Book Excerpt February 26, 2010, 1:11PM EST

Book Excerpt: Denial at Sears

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An even bigger problem is that he was the antithesis of the incomparable Sam Walton.

Just prior to the first oil shock in 1973, retail sales in the United States began to decline in real terms. Sears's economist (this is prior to the oil shock) felt the country was looking at a severe recession the following year. A "senior officer" of the company, according to Katz, told the economist that if he publicized an official forecast to this effect, he would be fired. There appears to be a persistent belief in once-great companies that have lost their way that if you simply avoid speaking the blunt truth, all the problems will just go away. It is almost as if by telling the truth, you are endowing problems with a reality that they would not otherwise have. It is this brand of magical thinking that leads to shooting the messenger.

Sales in 1974 actually increased seven percent, which would not have been bad if the company had not forecast a rise of fifteen. Profits were off almost a quarter, a dramatically steep slide. Here indeed is the essence of the problem of denial. Reality is always just around the corner.

Sears wandered in the wilderness amid intermittent signs of life from 1973 until it was bought by Kmart owner Eddie Lampert in 2005. The company abandoned its Tower in 1992, a year in which it lost almost $4 billion, and relocated outside of Chicago to a town called Hoffman Estates. Kmart adopted Sears's name and the combined company is today called Sears Holdings.

Sears began to hire consultants in the 1970s, but they were no more helpful than the homegrown executives. Sears convinced itself that its market was "saturated." The way to grow, therefore, was to enter whole new lines of business. The company bought the real estate franchise Coldwell Banker and the financial broker Dean Witter. Why the company's CEOs thought they would do better managing businesses in industries they did not understand than they would in general merchandise retailing remains one of life's mysteries.

In fact, there was a fortune to be made in the very classes of trade in which Sears made its name. We know this—and everyone at Sears should have known it at the time—because Wal-Mart's spectacular success was no secret. Sam Walton had become the richest man in the world. He dressed in a grass skirt and did the hula on Wall Street itself in 1984 because Wal-Mart's stock had so outperformed what he had bet it would be. You had to be wallowing pretty deeply in denial to miss this.

Sears executives should have been focused on nothing else. Instead, they were playing around with the "store of the future" and telling themselves they would succeed selling "socks and stocks."

For the sake of symmetry, we should note that Walton did not pay much attention to Sears. In his autobiography, he only mentioned it once, and not very flatteringly. "One reason Sears fell so far off the pace is that they wouldn't admit for the longest time that Wal-Mart and Kmart were their real competition," he wrote. "They ignored both of us, and we both blew right by them."

It has often been observed there are no mature markets, only tired marketers. Unfortunately, nobody at Sears was making that observation, and there is no company which it described—or which demonstrates the pitfalls of denial—more perfectly.

Tedlow is the Class of 1949 Professor of Business Administration at Harvard Business School. His previous books include Andy Grove, Giants of Enterprise, and The Watson Dynasty.