Home Depot Improvement

Based on net sales for the fiscal year ended January 2007, the Home Depot (NYSE: HD, NAICS: 444110) is considered the largest home improvement retailer in the world and the second largest retailer in the US ^{1, 8, 9 10}. In 2006, the company expanded its presence in China with the acquisition of The Home Way, a Chinese home improvement retailer⁹. Home Depot got a head start in global home improvement retailer industry compared to its main competitor, Lowe’s, whose international operations amount only to 6 stores in Canada which were opened in 2007. The company operated 2,258 stores throughout the US, Mexico, Canada, and China at the end of the first quarter of the 2008 fiscal year⁸.

• U.S.: 1,970 The Home Depot Stores; 81 opened in 2007; 15 closed in Q1 FY08

• Canada: 166 The Home Depot Stores; 10 new opened in 2007

• Mexico: 69 The Home Depot Stores; 5 new opened in 2007

• China: 12 The Home Way stores, acquired in 2006

• Other: 34 EXPO Design Center stores, 5 Yardbird stores, 2 THD Design Center stores

The market structure for Home Depot is a dominant firm oligopoly. Home Depot is the world’s largest home improvement retailer. Home Depot’s focus is on pricing and product range. “Oligopoly” denotes a situation where there are few sellers for a product or service. The two dominant firms in the US in the home improvement retailer are Home Depot and Lowe’s. There are only two to four major players that prosper in this market structure. It is difficult to start a company in this market segment. The few that does succeed are often run out of business by the oligopolies⁵.

According to Karatash & Rittberg (2004), Home Depot and Lowe’s both recognize that they are rational players in an oligopoly industry and both companies will behave appropriately to maximize margins by engaging in fierce competitive pricing. Unlike the smaller, undifferentiated retailers who purchase through wholesalers and similar intermediaries, Home Depot and Lowe’s have sought to leverage their market concentration by negotiating directly with manufacturers. As the home improvement retailer leaders have created a relationship with key suppliers, they have developed another cost advantage which is squeezing out the remaining independent retailers and provides a massive barrier to entry protecting the dominant players in the industry².

Home Depot utilizes gigantic scale to produce goods, significantly cheaper than any other firm, and dominate the US market. However, there still exists a degree of locality in the home improvement retail market as a proportion of people are not prepared to visit these huge retailers, which are often found industrial parks at the edge of cities and towns. Threat of new entrants is there assessed as strong overall¹⁰.

The only viable substitute to utilizing the home improvement retail market is the purchase of a new house. This alternative is not a close fit to the market because it is much more expensive and deem unnecessary. In the home improvement retail market segment, the threats for substitutes are non-existent¹⁰.

With its size and their network of stores, Home Depot keeps large inventories of items through the flexible inventory management system. Some larger stores act as a distribution points within the geographic area to leverage other stores’ inventory. This flexible inventory management system is one of Home Depot’s distinct competitive advantages and demands a complex network system of transportation, warehouse space, and extensive back office operations that take care of inventory shifts and order execution. Many smaller firms do not have the resources to support the additional cost⁸.

Home Depot’s only rival in the home improvement retail industry is Lowe’s Companies (NYSE: LOW). In terms of sales revenue ($77B vs. $48B), Home Depot dominates the US home improvement retail market. Lowe’s and Home Depot are leaders of the home improvement retail industry, but both companies only cover 18% of the estimated $725 billion home improvement market together (this includes pure product demand as well as installation labor demand). The remainder is split between other “big-box” retailers such as Wal-Mart Stores (NYSE: WMT), smaller hardware store chains, construction firms, and other small businesses⁸.

Lowe’s Companies, Inc. (NYSE: LOW) is a $48.3 billion retailer that offers a complete line of home improvement products and services. The Company, through its subsidiaries, serves approximately 14 millions do-it-yourself, do-it-for-me and Commercial Business Customers each week through 1,534 stores in the US and Canada. Lowe’s is ranked as the second largest home improvement retailer in the world⁴.

http://www.wikinvest.com/image/HDCompeteLOWSales.png

Both companies’ sales do not paint the whole Lowe’s and Home Depot picture. Lowe’s has surpassed Home Depot recently along key metrics of same stores sales growth and operating margin growth. Also, Lowe’s may see more growth by expanding internationally in 2007^{6, 8}:

http://www.wikinvest.com/image/HDCompeteLOWSSS.png

Two key areas of focus emerge as Lowe’s battles Home Depot in the home improvement retail arena. The first key area is the expansion of domestic and international stores. The second key area is the growth of installed sales services for the growing do-it-for-me (DIFM) customer base⁶.

The majority of Lowe’s business consisted of sales to professional homebuilders. In 1980, this began to change due to the decline of the housing market. At the same time, Home Depot introduced its low-price warehouse concept. Instead of following Home Depot’s footsteps, Lowe’s began to change the layout of its stores. By 1982, Lowe’s had re-designed half of its 229 stores to serve do-it-yourself (DIY) customers⁷.

The Home Depot stores serve three primary customer groups¹:

• Do-It-Yourself (“D-I-Y”) Customers: Customers/home owners who purchase products and complete their own projects and installations¹.

