BUSINESSWEEK ONLINE : DECEMBER 18, 2000 ISSUE
INFORMATION TECHNOLOGY Federated's Fingerhut Fiasco How the cataloger's grandiose Net dreams turned ugly Remember Fingerhut Cos.? When Federated Department Stores Inc. (FD) acquired the company for a lofty $1.7 billion in February, 1999, it looked like an Old Economy company on its way to becoming a New Economy darling. The savvy old catalog retailer was rapidly opening e-commerce sites and buying equity stakes in online retailers. With its expertise in filling catalog purchases, Fingerhut was offering order-fulfillment services to other Net retailers. Federated's acquisition couldn't have looked smarter when Fingerhut snagged order-fulfillment contracts with up-and-comer eToys Inc. (ETYS) and heavyweight Wal-Mart Stores Inc. (WMT) last year and Fortune declared Fingerhut one of the ''10 companies that get it.'' These days, all Fingerhut is getting is an avalanche of trouble. The company's Internet sales fell so far short of expectations this year that Federated is shuttering five of its eight e-commerce sites. Federated stopped investing in a sixth site, clearance retailer AndysGarage.com, and is likely to close or sell it. Fingerhut has seen its fulfillment contracts drop to 8 from 22 after allegations of poor service and a messy dispute with eToys. Worse, Fingerhut botched a plan to provide additional credit to its core catalog customers. The result is an ugly collection of special charges and layoffs. Federated took a $795 million hit because of Fingerhut's troubles in the third quarter and expects losses from unpaid credit-card bills to cost it an additional $350 million to $400 million this year. Parent company Federated, which also owns Bloomingdale's and Macy's, is cutting 550 positions at Fingerhut, or 24% of its workforce. ''In the annals of corporate acquisitions, this is one that from the outset was pretty stupid,'' says Brian S. James, a retail analyst at Loomis, Sayles & Co., a Boston investment firm that holds 2.7 million Federated shares. ''Like many managements, they got sucked in at the top of a cycle.'' Forget Internet visionary. Now, Federated looks like a Digital Age chump. The company and CEO James M. Zimmerman appear to have been blindsided by the Net's hype. While Fingerhut had grand plans for its Internet and catalog businesses, the company's execution has been dismal. Federated projected that its overall Net sales would hit $2 billion to $3 billion by 2004 with the addition of Fingerhut, but it's now clear that results will fall well short of the goal. Internet sales will total only about $180 million this year. The Fingerhut fiasco is a reminder that capitalizing on the Net is far from a slam dunk. While pundits predicted that catalog companies and direct marketers would have a natural advantage on the Web because they know how to operate without retail stores, that's not always the case. Sure, Dell Computer Corp. (DELL) reaps $1.5 billion in sales from its Web site each month. But Fingerhut, like many other companies, found itself struggling in the wired world: Its technology was lacking, its operations were sluggish, and its management didn't have the experience to tell the difference between the players and the pretenders on the Net. Now, Federated is working hard to make the best of a bad situation. Ronald W. Tysoe, the company's vice-chairman and a key executive behind the Fingerhut deal, admits that ''the acquisition has not worked out the way we hoped.'' Still, he says, Fingerhut is proving important strategically because it's helping Federated bolster its own Internet and catalog operations. For example, Federated is using the catalog company's skills in gleaning information from customer databases to create more targeted marketing for customers of Macy's catalogs and e-commerce site. Fingerhut has successfully taken over management of Federated's order-fulfillment center and is starting to handle some of Federated's catalog and Net sales from its own warehouses. ''Hindsight is always 20/20,'' says Tysoe. But ''the acquisition was a good strategic acquisition for us.'' Or was it? Whatever additional skills Fingerhut brings to Federated, the two companies don't fit well together, and eventually, they're likely to be separated. Here's why: At its core, Fingerhut lends money to people who can't get credit anyplace else. That kind of volatile, risky business is very different from the upscale department-store operations most Federated shareholders are looking for. Already, Federated's shares have tumbled 35%, to $35, from their peak in January. Investors will likely continue to penalize Federated's stock as long as Fingerhut is part of the company. ''That's why I believe they will ultimately sell the business or spin it off to shareholders,'' says analyst Jeffrey S. Stein of McDonald Investments Inc. Tysoe says Federated will consider anything that's in the best interests of