In 1991, the California Department of Consumer Affairs began investigating Sears Auto Repair Centers

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In 1991, the California Department of Consumer Affairs began investigating Sears Auto Repair Centers. Sears’ automotive unit, with 850 repair shops nationwide, generated 9 percent of the merchandise group’s $19.4 billion in revenues. It was one of the fastest growing and most profitable divisions of Sears over the previous two years. In the California investigation, agents posed as customers at thirty-three of the seventytwo Sears automotive repair shops located from Los Angeles to Sacramento. They found that they were overcharged 90 percent of the time by an average of $223. In the first phase of the investigation, the agents took thirty-eight cars with worn-out brakes but no other mechanical problems to twenty-seven Sears shops between December 1990 and December 1991. In thirty-four of the cases, the agents were told that their cars needed additional work. At the Sears shop in Concord, a San Francisco suburb, the agent was overcharged $585 to replace the front brake pads, front and rear springs, and control-arm bushings. Sears advertised brake jobs at prices of $48 and $58.50 In the second phase of the investigation, Sears was notified of the investigation and ten shops were targeted. In seven of those cases, the agents were overcharged. No springs and shocks were sold in these cases, but the average overcharge was $100 per agent. Up until 1990, Sears had paid its repair center service advisors by the hour rather than by the amount of work.51 But in February 1990, Sears instituted an incentive compensation policy under which employees were paid based on the amount of repairs customers authorized.52 Service advisors also had to meet sales quotas on specific auto parts; those who did not meet the quotas often had their hours reduced or were assigned to work in other departments in the Sears stores. California regulators said the number of consumer complaints they received about Sears shops increased dramatically after the commission structure was implemented.

The California Department of Consumer Affairs charged all seventy-two Sears automotive shops in the state with fraud, false advertising, and failure to clearly state parts and labor on invoices. Jim Conran, the director of the consumer affairs department, stated: This is a flagrant breach of the trust and confidence the people of California have placed in Sears for generations. Sears has used trust as a marketing tool, and we don’t believe they’ve lived up to that trust. The violation of the faith that was placed in Sears cannot be allowed to continue, and for past violations of law, a penalty must be paid.53 Dick Schenkkan, a San Francisco lawyer representing Sears, charged that Conran issued the complaint in response to bipartisan legislative efforts to cut his agency’s funding because of a state budget crunch and claimed, “He is garnering as much publicity as he can as quickly as he can. If you wanted to embark on a massive publicity campaign to demonstrate how aggressive you are and how much need there is for your services in the state, what better target than a big, respected business that would guarantee massive press coverage?” 54 Richard Kessel, the executive director of the New York State Consumer Protection Board, stated that he also had “some real problems” with Sears’ policy of paying people by commission. “If that’s the policy,” Kessel said, “that in my mind could certainly lead to abuses in car repairs.” 55 Immediately following the issuing of the California complaint, Sears said that the state’s investigation was “very seriously flawed and simply does not support the allegations. The service we recommend and the work we perform are in accordance with the highest industry standards.” 56 It then ran the following ad: With over two million automotive customers serviced last year in California alone, mistakes may have occurred. However, Sears wants you to know that we would never intentionally violate the trust customers have shown in our company for 105 years. Ten days after the complaint was announced, the chairman of Sears, Edward A. Brennan, announced that Sears was eliminating the commission-based pay structure for employees who propose auto repairs.57 He conceded that the pay structure may have created an environment in which mistakes were made because of rigid attention to goals. Brennan announced the compensation system would be replaced with one in which customer satisfaction would now be the primary factor in determining service personnel rewards, shifting the emphasis away from quantity to quality. An outside firm would be hired to conduct unannounced shopping audits of Sears auto centers to be certain the hard sells were eliminated. Further, Brennan said, the sales quotas on parts would be discontinued. While he did not admit to any scheme to recommend unnecessary repairs, he emphasized that the system encouraged mistakes and he accepted full responsibility for the policies. “The buck stops with me,” he said.58 Sears auto repair customers filed class action lawsuits in California, and a New Jersey undercover investigation produced similar findings of overcharging. New Jersey officials found that 100 percent of the Sears stores in its investigation recommended unneeded work compared to 16 percent of stores not owned by Sears.59 On June 25, 1992, Sears ran a full-page ad in all major newspapers throughout the country. The ad, a letter signed by Brennan, had the following text: An Open Letter to Sears Customers: You may have heard recent allegations that some Sears Auto Centers in California and New Jersey have sold customers parts and services they didn’t need. We take such charges very seriously, because they strike at the core of our company—our reputation for trust and integrity. We are confident that our Auto Center customers’ satisfaction rate is among the highest in the industry. But after an extensive review, we have concluded that our incentive compensation and goal-setting program inadvertently created an environment in which mistakes have occurred. We are moving quickly and aggressively to eliminate that environment. To guard against such things happening in the future, we’re taking significant action: We have eliminated incentive compensation and goal-setting systems for automotive service advisors—the folks who diagnose problems and recommend repairs to you. We have replaced these practices with a new non-commission program designed to achieve even higher levels of customer satisfaction. Rewards will now be based on customer satisfaction. We’re augmenting our own quality control efforts by retaining an independent organization to conduct ongoing, unannounced “shopping audits” of our automotive services to ensure that company policies are being met. We have written to all state attorneys general, inviting them to compare our auto repair standards and practices with those of their states in order to determine whether differences exist. And we are helping to organize and fund a joint industry-consumer-government effort to review current auto repair practices and recommend uniform industry standards. We’re taking these actions so you’ll continue to come to Sears with complete confidence. However, one thing we will never change is our commitment to customer safety. Our policy of preventive maintenance—recommending replacement of worn parts before they fail—has been criticized by the California Bureau of Automotive Repair as constituting unneeded repairs. We don’t see it that way. We recommend preventive maintenance because that’s what our customers want, and because it makes for safer cars on the road. In fact, 75 percent of the consumers we talked to in a nationwide survey last weekend told us that auto repair centers should recommend replacement parts for preventive maintenance. As always, no work will ever be performed without your approval. We understand that when your car needs service, you look for, above all, someone you can trust. And when trust is at stake, you can’t merely react, we must overreact. We at Sears are totally committed to maintaining your confidence. You have my word on it. Ed Brennan Chairman and Chief Executive Officer Sears, Roebuck and Co.60

