When Service Merchandise finally filed for Chapter 11 bankruptcy protection on March 27, few in the retailing community were surprised. The jewelry/home goods specialty retailer, based in Brentwood, Tenn., has struggled for years. As the last major survivor of the catalog showroom format that prospered in the 1960s, ’70s, and ’80s, Service has seen its sales and profits slip in recent years and has lost market share in key merchandise categories to mega-discounters like Wal-Mart and Kmart and “category killers” like Circuit City.

Over the last two years the company has tried desperately to put its catalog showroom past behind it, launching a flurry of initiatives it hopes can put it back on the road to profitability. These have included management shake-ups, massive store closings, multiple new store formats, the elimination of its catalog, a major merchandising and marketing repositioning, and a move to a more self-service format in the stores. Perhaps even more central to the company’s strategy is an increased emphasis on jewelry, the retailer’s most profitable category—and at $1 billion in sales, about 27% of its $3.7 billion business. Are these moves too little, too late, or can Service resurrect itself?

“Chapter 11 allows us to continue to move forward with our planned improvements in operations and merchandising and achieve our restructuring objectives in an orderly manner,” says Sam Cusano, newly appointed chief executive officer. “With the support of our vendors and the hard work of our employees, we will be able to emerge from this process a stronger, more competitive company.”

Some industry observers are skeptical. “If they do survive, they’ll have to totally transform the way they do business,” says one volume industry supplier. “Putting more emphasis on jewelry is fine, but it only represents a quarter of their sales. They’ll have to find a way to make their other categories profitable. I’m doubtful whether they can do that.”

Long road ahead. The new management team (see p. 237) certainly has a tough assignment. In its filing, Service listed assets of $1.5 billion and debts of $1.3 billion owed to more than 1,000 creditors. According to court papers, the 20 largest unsecured creditors—none of whichare in the jewelry industry—are owed a combined $384 million.

The retailer, which hadn’t yet announced 1998 financial results at press time, had a $68.5 million loss for the nine months ended Sept. 27, 1998. This came on the heels of a $91.6 million loss in 1997. As of April 6, the company’s stock was trading at 25 cents per share on the New York Stock Exchange, down from a 52-week high of $2.37 last spring.

To reverse the downward spiral, Service has initiated a number of moves in an out-of-court restructuring effort the last few years. Most of the measures represent a backpedaling away from its catalog showroom roots toward a more conventional retail store format:

• In February, the company announced the closing of up to 134 of its 347 stores—nearly 40% of its operations. It also said it would lay off 150 staffers at its corporate headquarters and shut down its Dallas distribution center. This follows 60 store closings, the shutdown of a Nevada distribution center, and the elimination of nearly 1,500 management positions in late 1997 and early 1998.

• Last year, the company discontinued its well-established (but expensive to produce) fall catalog in favor of more timely and targeted monthly fliers, newspaper circulars, and TV advertising.

• Since late 1997, Service has been experimenting with new store formats, including its Service Select stores, which feature a full-line jewelry department and only the best sellers from other merchandise categories; a self-service pilot format launched in Hickory Hollow, Tenn., last year, offering more floor stock customers can take from the shelves and bring directly to the register; and a new closeout concept called Treasure Quest, which features clearance and special-value merchandise at deep discounts.

• Also in 1997, the retailer dropped its antiquated clipboard ordering system—which required customers to carry around a clipboard and write down their selections—in favor of a new pull tag system that lets customers take order tickets off of display samples and bring the tickets right to the register for scanning.

• In the summer of ’97, Service consolidated its jewelry repair operations into 13 regional service centers and phased out its low-margin personal computer business.

• In the fall of ’97, Service unveiled a major restructuring of its marketing division into individual teams to oversee its eight remaining merchandise “worlds”—fine jewelry, kitchen and dining, home accents and furniture, “looking healthy/staying healthy,” “season to season,” travel shop, electronics, and “kid essentials.”

• Two years ago, the chain revamped its advertising and credit card programs.

To what end? The changes have had little effect on the company’s performance. Service had a poor holiday ’98 selling season, and the chain missed a $13.5 million interest payment in early January. It got a bit of a reprieve in mid-January when it secured a $750 million financing commitment from Citicorp USA and BankBoston to replace its previous $900 million credit facility with Chase Manhattan Bank. But same-store sales in the critical fourth quarter showed a dismal double-digit decline. And the company was further rocked by the sudden resignation of CEO Gary Witkin right after Christmas.

