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Can Office Depot Get Back On Track?

The Corporation: Strategies

Can Office Depot Get Back on Track?

A new CEO must rev up a chain that has been stalled for years

After taking the helm as chief executive of Office Depot Inc. on July 18, M. Bruce Nelson quickly employed a mystery shopper to get a firsthand look at the office retailer's stores--himself. As the former head of the company's international division, Nelson took advantage of his relative anonymity to drop in, unannounced, on a dozen of the chain's 817 U.S. stores. "In most of our stores today, when I walk in the first time, they do not know who I am yet," says Nelson.

For some, it may be a fleeting acquaintance. Nelson acknowledges he may soon be shuttering some underperforming locations as he scrambles to revitalize the largest chain of office superstores, based in Delray Beach, Fla. That's only part of the fix he'll need to apply to Office Depot, which nearly barreled off a cliff with an ill-advised expansion, after the Federal Trade Commission three years ago killed a plan to merge with aggressive competitor Staples Inc. Nelson is already biting the bullet on expansion, cutting new-store openings to about 80 this year from 123 in 1999. "We're looking at every single store," he vows.

It's about time. Office Depot's problems can be traced back to the ill-fated Staples deal. CEO David I. Fuente and his team almost froze expansion plans in deference to their would-be partner. But when the deal died, they scrambled to make up for lost time. The result was a flurry of ill-advised store openings in weak locations. Meanwhile, Office Depot was badly out-marketed by Staples and delayed squeezing costs out of a 1998 merger with Viking Office Products, a leading supplier of office products through catalogs. "Office Depot never got back on track after the failed merger attempt with Staples," says Dan Wewer, a retail analyst at Deutsche Banc Alex. Brown.

Meanwhile, the office-supplies business was shifting dramatically. Warehouse discounters, such as Costco Wholesale Corp. and Wal-Mart Stores Inc.'s Sam's Club, have successfully targeted the most profitable product categories, including computer paper and printer cartridges. That left Office Depot highly dependent on computers and related technology equipment, a category that accounts for more than 55% of Office Depot's store sales. But margins on computers are paper-thin because of competition from another direction, direct-selling computer makers such as Dell Computer Corp. and Gateway Inc. and electronics discounters Circuit City Stores Inc. and Best Buy Co. Inc.NEW TEAM. Things came to a head in July, when Office Depot announced that its second-quarter earnings had dropped 22%, to $57.9 million. And because it has cut prices of basic office supplies to compete with the discounters, the chain's full-year net income is expected to barely top its 1999 total of $258 million. Sales for the full year should rise 13%, to $11.6 billion, says PaineWebber Group Inc. analyst Aram Rubinson. That compares with a 24% increase, to $11 billion, projected for Staples. Sales at Office Depot stores open at least a year rose only 2% in the first half, and the stock, which has fallen by half since April, now trades around 7.

Office Depot's board eased Fuente, CEO since 1987, into the job of nonexecutive chairman and promoted Nelson. It hopes Nelson can bring some of the spark that he injected into Office Depot's international division, which has been its fastest-growing and most profitable. Nelson, who arrived when Office Depot bought Viking two years ago, is moving quickly. He revamped management, ousting Shawn P. McGhee, head of North American operations, and creating several new posts, such as president of North American retail stores, that are directly accountable to him.

That's a recognition that much of the expansion effort over the past two years was wasted energy. Staples, which will open 170 stores this year, has done a much smarter job of growing. Its clusters of smaller stores, along with a larger marketing budget, have given it an edge. Last year, when Staples moved into Atlanta--an Office Depot stronghold--it did so with 10 new stores. It now has 13. Office Depot, on the other hand, broke into Boston in 1998 with two stores. As a result, Staples is the only office superstore that's increasing its market share--from 34% in 1997 to 37% in 2000--says Deutsche Banc Alex. Brown. "Whatever challenges Office Depot has had have been of their own making, because this is a terrific industry," says Staples CEO Thomas G. Stemberg.NET GAINS. A slower growth pace may allow Nelson to improve a reputation among some once loyal customers for indifferent service and high prices. The chain has to woo back small-business customers such as Beverly Ratcliff, office manager at Centennial Golf Club in Acworth, Ga. Ratcliff says she has moved much of her business to Staples. She's also shopping more through Viking's catalogs, which she says do a better job than the parent of matching promotions. "Viking almost always beats Office Depot's price on [printer] ribbons," says Ratcliff.

Some analysts question whether Nelson can match the discounters' high product turnover and other cost advantages. But they agree there are abundant distribution savings to be wrung out of the Viking merger. He also can emphasize direct sales through Viking, which gets more than half of its revenues from overseas. Also, Office Depot is far ahead of Staples in e-commerce. It expects Net sales to double this year, to $800 million, with an undisclosed profit. Staples, by comparison, will lose money on $350 million of e-commerce sales.

Nelson clearly believes he's on the right track: In the past two months, he has personally bought 150,000 Office Depot shares. That's probably best viewed as a long-term investment. This reclamation project doesn't promise any quick fixes.By Aixa M. Pascual in Delray Beach, Fla.Return to top

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