from trading over the internet where you are able to avoid crowds, nasty people and dissatisfied cashiers.
Facing strong competition and being unable to change the business model made this ship sink.
Much more interesting question is if the company would have survived with a flexible strategy and an innovative business model?
I kind a love this article, i think its good stuff to our audience. so many things to learn and i hope you continue write great stuff on this article. keep it up
The core of your writing while appearing reasonable in the beginning, did not sit perfectly with me personally after some time. Somewhere throughout the paragraphs you managed to make me a believer unfortunately just for a very short while. I nevertheless have a problem with your jumps in logic and you might do well to fill in those gaps. If you actually can accomplish that, I would surely be fascinated.