shareholders. To understand how Federated and Fingerhut got into this jam, turn back the clock to 1998. The catalog company was still independent. It was racking up revenues of nearly $2 billion annually by selling pots, toaster ovens, and other items at high prices to a base of largely poor customers. To drive sales, Fingerhut offered easy credit at high interest rates. But Ted Deikel, Fingerhut's longtime CEO and chairman, wanted more. With the stocks of Amazon.com Inc. (AMZN) and America Online Inc. (AOL) soaring, Deikel figured it was time to remake his company into an e-commerce player. In the spring of 1998, he hired William J. Lansing, a 40-year-old business-development officer at General Electric Co. (GE), to develop a Net business and boost catalog sales. The company's new president was a blur of activity in the eight months before the Federated acquisition. He carved out the e-commerce employees into a separate group, ramped up hiring, and boosted capital spending for the company's three fledgling Web sites. He started an e-tailing site for Gen-Xers called TheHut.com, along with an accompanying catalog. He bought minority stakes in four e-commerce sites, including mountain-sport content site MountainZone.com and FreeShop.com, which offers trials of magazines and other goodies. He also bought three catalog outfits and started others from scratch. EASY MONEY. Lansing showed an innovative touch as well. Fingerhut had loads of excess capacity at three warehouses in Minnesota, Tennessee, and Utah. In fact, the 1 million-square-foot Utah facility was vacant because the home-shopping venture Deikel built it for never panned out. Lansing's solution? Use them to provide warehousing, packaging, and shipping services to other catalog and Web companies. To turbocharge sales, Lansing pushed a plan to provide Fingerhut's customers with easy money. Even before he arrived, the company had started to offer some customers credit cards to buy Fingerhut goods instead of making them buy products on an installment plan. Lansing sped up the rollout, giving credit cards to 4 million customers in two years instead of the previously scheduled three years. The company also started offering credit cards to riskier customers and aggressively extending them credit. Almost from the start, there were signs that such vast change was creating problems. ''The infrastructure was always a step-and-a-half behind,'' says a former Fingerhut executive. Fingerhut's November, 1998, acquisition of the Popular Club catalog, which sells fashion apparel, bedding, and other goodies, was a case in point. Within months of the deal, Fingerhut moved Popular Club's fulfillment operations from New Jersey to Fingerhut's Minnesota facility. But that tripled how long it took to get mailings to Popular Club's largely Northeast-based customers, causing sales to plummet, say a former Popular Club employee and a former Fingerhut executive. Fingerhut moved Popular Club's fulfillment back to New Jersey last summer. LOST ORDERS. Fingerhut also struggled with the technology it needed to be a big Net player. The company found that it was too difficult to modify its existing software to communicate with fulfillment customers and its warehouse network. So Fingerhut created another version of the software called Fingerhut Logistics Software, or FLS, to handle orders for other companies. But FLS had kinks in it, say former Fingerhut execs. In some cases, notice of a customer's purchase would get lost between the company's central computers and its warehouses, causing days of delay. At other times, the software lost track of inventory so Fingerhut didn't have an accurate measure of what was in stock at the warehouse. Zimmerman and the rest of Federated's management saw few problems with Fingerhut when they acquired the company in February, 1999. Federated paid $25 a share--30% above the cataloger's stock price just before the deal, and nearly four times the shares' $6.62 low just four months before. Although Federated officials now say Fingerhut's Internet forays were not a major reason for the purchase, they cited those initiatives at the time of the deal. Zimmerman plugged the fulfillment business in one newspaper article, and management discussed the potential gains from Fingerhut's Net investments with Wall Street analysts. ''They did communicate that to the Street when they first announced the acquisition,'' says McDonald Investment's Stein. ''That was part of the plan.'' Federated certainly did nothing to slow down Lansing. Two months after the acquisition, the company promoted him to head a new operating unit called Federated Direct, which included Fingerhut's catalog and Net businesses and most of Federated's catalog and Net operations. During the rest of 1999, he launched three more e-commerce sites and made four more investments in Internet startups. Over the summer, he landed fulfillment contracts