ACCT 600 MAFM CAPSTONE
BECAUSE OF THE RISKS CAN COSTCO ACQUIRE THE #3 KMART?

ABSTRACT
The retail business is very competitive. Because the retail industry provides products and or services for the needs, wants, and sometimes feelings of the consumer it can be hard to determine what they like and don’t like. Moreover, with the economy, which by the way affects all businesses, you just do not have an exact science on how things will turn out. Industry businessman, economist etc. can only make assumptions based on occurrences. So, if you are in a business to make a profit, and satisfy stakeholders you need to have a plan. Sometimes the plan calls for mergers and acquisitions. Mergers and acquisitions can have a positive and/or negative effect. “According to a KPMG study, 83% of all mergers and acquisitions failed to produce any benefit for the shareholders and over half actually destroyed value.”(http://www.itapintl.com/...the-impact-of), to be a good CFO you must do the research to determine if acquiring another company will be beneficial. This report will identify the risk factors of the target acquisition company Kmart and the risk factors present in the parent company Costco. Our team will then show how these risks can be mitigated.

BECAUSE OF THE RISKS CAN COSTCO ACQUIRE THE #3 KMART?
KMART RISKS/MITIAGATION Many investors such as Costco may be unaware of all the risks associated with investing in a specific company. Providing current and future investors with risk factors allows investors to evaluate a company and make an informed investment decision.
Kmart’s operations and financial results are subject to various risks and uncertainties, including those described below, that could significantly affect the Costco’s judgments in acquiring the business. Here are few risks factors which Kmart may face with Costco. The first being changes in senior management and any future departures of key employees may disrupt Kmart’s business and materially adversely affect its results of operations. As organizations grow, changes in the leadership needs of the organization require different skills to navigate through various phases of growth. Corporate acquisitions are frequently undertaken with an emphasis on getting the deal completed. Therefore, the integration issues that might arise afterwards are often overlooked or ignored. Inadaptability of employees and managers of the acquired business is one of the primary reasons that corporate acquisitions fail to meet the expectations of the parent organization (Johnson, H. 2002). Members of the newly acquired company’s management team struggle with the new direction, structure, expectations, culture and accountability forced upon them; however it is the ability of these managers to make the acquisition successful. In order to mitigate this risk we would constantly keep a list of people that can step into those positions both internally and externally. Also make sure that we have an appropriate amount of Key person insurance. Another consideration is to have a no compete clause on some of the key leader’s contract. According to Kmart’s annual report the second risk factor Kmart faces with merging with Costco is that “sales may fluctuate for a variety of reasons, which could adversely affect Kmart results of operations” (SHLD 2011 Annual Report, Risk Factors, page 8).

All business has become sensitive to their customers spending patterns, whit the downturn of the economy; Customers are not spending as much. With this being said sales and results of operations will fluctuate going forward to the future. To mitigate this risk, I would have in place a system that can determine when sales are underperforming and start selling the inventory with discounts immediately. Another risk factor which Kmart may be subject to according to its 2011 Annual report is that it can face “product liability claims if people or properties are harmed by the products they sell or the services they offer” (SHLD 2011 Annual Report, Risk Factors, page 11).
Some of the products that Kmart sells may expose them to product liability claims relating to personal injury, death, or property damage caused by such products, and may require them to take actions such as product recalls. Although they have insurance they are not certain that coverage will be adequate for liabilities actually incurred or that insurance will continue to be available to them on economically reasonable terms, or at all. In order to mitigate this factor
Kmart has done everything in their power to avoid losses against lawsuits by purchasing the insurance they already have. What I may do is analyze what they have and determine if we need to purchase more. If Kmart is unable to compete effectively in the highly competitive retail industry, business and results of operations could be materially adversely affected (SHLD 2011 Annual Report, Risk Factors, page 7) is another risk factor they may face according to its 2011 annual report. Kmart competes with a wide variety of retailers, including other department stores, discounters, home improvement stores, appliances and consumer electronics retailers, auto service providers, specialty retailers, wholesale clubs and many other competitors operating on a national, regional or local level in the U.S. and Canada; the two major ones are Wal-mart and Target. In order to be success in this competitive marketplace, price, product assortment and quality, service and convenience are major factors. According to Kmart’s Annual report a last risk factor which Kmart may face is that “it has been and will continue to be affected by worldwide economic conditions”; a failure of the economy to sustain its recovery, a

renewed decline in consumer-spending levels and other conditions, including inflation, could lead to reduced revenues and gross margins, and negatively impact its liquidity (SHLD 2011 Annual Report, Risk Factors, page 7). To avoid this I would have a plan in place to make sure all our employees are continuously improving their product knowledge and people skills. I would develop a compensation program to encourage improvement in each department. Economic and other factors are outside of Kmart’s control, including consumer and commercial credit availability, consumer confidence and spending levels, including the impact of payroll tax increases in the U.S. that went into effect this past January. These economic conditions could be lead to less spending and demand for the company merchandise. In Conclusion the Risk Factors of Kmart, as the target acquisition company reveals that the company has been and will continue to be affected by worldwide economic conditions; a failure of the economy to sustain its recovery, a renewed decline in consumer-spending levels and other conditions, including inflation and changing prices of energy, could lead to reduced revenues and gross margins, and negatively impact on the corporations liquidity. The recommendation will be made to the board of directors of Costco to purchase Sears Holding Corporation in the current year 2013.
COSTCO RISKS/MITIGATION Retail transformation and proper talent acquisition could be problems in the merger between Costco and SHLD. There have been many different shake-ups throughout all businesses over the past few years due to the recent economic downturn. No industry has been totally safe from the impact this economic “storm”; this includes retail based firms. These firms are feeling the need now more than ever to make certain sacrifices while continuing to innovate and find new strategies to insure longevity. There has been no relief for the head leadership of these firms either, as a result, numerous executives have stepped down or been relieved of their duties. SHLD’s CEO speaks of this dilemma in his chairman’s letter in Feb. of 2013, “Changes at the CEO or President level of Safeway, Toys "R" Us, Staples, JC Penney, Best Buy