• Do-It-For-Me (“D-I-F-M”) Customers: Customers/home owners who purchase materials themselves and hire third parties to complete the project and/or installation¹. With the baby boomers getting older, this category of customers should become a larger portion of the total. Home Depot will bring in additional profit in this segment from installation charges that they do not accrue from DIY (do-it-yourself) customers⁸.

• Professional Customers: Customers who are professional remodelers, general contractors, repairmen, small business owners and tradesmen¹.

The typical Home Depot store usually carries between 35,000 to 45,000 products during the year¹. Each Home Depot store provides a variety of proprietary brands exclusively sold by Home Depot and national brand name items sold by other retailers and suppliers. With contracts and agreements, Home Depot has been given exclusive rights to sell certain brands generate dual value, especially in regards to the professional customer base⁸.

• When consumers or professionals contractors become accustomed to one type/style of tool they will most likely replace that tool with one of the same style/type. The reason for this behavior can be as simple as the cost, time spent, associated with learning how to operate a new tool, which can be significant⁸.

• Home Depot has private label brands that contribute to higher profits⁸.

The strong market position provides economies of scale and enhances the brand image of the company. As a result, this enables the company to serve a wide range of customers to penetrate the market more effectively⁹.

All home improvement retailers are vulnerable to macro economic changes in the housing market as well as natural disasters such as hurricanes. Home Depot and Lowe’s are at the mercy of the housing market^{6, 8}. When the housing market strengthens, the demand for home improvement products rises. If the housing market weakens, consumers are reluctant to invest money into their homes because of the fear that they won’t see a return on that investment. The housing market boom from 2005 to 2006 resulted in a high demand for home improvement supplies. In mid-2006, the housing market slowed down, this resulted in a negative growth and the same store sales growth for both companies. In the summer of 2007, the housing market continued to fall due to the sub-prime mortgage crisis. This crisis has negatively impacted the U.S. Housing Market which has a domino effect on the home improvement retail industry^{3, 6, 8}. Quarterly profits for Home Depot has fallen for the past seven quarters in the midst of the weak housing market and Lowe’s has posted three straight quarterly profit declines³.

Home Depot main focus was to compete in pricing and product range. As a result, the company’s customer service has fallen short of the industry benchmark⁸. Home Depot has lagged behind the industry standards not only in the quality of its customer service, but also in store layout and appearance. The inconsistencies of the store’s layouts have led to a high level of customer dissatisfaction. With the focus on pricing and product range, it has allowed competitors such as Lowe’s to increase sales through better customer service and well laid out stores^{8, 9}.

Home Depot had reached its maturity, which means the retailer is under increasing pressure to mine growth with new merchandise offers, services, formats, and markets. The challenges are being magnified as they occur in the context of significant corporate restructuring and increasing competition from Lowe’s¹¹. In 2010, The Home Depot will be expected to aggressively pursue innovations as it seeks to build a sturdy platform for future growth¹¹.

The Home Depot 2010 encompasses the following items:

• Store Modernization—Improving the Experience. Home Depot modernizes its store layout to make store easier to navigate, reduce complexity, and provide more product information¹¹.

• Merchandising—New Products, New Appeals. Home Depot will strengthen its efforts to differentiate its merchandise offer¹¹.

• Services—A Do-It-For-Me Focus. The key factors for fueling the growth of the do-it-for-me segment of home improvement retailing is the aging baby-boomers and time pressed consumers¹¹.

• Formats—Tapping New Markets. Unlike previous efforts, the new smaller-format strategy acts to the retailer’s strengths by maintaining a broad, competitively priced merchandise offer, but in a smaller box¹¹.

• Non-store—Extending Multichannel Reach. Home Depot will upgrade its Web site to strengthening its multichannel. The Internet plays a bigger role in home improvement shopping. The company’s goal is to reach $1 billion in Internet sales by 2010¹¹.

• Pro Market-Moving Beyond Retail Core. The company plans to shadow in the pro market what the company has done at the retail level in an effort to sustain overall growth. This highly, fragmented sector offers clear potential for growing sales¹¹.

• Capabilities—Enhancing Efficiencies. With its massive size, Home Depot can utilize the latest technologies as it looks to streamline the supply chain to keep prices competitive while maintaining product quality levels¹¹.

• International—Getting Serious Overseas. Starting outside of North America with China, Home Depot is in position to become a much bigger player internationally, ¹¹.

References

¹Home Depot Annual Report, 2007

²Karatash & Rittberg (2004). Equity Research.

³Jacobs, K., (2005). Home Depot see growth -when market stabilizes.

⁴Lowe’s Annual Report 2007

⁵http://www.oligopolywatch.com/stories/2003/04/17/definingTheNewOligopoly.html

⁶http://www.wikinvest.com/stock/Lowe%27s_Companies_(LOW)

⁷http://www.datamonitor.com. (May 2007). Lowe’s Companies, Inc.

⁸http://www.wikinvest.com/stock/Home_Depot_(HD)

⁹http://www.datamonitor.com. (Dec. 2007). Home Depot.

¹⁰http://www.datamonitor.com. (April 2008). Global Home Improvement Retail.

¹¹http://www.retailforward.com (Oct 2006). Home Depot 2010.