with eToys and Walmart.com. Lansing's vision was anything but modest. With Fingerhut's infrastructure, Federated's merchandising expertise, and his growing network of Web sites, Lansing figured he could create a ''strategic incubator.'' The Web sites would share customers and warehouses and promote each other's offerings. Lansing thought the combo could become bigger even than Amazon. ''Yes, I had very bold aspirations. That's true,'' says Lansing, who left Fingerhut in March for NBCi, the TV network's online arm. He says his Net investments were strategically sound and Fingerhut was a ''world leader'' in fulfillment when he departed. ''We had a good business, and we made it better,'' he says. While Lansing was thinking big, Fingerhut's operational problems were getting worse. Shortly after the Federated acquisition, Fingerhut acquired a minority stake in Hand Technologies, an Austin (Tex.) company that sells computers on the Net. Fingerhut started shipping computers for Hand out of its Minnesota facility, but there were troubles right away, according to Hand CEO Andrew Harris. Fingerhut had a hard time keeping track of computers in its warehouse, so Hand would sell products that weren't in stock. Fingerhut also was unable to supply Hand with basic shipment details, such as computer serial numbers. ''They were definitely struggling with their information systems,'' says Harris. ''DISCONNECT.'' By the fall of 1999, differences began to emerge between Lansing and Federated's management, according to former Fingerhut execs. While Lansing still wanted to pursue his grand network of e-commerce sites, his bosses were becoming less enthusiastic in the wake of early declines in Net retailing stocks. Rather than see Lansing cut more deals, Federated wanted him to focus on how Fingerhut could serve its store, catalog, and Web companies. When both sides sat down to set a budget for Fingerhut for 2000, Lansing asked for about $200 million, according to a former Fingerhut executive. He got $100 million. While Tysoe wouldn't comment on the budget figures, he concedes that ''there may have been some sort of disconnect there.'' Lansing's big plans ran into even more trouble over the Christmas selling season. Execs at eToys were warring with Fingerhut over escalating costs. People close to eToys contend that Fingerhut was, in some cases, sending out partial orders, so eToys had to pay for two separate shipments. In other cases, Fingerhut took so long to assemble orders that eToys had to pay for express shipments. By February, the parties broke off their contract, and Fingerhut launched an arbitration suit, claiming eToys had failed to pay for $14.8 million in services. The dispute has only gotten messier since. In August, eToys CEO Toby Lenk said in an article in The Boston Globe that he had fired Fingerhut--prompting Fingerhut to sue for defamation. Neither side will comment, but in court documents, Federated blames the fulfillment problems on eToys' own disorganization. EToys wasn't the only one questioning the quality of Fingerhut's fulfillment. Mark Amodio, head of e-commerce at Children's Place (PLCE), a New Jersey children's-apparel retailer, says its Net orders sometimes are sent in two shipments or are canceled because of difficulties in tracking inventory. MountainZone.com and Walmart.com also had inventory troubles. Tysoe concedes that the fulfillment business has been challenging but declined to discuss specifics. DEBT SQUEEZE. The Fingerhut situation went from bad to worse this year. First, Federated's stock slid nearly 31% from the first of the year through the end of April as investors got more nervous about Net retailers. Then, in July, Federated disclosed that rising delinquencies in Fingerhut's credit business would cut earnings this year by at least $350 million. Federated blamed the rise in bad debt on aggressive lending practices, which occurred under Lansing. To turn the business around, Federated is tightening credit standards--but that is expected to cut Fingerhut's core catalog sales by as much as 39% this year, to $850 million. In October, Lansing's grand vision abruptly came to an end. Federated announced that all five Web sites he started will be closed or folded into other sites. The company will no longer invest in e-commerce companies. And Federated will stop pursuing new third-party fulfillment contracts. Tysoe says it is too costly to serve dot-coms. In hindsight, he says, it's easy to question the wisdom of the acquisition. Was the deal a mistake? ''I have to let others tell you that,'' he says. With Federated's market capitalization down about 18%, to $7 billion, the answer is pretty clear. By Robert Berner in Chicago _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS Federated's Fingerhut Fiasco TABLE: Fingerhut's Avalanche of Errors INTERACT E-Mail to Business Week Online

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