Retailers: The strong will survive

Former Staples CEO Tom Stemberg talks about the state of back-to-school shopping and what's in store for merchants.

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By Suzanne Kapner, writer

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Tom Stemberg on retailers: "The strong will get stronger, and the weak will get weaker."
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NEW YORK (Fortune) -- The number of people who have created entirely new categories in retailing can probably be counted on one hand.

There's Sam Walton, whose Wal-Mart Stores were an early pioneer of discount shopping, and Leslie Wexner, who conceived of the "specialty" store with his Limited chain. Add to that list Tom Stemberg, the father of the office supply superstore.

Back in 1986, when Stemberg drew up a business plan for Staples (SPLS, Fortune 500), most companies bought their office supplies from mom and pop shops. Today, with $23 billion in sales, Staples dominates the category it helped create.

After 16 years as Staples's CEO and an additional three as chairman, Stemberg -- in 2005 -- joined the venture capital firm Highland Capital Partners, where he serves today as general partner of its $300 million Consumer Fund. His mission: to provide hot new retail concepts with the early stage financing that was so critical to Staples' success. Stemberg talked to Fortune recently about the art of investing in retail, as well as the upcoming back-to-school shopping season.

What types of companies does the Highland Consumer Fund invest in?

We focus on retail and consumer product companies that are in their early lifecycle. The first company we invested in was Lululemon Athletica (the maker of yoga and other workout clothes). We also own a stake in StriVectin (the anti-wrinkle cream) and we just made an investment in Pinkberry (the frozen yogurt chain).

You must be crazy to invest in retail right now considering how many retail enterprises are going out of business.

It would be easier if the economy were running on all cylinders. But there are still companies that are doing well.

What signs are you seeing that consumer spending has bottomed?

The good thing about retailing is that you get a report card every day in terms of sales figures. I look at sales at stores open at least a year -- both for the companies in which we have an investment and for other retailers as well. The sales figures have turned slightly positive -- or at least less negative -- than they were a year ago.

How do you think the back-to-school season will play out?

It's going to be better than people had feared, but not nearly as robust as some of the stock prices would suggest.

If back-to-school sales are soft, does that mean retailers should expect a tepid holiday shopping season?

I don't think there is a big correlation between back-to-school and holiday spending. Back-to-school is necessary spending. People buy what they need -- shoes, notebooks -- and they want to pay as a little as possible for these items.

Christmas shopping is way more discretionary and emotional. I think Christmas spending will be stronger than back-to-school spending. As long as unemployment, the stock market, and housing prices hold steady -- and inflation doesn't come into play -- the psychology at Christmas will be far better than it is today.

Which retailers stand to win and which stand to lose?

The strong will get stronger, and the weak will get weaker. Companies that are financially stronger will be able to invest more right now in merchandise and services. In office products, which is an area I happen to know well, Staples will continue to take share from Office Depot (ODP, Fortune 500) and OfficeMax (OMX, Fortune 500).

That makes sense. But what about a company like Best Buy? It's outlived most of its competitors, and yet is still facing headwinds.

Best Buy (BBY, Fortune 500) is getting a market share bounce from the closure of Circuit City, but it's still in a market that is not doing that well. You just don't have to buy a new $2,000 widescreen TV right now.

What other businesses would you stay away from right now?

I don't want to be selling $10,000 diamond rings or $5,000 snowmobiles. I don't want to be in any business where the purchase can be deferred.

Are there any silver linings out there?

I look at the Sunday circulars, and promotional activity is extremely aggressive for the back-to-school season. So there is some concern about margin pressure. But that said, retailers have dramatically reduced expenses and have very lean inventories. If there is any tailwind whatsoever in sales, they will be way more profitable than people expect. To top of page

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