Service did make the interest payment in mid-January and brought back Raymond Zimmerman as a non-executive chairman. Zimmerman, who retired as chairman in April 1998, is the son of the 65-year-old company’s founders.

Dissatisfied with the chain’s out-of-court restructuring efforts, a group of five vendors, owed a combined $8 million, forced Service’s hand by filing an involuntary bankruptcy petition against the retailer on March 15. That week, the company’s board of directors authorized it to commence voluntary Chapter 11 proceedings. Service formally filed for bankruptcy protection on March 27.

Since then, Service has secured $50 million in debtor-in-possession financing. The company says it expects to operate as before and pay for wages, vendor shipments, and services without interruption. The retail chain has received strong support from the vendor community. Beyond that, executives say it’s too soon to discuss the company’s strategies for going forward.

Gary Wright, president of retail consulting firm G.A. Wright in Denver, says that Service occupies a difficult niche. In terms of price, selection, and fashion offerings, it’s sandwiched between big-box discounters like Wal-Mart, Kmart, and Target on one hand, and national department stores like Sears and J.C. Penney on the other. It also competes with category killers like Circuit City in specific merchandise niches. “[Service is] stuck because they can’t sell as cheaply as Wal-Mart, and they’re not as good as the niche operators on specific products, other than jewelry,” he says. “I don’t see great prospects for them.”

Kurt Barnard, president of Barnard’s Retail Trend Report, Upper Montclair, N.J., says that despite its efforts, Service has yet to shed its catalog showroom image with the consumer. “This is a company in a very difficult spot,” he says. “They are struggling to avoid extinction and looking to jewelry to save them. What they have to do is persuade the public they are no longer a catalog showroom. And they need to get rid of every store that doesn’t fit their new identity in terms of the market or its performance.”

Barnard stresses that a successful repositioning and financial turnaround by Service isn’t impossible: Sears and, most recently, Kmart seem to have accomplished the feat (although Sears’ performance has slipped recently, and many feel the jury’s still out on Kmart). But even if Service succeeds in positioning itself primarily as a jewelry store, Barnard notes that “there are a lot of major jewelry chains and independents out there that won’t lay down and play dead.”

Analysts and industry observers say Service’s other big problem is that it’s shackled with huge locations (averaging about 50,000 sq. ft., with half of that selling space and the other half stockroom space). Going to a jewelry-only format—which many say Service would thrive at—isn’t practical because of the tremendous amounts of high-cost jewelry inventory the company would need to carry and sell to be profitable.

Others have suggested the company should consider renting out space inside its stores to lease operators to manage non-jewelry departments. Service Merchandise officials would not comment on the speculation.

The New Leadership at service merchandise

Service has tapped Sam Cusano as its new CEO, along with a new management team, to lead its restructuring. Cusano, 45, has been with the company since 1991. He most recently was executive vice president, chief financial officer.

Raymond Zimmerman, Service’s chairman, says Cusano’s experience and in-depth knowledge of the company make him a good choice to lead Service Merchandise into the future. “Sam Cusano has extensive knowledge of every aspect of Service Merchandise’s operations,” Zimmerman says. “With his historical perspective as executive vice president and a board member, he is in a unique position to lead the transformation of the company’s business.”

Cusano replaces Bettina M. Whyte, who had served as interim CEO since January, when Service president and CEO Gary Witkin resigned unexpectedly. Whyte is a principal with Jay Alix & Associates, a Southfield, Mich., consulting firm retained by Service to lead the restructuring it announced prior to bankruptcy. Jay Alix is expected to remain as a financial adviser to the company throughout the bankruptcy process.

In a move that underscores the critical role that jewelry sales play in this transformation, Service has promoted its long-time head of jewelry, Charles Septer, to president and chief operating officer, and a member of the board. Septer, 47, joined Service in 1982 and has been senior vice president, jewelry merchandising, since 1988. In his new role, he will lead all of the retailer’s merchandising and marketing operations.

“Under Charles Septer’s leadership, Service Merchandise’s jewelry organization has continued to expand and flourish, despite the significant challenges our company has faced in recent years,” says Zimmerman, who retired in 1998 but rejoined the company this year. “Going forward, we are confident that he will be able to translate the success of our core jewelry business to our company’s overall operations.”

