The Sorry Side of Sears:    page 3

At 4:15 p.m. on April 9, a cryptic e-mail message flashed onto screens at Prairie Stone. It summoned Sears's top 200 executives—the so-called Phoenix Team—to an urgent meeting at 8 the next morning. As Martinez explained Sears's serious breach of law, says one attendee, "Arthur was not angry, but very sad." The costs, he said, were incalculable. "We've rebuilt our customers' trust and confidence in this company brick by brick," he said, "and now all of that has been bulldozed."

It was a devastating moment for the Phoenix Team. "I was watching the veterans, the people who've been through so much," says one executive. "There was no movement, no expression, no shuffling of feet. They were heartbroken." As the meeting ended, Martinez told every executive to spend the next half hour at his or her desk. Do nothing, he said, but think about your own operation. "Not just to identify additional exposure," he says, "but to fundamentally rethink—Is what I do, the direction I give, the body language I use, creating an environment where something like this could happen? Is my message, 'Make the numbers at any cost'?"

Martinez has asked himself the same question. Sears had suffered a black eye before he arrived, when auto-repair employees in California were caught hiking their own commissions by selling customers products they didn't need. Martinez is proud of the ethics office and other integrity initiatives he launched after he joined Sears. "We tried to set a tone at the top," he says. But in the early 1990s Martinez also oversaw the extension of credit cards to 17 million new customers. That's about 5 million more than Sears might routinely have added. Credit by itself is big business: last year the company earned 50 percent of its operating income from credit, including charge cards held by more than half of all U.S. households. The problem, Martinez admits, is that too many of those new cardholders barely qualified. So, in its zeal to attract new business, Sears became a lender to its riskiest customers. As the number of bankruptcies nationwide mushroomed, so did the number of unpaid accounts at Sears: by 1997 more than one third of all personal bankruptcies in the United States included Sears as a creditor.

Any company that dependent on income from its credit cards must aggressively pursue bad debts, and Sears isn't the only retailer to have crossed the line. Bankruptcy experts estimate that creditors historically haven't filed perhaps one third of all reaffirmations that bankrupt Americans sign. Since the Sears case broke, Federated Department Stores (which owns Macy's and Bloomingdale's), May (Filene's), G.E. Capital (Montgomery Ward) and Discover card have settled with debtors. But Martinez saw the scandal as more disturbing than a credit tactic run amok. Several weeks after the crisis erupted he probed for deeper cultural flaws during a Saturday retreat with his Phoenix Team. "Maybe all the bullshit that's being written about how we've changed values and culture is just that," he told his executives. "What allowed this thing to go unnoticed, untouched and unreported for so long?" Talking in small groups, the managers agreed that Sears's transformation from an exhausted, defeatist bureaucracy into an aggressive, can-do company had an unanticipated consequence: they hated to send bad news back up to the top. That's a common pathology. Managers aren't trained to expose problems, says James Schrager, a business ethicist at the University of Chicago. "They're trained to make their goals or heads will roll." CEOs can't control every employee's actions, Schrager says. They can, however, emphasize that workers may lose their jobs for failing to report violations—but never for telling management the truth.

The Sorry Side of Sears:    page 5

The search cost $14 million, but Sears's eagerness to find and repay the people it had wronged won high marks from Justice and other combatants in the case. "Usually we have two years of knock-down, drag-out before we get down to business," says John Roddy, a Boston attorney for the debtors. "This is the only case I've ever filed where I didn't get a pure stonewall response." A few of those affected stepped forward to identify themselves. Several dozen people wrote the company to say they didn't deserve refunds, and planned to keep paying off their debts. One man called to say that he'd declared bankruptcy twice, under the names Jeff and Geoff; he wanted to make sure he got both refunds. Another man called on his mobile phone while cruising past Prairie Stone on Interstate 90. Would it be possible, he asked, to drop by and pick up a refund?

When the last lawyer's bill arrives, the scandal will have cost Sears close to $475 million. Almost $300 million has gone to the wronged debtors, both as refunds (plus interest) of about $1.40 for every $1 Sears improperly collected, and as forgiveness of remaining debt for whatever items they'd purchased. The balance: the pending federal fine, a separate penalty paid to the 50 states and the cost of settling a lawsuit brought by a group of shareholders who claimed that the scandal had hurt the price of their stock. Sources outside Sears say six managers have been forced out of their jobs. (Levin also has departed for unrelated reasons.)

Last week's plea bargain—which Sears swallowed in order to avoid a criminal trial—should let the company dispose of the scandal for good. Martinez says he's pleased that "the end is clearly in sight." He's got other things to worry about. His turnaround has lost some momentum, and Sears stock is languishing near its 52-week low. Martinez is now launching his "Second Revolution," a plan to re-energize the company with, among other things, new merchandise and more store remodelings. Pressing as those challenges are, it's a relief for Martinez—and everyone else at Prairie Stone—to get back to business.

Newsweek, February 22, 1999