Kmart shoppers may have been surprised at the decision by the 40-year-old discount chain to file for bankruptcy-court protection on January 22. But the company’s decline was anything but sudden and its future is anything but certain, say three members of Wharton’s marketing department.

Professor Peter S. Fader has had his eye on Kmart for years, amassing a file of newspaper and magazine clippings that chronicle the company’s missteps. Each fall, on the opening day of class, he hauls out that file and points to Kmart as an object lesson for his students.

“Moody’s May Downgrade Kmart Debt, Citing Concern Over Lackluster Results,” proclaimed a headline in the Wall Street Journal in 1993. “S&P Cuts Kmart to Junk Status, But Discounter Says It’s on Track,” said another Journal headline in 1996. The title of a piece in Fortune that same year was especially ominous, as well as prescient: “Kmart is Down for the Count.”

“I’ve been using Kmart as an example for 10 years of how not to do business,” Fader says. “The failure of Kmart is clearly a failure of marketing. Kmart can blame all kinds of things – economic conditions, problems with their supply chain – but it’s their own fault for completely misunderstanding their market, for guessing in the absolutely wrong direction and being completely out of touch.”

According to Fader, one particularly bad mistake that Kmart made was its attempt in 1992 to position itself as a purveyor of fashions for women. An article in Advertising Age on October 12 of that year quoted Kmart’s vice president for marketing as stating, “Apparel is our competitive advantage over other discounters.”

Professor Barbara E. Kahn also has used Troy, Mich.-based Kmart in her classes as a prime example of a business that exhibits poor strategic thinking. “In discussing marketing strategy we stress that you have to have a focused strategy, but Kmart’s strategy was all over the place,” says Kahn.

The students that Kahn and Fader teach today had not even been born when Kmart got its start. The first Kmart store was opened in Garden City, Mich., in 1962 (the same year that Wal-Mart and Target began operations) by the S.S. Kresge Co., a five-and-dime chain that was founded at the turn of the 20th century in Detroit by Sebastian Spering Kresge. By 1977, Kmart generated nearly all of Kresge’s sales, and the company changed its name to Kmart Corp. Kmart sold the remaining Kresge stores in 1987.

Business was so good that in 1976 alone Kresge opened 271 Kmarts. With its BlueLight Specials and much-parodied in-store announcement, “Attention Kmart shoppers,” the discounter gained icon status among the polyester and sweatpants set.

“In the 1970s they clearly were superior and had better business practices than their competitors,” says professor Stephen J. Hoch. “But they weren’t able to adapt and grow as deftly as Wal-Mart.”

Wal-Mart positioned itself as the unequivocal low-cost discounter with superior service and super-efficient supply-chain management that kept costs down. Target emerged as the mass merchandiser that did not have everyday low prices but made up for it with bright, well-stocked stores and a splash of style. Where did Kmart fit in? “Who knows?” says Kahn. “They just didn’t have a clear, consistent strategy.”

Hoch points to four key factors that spell success or failure for retailers: location, price, assortment and service. Many Kmart stores are older than those of its competitors and located in less-than-attractive urban areas, Hoch says. A concentration of older stores in congested places makes the stores less appealing to shoppers. It also makes it hard for trucks to deliver merchandise efficiently, which makes it difficult to achieve economies of scale. “Kmart suffered from its early success in opening a lot of stores in urban settings. It’s an example of what you could call first-mover disadvantage,” Hoch says.

When it came to price, Kmart never matched the prowess of Wal-Mart. “By definition, there’s only one player who can have the lowest price and that’s Wal-Mart,” Hoch says. “It’s very difficult to establish an everyday-low-price image. Everybody has tried and failed except for Wal-Mart, Home Depot and warehouse clubs.”

As for assortment, Hoch gives Kmart credit for signing exclusive deals with high-visibility brands like Martha Stewart, Jaclyn Smith and Sesame Street. The problem was, though, that Kmart, unlike Wal-Mart’s, “had such a terrible replenishment system that they were always out of stock.”