Rounding out the new management team is C. Stephen Moore, senior vice president and general counsel, who was given the additional title of chief administrative officer. Moore, 36, has been with the company since 1992 and assumed the role of general counsel and corporate secretary in 1996.

At press time, the company had not yet named a new chief financial officer or head of jewelry.

Houston Jewelry Breaks Catalog Showroom Shackles

It’s difficult and risky to change the format and strategic direction of a long-standing company — as Service Merchandise is finding. But it’s not impossible.

Case in point: Houston Jewelry. In 1992, this Texas business did what Best Products, Brendle’s, and other catalog showrooms could not: transform itself into a full-service, traditional retail jeweler.

Started in 1953, Houston Jewelry (formerly Houston Jewelry & Distributing Co.) and its parent store, Sterling Jewelry & Distributing Co. in Dallas, had grown by leaps and bounds via the catalog showroom concept. At its height, Houston Jewelry was pulling in $20 million to $30 million in annual volume at its 40,000-sq.-ft. location, employing a staff of 125 to 150, and carrying $7 million in inventory. Between them, the two stores were generating some $60 million in revenues but no profits for their owners and founders, the Donsky-Solomon family.

“In 1990, I drove from Boston to Houston to see as many catalog showrooms as I could find,” recalls Rex Solomon, executive vice president of Houston Jewelry and part of the third generation of Solomons to run the business. “Most of them were gone. The writing had been on the wall for some time. Our company stopped making a profit in ’87-’88. We had a family meeting, and I said to the older members, ‘If we don’t change, we’ll die.’ ”

Like other catalog showrooms, the company was now facing category killers that were eating away at its business. The retailer was also a step behind the times, with the older generation resistant to technology and change — or even accepting credit cards.

“We were totally manual,” Solomon says. “The salesperson would write up the order, and the customer would pay by sending their money through a pneumatic tube to a cashier with an adding machine.”

After several cataclysmic events in 1992, including the death of one of the three founding brothers and the incapacitation of another from a stroke, the remaining family members met to discuss the company’s future. The consensus: Liquidate the business and start over as a traditional retailer. The Dallas store was sold to Barry Zale, and the company was dissolved to allow family members to pursue independent ventures. The Houston location was leveled. Rex, his father, Andrew, his mother, Dana (daughter of Houston jewelry founder Abe Donsky), and brother Keith erected a new 6,500-sq.-ft. guild store across the street.

Besides selling jewelry and watches, the new business carries some of the better-selling categories from its catalog showroom days, including china, flatware, holloware, porcelain, crystal, designer fragrances, clocks, leather goods, writing instruments, vintage books, fine art photography, and famous gift lines. It is the largest independent jewelry and gift store in Houston.

The store enjoys the luxury of a 250,000-customer database in Houston and 350,000-customer database in Dallas for advertising and direct mail, compiled during four decades as a catalog showroom. Solomon says the company uses only an active list of about 50,000 customers from the last four years.

Houston Jewelry has become fully automated. Orders are generated on laptop computers. Inventory, cash registers, accounts payable, timeclocks, and payroll interface seamlessly into its general electronic ledger. Customer purchases are recorded and archived electronically for future reference.

“We’re one of the few independent jewelers that have totally embraced technology in our store,” Solomon notes. “This has enabled us to cut costs and optimize inventory turn as well as evaluate the productivity of vendors and personnel. And technology and unique product offerings have allowed us to stay on a par with the largest jewelry and department store chains but retain our local feel.”

The store generates about $2 million per year in revenues — a fraction of what it used to do. But it’s become more profitable.

The firm has embraced the Internet, using a general home page (www.houstonjewelry.com) as well as a series of niche sites it uses to market individual categories. The company launched its first site last August. Solomon estimates that cyber-sales already account for 2.5% of the company’s total volume, with minimal investment and no advertising.

“We’ve contemplated opening a 1,500-sq.-ft. second location, but a store would realistically only have the potential to increase 5-6% in a given year. There is a realistic probability that the Internet will become much more profitable than any single location. Even at only 2.5% of sales, our online business will make five times the profit of our store, and with little overhead.”

Glen A. Beres is editor-in-chief of JCK’s High-Volume Jeweler.