business

Home Depot's "Big Disappointment": Sales

CEO Robert Nardelli talks about the changes he's instituting, employee morale, and what repairs still remain to be made

When Robert L. Nardelli took the helm at Home Depot (HD ) in December, 2000, he looked like a smart -- if unconventional -- candidate for the job. True, as a longtime manufacturing executive at General Electric (GE ), Nardelli didn't bring any retailing experience. But for all Home Depot's success at reinventing the hardware business, it was showing signs of strain.

While founders Bernie Marcus and Arthur Blank were spreading the trademark orange-striped stores across America, the chain was underinvesting in the systems to manage its sprawling network. Other retailers converted to automated inventory systems, but Home Depot was still logging each new shipment to stores with pencil and clipboard as late as 2000. Store managers often devised their own methods for evaluating employees, meaning that 140 appraisal forms were in use.

In his two years as CEO, Nardelli has brought much-needed rigor and discipline to Home Depot -- methodically analyzing and changing everything from how the hardware giant orders from suppliers to how it restocks the shelves. Yet in recent quarters, Home Depot has reported an unexpected drop in a key industry measure known as "same store" or "comparable" sales -- sales at stores that have been open a year or more.

Thanks to its growing number of new stores, Home Depot is still on track to report a 10% increase in fiscal 2002 revenues, and a 21% to 23% rise in profits. But on Jan. 2, when Nardelli announced that same-store sales for the fiscal fourth quarter ending Feb. 2 would be down as much as 10% over the year-ago quarter, Home Depot's stock tumbled 14%, to $21.38, a four-year low.

Some on Wall Street fear Nardelli's aggressive initiatives are creating too much upheaval and crimping sales (see BW Online, 1/17/02, "The GE Way Isn't Working at Home Depot"). For now, Home Depot's board remains resolute in their support of Nardelli's overhaul. "I have never felt better about the leadership of the company than I do right now," says director Ken Langone, another of Home depot's co-founders.

Nardelli discussed the state of Home Depot on Jan. 14 in an interview with BusinessWeek Atlanta Bureau Chief Dean Foust. Here are edited excerpts from their conversation:

Q: The big issue among institutional investors and analysts is the recent drop in same-store sales: Third quarter was down 2%, and there was your recent announcement that fiscal fourth quarter would be down as much as 10%. What's behind those declines?

A:

We had announced in the third-quarter earnings that we thought the fourth quarter would be down about 3% to 5%. The reason was that we knew we weren't going to run heavy promotions in the fourth quarter. We knew we weren't going to run the 12-month-deferred [interest promotion]. We knew we didn't have the [need to run inventory] clearance sales. We cleared out last year over $1 billion worth of inventory, and the team has done a very good job of...not letting that get out of control again. The good news is we don't have it. The bad news is: It affects fourth-quarter comp sales.

Q: Some analysts wonder if the decisions to run with leaner inventories and staff the stores with more part-time workers are hurting business. What's your view?

A:

I think the discussion out there is that we went to part-time workers in an attempt to cut costs. I would tell you that is absolutely not the case. And here's why: If we were doing it to cut costs, we would not have simultaneously offered benefits to part-time associates for the first time in the history of the company. We would not have simultaneously advanced tuition reimbursements for the first time. We would not have simultaneously allowed part-time associates to participate in a bonus program we put in place this year.

This was about "off-shift" and weekend coverage. What we saw was the need to have additional coverage in the "off hours," especially Friday night, Saturday, and Sunday. It was increasingly difficult to get full-time associates to provide that critical coverage.

So I would tell you absolutely, positively, this was not about cost. It was driven [by the need for] increased coverage. The numbers when we started this were about 70% full-time, 30% part-time in the beginning of 2001. During the course of the year, we got to 50-50, and today that ratio is about 60% (full-time). We're in the midst of a pretty pervasive transformation, with a lot of moving parts. To generalize or broad-brush that it was peak-time/full-time, or it was inventory, is not a fair evaluation.

Q: There is some concern among investors and analysts that the increased use of part-time workers has hurt Home Depot's once-vaunted customer service -- that they might not be as knowledgeable. And that this has hurt morale -- that some full-time workers who were cut back to part-time aren't happy about that.