Hoch says service is the least important of the four factors, given that Kmart is a discounter. But service does have an effect on shopper satisfaction and loyalty. “Kmart did not have a good pool of store-level talent and that led to a decrease in service,” he notes. Wal-Mart, by contrast, emphasized friendly customer service.

According to Hoch and Kahn, a recent attempt to try to beat Wal-Mart at its own game – encapsulated in its slogan “Always Low Prices. Always.” – proved costly for Kmart. For years Kmart was known for its BlueLight Specials, which highlighted sales on various goods. Last April, however, chairman and CEO Charles “Chuck” Conaway reintroduced and broadened the strategy, renaming it “BlueLight Always” and cutting prices on thousands of items. As part of the strategy, Kmart also cut back sharply on expensive weekly newspaper circulars that the chain had used for years to advertise its products.

But the idea bombed. Wal-Mart responded by cutting prices that Kmart could not beat. Kmart’s Christmas sales fell, while Wal-Mart’s and Target’s rose. “The return to the BlueLight Special was an attempt to go back to their roots, thinking there was some value there,” Fader says. “But in fact there wasn’t anything about the new BlueLight Special that gave people a warm and fuzzy feeling and offered them a reason to visit the stores.”

Years ago, Fader adds, the BlueLight Special was a novelty that provided “an element of surprise to the shopping experience and made shoppers feel connected to Kmart. But that was a different generation. Shoppers today have different habits. They are directed; they go into a store to buy certain things,” and are less apt to hang around waiting for the store to announce specials on items they do not want to buy.

Kmart removed Conaway as chairman following the disappointing holiday season and ousted president Mark Schwartz, a Conaway ally. Conaway, however, is still CEO. James Adamson, a member of Kmart’s board since 1996 and an executive with experience in turnaround situations, was named chairman. Adamson moved quickly, bringing in Ronald B. Hutchison, who was named to the new position of chief restructuring officer. Hutchison, former chief financial officer of Advantica Restaurant Group, which owns, among other things, Denny’s Restaurants, had experience helping to restructure Advantica and Leaseway Transportation in the 1990s.

Kmart says it plans to emerge from Chapter 11 of the U.S. Bankruptcy Code in 2003, but has yet to spell out a reorganization plan.

Aside from its new executives, Kmart has a few other things going for it. Martha Stewart Living Omnimedia has said it has no plans to exercise an option to break its contact with Kmart, which the contract permits because Kmart is in bankruptcy court. Kmart reportedly owes Martha Stewart $13 million. In addition, bankruptcy protection will allow Kmart to save millions by terminating leases on some 350 properties that are closed or sublet. The company can save money by closing stores and cutting its workforce. Kmart also has secured $2 billion in senior secured debtor-in-possession financing that will be used to supplement cash flow during the reorganization.

Kmart has been in tight spots before, but has not always made the best choices. In the 1980s and 1990s, Hoch says, the company opted to achieve growth through diversification by acquiring Builders Square (1984), The Sports Authority (1990) and Borders Group (1992). In 1991, Kmart also acquired an ownership interest of 22% in Office Max; the following year it boosted that position to more than 90%. “Kmart did that in desperation,” Hoch says of the acquisitions. “For a while the company lost its focus.”

In 1995, Kmart spun off Borders in an initial public offering and sold its remaining interests in The Sports Authority and Office Max. Builders Square was sold in 1997.

With a history of eroding profits and market share, the Wharton faculty members say it is hard to see what Kmart might do to emerge from bankruptcy as a stronger company. It is conceivable that another retailer, perhaps the European giant Royal Ahold, could buy Kmart to expand its presence in the United States, says Hoch, but no firm has yet stepped forward. Kmart’s leaders, adds Kahn, have a clear goal: “They’re going to have to get a cohesive strategy or they’re destined to fail.”