On September 2, 1992, Sears agreed to pay $8 million to resolve the consumer affairs agency claims on overcharging in California. The $8 million included reimbursement costs, new employee training, and coupons for discounts at the service center. Another $15 million in fines was paid in forty-one other states to settle class action suits.61,62 In December 1992, Sears fired John T. Lundegard, the director of its automotive operations. Sears indicated that Lundegard’s termination was not related to the controversy surrounding the auto centers. Sears recorded a net loss of $3.9 billion despite $52.3 billion in sales in 1992—the worst performance ever by the retailer in its 108-year history and its first loss since 1933. Its Allstate Insurance division was reeling from damage claims for Hurricane Andrew in the Gulf Coast and Hurricane Iniki in Hawaii ($1.25 billion). Auto center revenue dropped $80 million in the last quarter of 1992, and Sears paid out a total of $27 million to settle state overcharging claims. Moody’s downgraded Sears debt following the loss announcement. In 1994, Sears partially reinstated its sales incentive practices in its auto centers. Service advisors must earn at least 40 percent of their total pay in commissions on the sale and installation of tires, batteries, shock absorbers, and struts. Not included on commission scales are brakes and front-end alignments (the core of the 1992 problems). Earnings in auto centers have not yet returned to pre-1992 levels. Many of the auto centers have been closed. There are some who have expressed concerns about the ethical culture at Sears. While incentive systems may have created the auto center fraud problems, consider the following dilemmas involving Sears since the time of its auto center fraud cases: • Montgomery Ward obtained an order from a federal court prohibiting Sears from hiring employees away from Wards as it works its way through Chapter 11 bankruptcy. The order was based on an e-mail sent from Sears’ regional vice president, Mary Conway, in which Sears managers are instructed to “be predatory” about hiring away Montgomery Ward managers. • A class action civil suit was filed in Atlanta against Sears by consumers who allege that Sears sold them used batteries as new. One of the plaintiffs in the suit alleges that an investigator purchased one hundred “new” batteries from Sears in 1995 (in thirty-two states) and that seventy-eight of them showed signs of previous usage. A Sears internal auto center document explains that the high allowances the centers must give customers on returns of batteries cut into profits and induce the sale of used batteries to compensate. (Sears denies the allegation and attributes it to disgruntled former employees and not understanding that a nick does not necessarily mean a battery is used.)63 • Sears admitted to “flawed legal judgment” when it made repayment agreements with its credit card customers who were already in bankruptcy, a practice in violation of creditors’ rights and priorities. Sears agreed to refund the amounts collected from the 2,700 customers who were put into the program. Sears warned the refunds could have a “material effect” on earnings. The announcement caused a drop in Sears’ stock price of 37/8. Sears included the following notice to its credit card customers: NOTICE: If you previously filed for personal bankruptcy under Chapter 7 and entered into a reaffirmation agreement with Sears, you may be a member of a Settlement Class in a proposed class action settlement. For information, please call 1-800-529-4500. There are deadlines as early as October 8, 1997 applicable to the settlement. Sears entered a guilty plea to criminal fraud charges in connection with the bankruptcy issues and agreed to pay a $60 million fine, the largest in the history of bankruptcy fraud cases.64 The company also settled with the fifty state attorneys general, which included $40 million in state fines, $12 million for state shareholder suits, and a write-off of the $126 million owed by the cardholders involved, which was forgiven as part of the settlement.65 Sears also settled the class action suit on the bankruptcy issue by agreeing to pay $36 million in cash and issuing $118 million in coupons to those cardholders affected by its conduct with regard to bankruptcy customers. Sears did not admit any wrongdoing as part of the settlement but indicated the action was taken “to avoid the litigation.” 66 Sears spent $56 million in legal and administrative costs in handling the bankruptcy cases. Sears has been struggling to find its market niche for some time. In 2001, it was forced to close eighty-nine stores as it watched its competitor, Montgomery Ward, close its doors for good.67 In 2004, Kmart purchased Sears.

Question

1. What temptations did the employee compensation system present?

2. If you had been a service advisor, would you have felt comfortable recommending repairs that were not immediately necessary but would be eventually?

3. Does it matter whether the overcharges were intentional or part of business incentives?

4. A public relations expert has said of the Sears debacle: “Don’t make the Sears mistake. When responding to a crisis, tell the public what happened and why. Apologize with no crossed fingers. Then say what you’re going to do to make sure it doesn’t happen again.”68 What are the ethical standards in this public relations formula?

5. What will be the likely results of the incentive reinstatement?

6. What do you believe creates Sears’ culture?

7. Sears’ stock price and earnings fell. What lesson is there in these consequences?

8. Compute the total costs of the bankruptcy cases to Sears.

9. Are there principles for a credo for, as an example, the mechanics at the auto centers? What about the lawyers who worked for Sears on the bankruptcy issues?