A:

I spend a lot of time in the stores. I think the morale thing is not fair to the majority of associates in this company who are still extremely passionate, who still have tremendous pride when they put that apron on in the morning, who are still really zealous about what they do. But we're concerned about this also. What did we do? We provided the opportunity for 300,000 associates to participate in an "employer of choice" survey to a degree that has never been done in the company before. We had over 80% participation. Over 70% of the associates said they planned to be with this company next year.

One of the other comments was that we lost long-tenured associates. If you look at our associates with 10 years or more of service, the average service of the longer-tenured associates increased in the last period, not decreased. That's not anecdotal. It's factual.

Q: Some analysts wonder whether the sales slump stems from the transition you've had to make, coming from a manufacturing background to retailing, and that you've brought in other top executives from the outside who don't have retail experience. What do you say to those people?

A:

If you look at my direct staff, they have 120 years of retail experience. Did we bring people in from the outside? We sure did. When I got here, there was no [human resources] manager for a year. The position was open. So, yes, I did bring some people in from the outside, but I think it has been a pretty healthy mix.

Is retail different from the industrial businesses? Sure it is. But not in total. There are certain fundamentals in running a business, whether it's the importance of cash, the importance of asset management, the importance of return on invested capital...that are pretty portable regardless of the business.

Did I step in knowing retail? No. Did I step in with 30-some years with a pretty proven track record of experience in running companies? I would say yes. Do I need to keep learning? Sure. Do we all need to keep adjusting? We will. That's part of running a business today in a much more complex environment than what we had in the past.

Q: What surprised you most, if anything, about the retail business?

A:

The thing that surprised us the most is the degree of difficulty, and the time required, to make some of these changes. We have 300,000 associates. We have to make sure that we are able to communicate the reason why -- and the what -- we want them to do differently. That's a huge, monumental task.

Remember, this is a very young company. This is the first time [the associates] have gone through a transition, let alone a transformation. There was no stage-setting for the change: There was an outsider, there was a nonretail outsider. So anytime you have that degree of change, you're going to have angst and concern about the future.

Lay on top of that some of the changes we're trying to make, [like] the merchandising consolidation. We went from nine separate buying offices, where vendors were charging different prices for the same product. We had different terms and conditions, different co-op and rebate schedules. We weren't using the benefit of a $50 billion company in our negotiations with our supplier base.

We're not trying to kill the entrepreneurial spirit. What we're trying to do is allow the entrepreneurial spirit to focus on the sale and the service in the store, and let's try and provide a consistent method of store planning, of store merchandising, and store sets.

Q: The stock price is down 50% from where it was the day you took the job as CEO. What is the market saying about Home Depot?

A:

Clearly, what the market is saying is that, for all the things we are meeting or exceeding, the biggest concern is comp [sales] and top-line growth. As I've said publicly, I'm personally disappointed in my performance as it relates to achieving top-line sales this year. We'll end the year with about 10% top-line growth, 21% to 23% earnings growth, return on invested capital over 19%, gross margins up 31%, a $2 billion stock buyback, a 20% increase in dividends, over $2 billion in cash. The list of "meet or exceeds" is very credible, but it isn't enough to offset the concern about sales.

The most disheartening part about it is, as the stock price went down, it had a tremendous impact on the morale of the associates. We use stock here probably more pervasively across the company than any other retailer. Every salaried employee in the company gets stock options, all the way down to the assistant store manager. The good news is that everybody is glued to a common currency. All of our interests are aligned with the shareholders.

The bad news is that, for all of these things that we feel we've been working on that meet or exceed [our goals], the one big disappointment for us is sales. We understand that. We understand the importance of sales in being a growth company. And that's what we're focused on. We will get sales and comps back. I had to get some underpinning, some infrastructure, to be able to do that on a predictable, consistent basis. And that doesn't happen overnight. I mean, we are working on fundamental infrastructure, systems infrastructure, where we were woefully behind.

Q: What do [co-founder] Bernie Marcus and the other directors tell you?

A:

Bernie and I still talk. He called me just last week. He was in some of the stores in South Florida. He said they're the best he has seen in 15 years...the "shopability" of the stores, the attitude of the associates. Bernie has basically encouraged me to continue to do exactly what we're doing within the company.

    Before it's here, it's on the Bloomberg Terminal. LEARN MORE