and others are signs that the talent needed to transform companies in the retail industry today and the persistence required to see transformations through are not easy to come by (Lampert, 2013). Product Regulation. Current and/or future regulation could be a problem for Costco. Some goods that Costco sell may require certain markup minimums in so territories. SHLD should try to mitigate this as much as possible by trying to identify which products these stipulations will be required for. For instance, if a merger between Costco and SHLD will require SHLD to sell products such as tobacco and gasoline, we must take into account that our profits will be less than projected if these “minimums” are not part of our forecasts. ("Costco annual report 2012," 2012). Vendor Cost. Varying vendor costs could be another stepping stone for Costco. If suppliers are unable to supply Costco with goods at the right price, this would spell disaster for Costco and its members. Costco’s strategy is primarily based on being able to deliver an abundance of goods at competitive prices. Costco’s major competitor in this department is the infamous Wal-Mart whose “buy in bulk” strategy proved to be a goldmine for Wal-Mart’s continued success in reductions in prices for its consumers. If changes in terms of any vendors occur, there could be shortages in inventory leading to a shortage in profits. ("Costco annual report 2012," 2012) Accounting Standards and Health Care. Changing in standards of accounting and health care legislation could impact the financial position of Costco. Specifically, the Patient Protection and Affordable Care Act and the Health Care Education Reconciliation Act will expand health care causing Costco’s health care costs to increase. Although these changes are not expected to cause tremendous revenue decreases, this legislation could make waves by changing legal interpretations and ultimately affect how claims are settled. A combination of all of these factors could hurt Costco’s bottom line significantly. Costco’s annual report discusses this in their annual report, “Although our estimates of liabilities incurred do not anticipate significant changes in historical trends for these variables, any changes could have a considerable effect upon future claim costs and currently

recorded liabilities and could materially impact our consolidated financial statements. ("Costco annual report 2012," 2012)” Costco’s change of guards can be relieved by always hiring talent that knows business and are competent in all fronts of knowing what the stakeholders want and need. There is no perfect CEO but there is such a thing as hiring the best person for the job. The best person is someone who has history of doing what is necessary to make a healthy, thriving company. Vendor cost can be reduced when Costco forms a relationship with the company their doing business with. To mitigate vendor cost Costco should always pay promptly and always establish a good relationship with its vendors. This helps to evaluate tension and because Costco buys bulk this helps to get a better price on merchandise. Costco management should also research the vendors their selecting to do business with. “Management should perform due diligence on potential vendors ideally, due diligence will provide management with the information needed to address the possible risks presented by potential vendors” (http://vendorverification.com/managing-risks-in-vendor-relationships/) such as vendor cost. Health care reform is going to affect any corporation big or small. The only company that can get through this with the new laws is a company that cares about the employees and not how much profits it may or may not lose. It is more of a risk losing a well trained, loyal, competent employee than not providing affordable healthcare. Because employees will leave a business if they feel the employer is not loyal to them also. Because Costco is a large corporation it will be able to do two things (1) establish their own healthcare company which is only for non health care companies with 50+ fulltime employees which is called a captive insurance company or (2) “form a private exchange, which may be complementary to forming a captive insurance company, in that the entity forming it creates its own marketplace, which means it may qualify as providing insurance with a defined contribution”( bswllc.com/tackling-health-care-reform-cost-vs-strategy/Share) Both strategies control health care cost.
CONCLUSION
Kmart and Costco could help each other in this competitive market. As you have read the risks are major but can be mitigated with the suggestions throughout the report. Costco management must further do their due diligence in providing accurate and further analysis in making a decision in acquiring Kmart.

References
Costco annual report 2012. (2012, December 14). Retrieved from http://phx.corporate-ir.net/phoenix.zhtml?c=83830&p=irol-reportsannual
Industry browser-services-department stores industry-company list. (2013, march 29). Retrieved from http://biz.yahoo.com/p/731mktd.html
Lampert, E. (2013, February 28). Chairman's letter February 2013. Retrieved from http://www.searsholdings.com/invest/index.htm
Shld competitors/sears holdings corporation stock-yahoo finance. (2013, march 29). Retrieved from http://finance.yahoo.com/q/co?s=SHLD Competitors http://www.investopedia.com/features/industryhandbook/retail.asp http://yahoo.brand.edgar-online.com/DisplayFiling.aspx?dcn=0001310067-13-000013 http://vendorverification.com/managing-risks-in-vendor-relationships/ bswllc.com/tackling-health-care-reform-cost-vs-strategy/Share http://www.itapintl.com/...the-impact-of Johnson, H. (2002). Post-acquisition pressure. Society of Management Accountants of Canada, 76 (8), 16-17.

http://www.searsholdings.com/invest/docs/SHC_2012_Form_10K.pdf#pagemode=thumbs&page=1&zoom=100,0,0