Home Depot's Remodeling Project

After two years of distracting renovations, the DIY giant is ready to unveil its new design. Will it be enough to hammer rival Lowe's?

By Dean Foust

As Carol Tomé strides into the Home Depot (HD ) store in Smyrna, Ga., a suburb of Atlanta, a few days before Christmas, it isn't to do some last-minute holiday shopping or plot a new home project. That's because this isn't your normal Home Depot store, and Tomé isn't just another shopper. She's Home Depot's chief financial officer, and she's here to provide a reporter with an exclusive walking tour of this prototype store -- which Tomé feels holds the key to better times ahead for the nation's second-largest retailer.

As 2004 kicks off and the broad market continues to rise, Home Depot shareholders would find that prospect heartening, because the past three years have been trying. When its board in late 2000 decided an outsider -- Robert Nardelli from General Electric (GE ) -- would succeed then-CEO Arthur Blank, performance was already starting to slip.

At the time, Home Depot blamed the sharp slowdown in revenues and profits on deflation in lumber prices, but the real issues were much bigger than the price of plywood. While Blank and co-founder Bernie Marcus slapped up stores in breakneck fashion over the 1980s and 1990s, they underinvested in the systems and technology to manage the sprawling retail empire, which now stands at 1,675 outlets.

CRUCIAL YEAR.

  Nardelli immediately put Home Depot through a sweeping restructuring, but it has been a bumpy ride. His efforts to trim the fat out of inventory levels resulted in shortages -- and lost sales -- during parts of 2002, prompting him to reverse course and build inventories back up.

That, coupled with Nardelli's efforts to reshuffle store staffing and initiate disruptive makeovers of older stores, caused sales at most of Home Depot's locations to turn negative for two quarters. The result: The stock, which had already fallen by nearly 30%, to around $50 when Nardelli arrived in late 2000, slid as low as $20.10 in early 2003. It has rebounded to around $35.50 as of Jan. 8, as sales and profits began to climb over recent months.

This year, Nardelli and his team must prove they can sustain that momentum and demonstrate that the makeover is paying off. Tomé -- one of the few senior executives who survived the management changeover -- is confident as she strides through the Smyrna store.

FOREIGN CONTRACTORS.

  While the disruptions and lost sales unnerved many investors, Tomé contends the wrenching overhaul was necessary to set the stage for the next round of growth. Nardelli, she recalls, "has said what got us to the first $50 billion wasn't going to get us to the next $50 billion. We had to change a number of things."

As she speaks, Tomé points to a prominent display of Ridgid power tools. It's a symbol of the increased emphasis Home Depot is putting on pushing its proprietary brands, many manufactured by low-cost contractors in Asia, rather than simply stocking wares by the likes of Black & Decker (BDK ).

Already, 9% of revenues come from its own imported lines -- up from 7% a year ago. Among the early successes: Hampton Bay ceiling fans, which Home Depot sources in Asia, that have helped the retailer garner half of all ceiling-fan sales in the U.S.

SINK SINKAGE.

  Home Depot is hoping for similar success with Ridgid, produced under contract by Emerson Electric (EMR ) and for sale only through Home Depot and some industrial-supply shops. "Ridgid is our brand," Tomé says flatly. By working with Emerson on design and then shifting production to Asia, Tomé says the new line, launched last October, has "better product attributes, a lower price -- and higher margins for us."

Tomé cuts through lumber to a display of door locks. Where Home Depot simply once stacked its merchandise on shelves up to the ceiling, it has lowered many displays to allow consumers to try out the products -- in this case, letting customers tinker with a panel of door locks to see and hear how easily each model closes.

"You'll see a lot more of our sets come down. It makes for a better shopping experience," Tomé says. She points to the new layout of high-end Kohler sinks and tubs. While Home Depot once simply hung such merchandise on massive hooks, it now displays these products at eye level as well in hopes of inspiring more bathroom renovations. "We used to do more kitchen displays than bathrooms, but you know, there are more bathrooms than kitchens in most houses." By Dean Foust

PREFAB DISPLAYS.

  Tomé walks briskly back to the kitchen section. While Nardelli & Co. worked feverishly to modernize the displays of cabinets and countertops, Tomé admits the refurbishments -- known as "resets" in retail parlance -- became a huge distraction in 2002. Workers roped off the section for weeks as they rebuilt the displays, and the combination of ear-splitting saws and dust often drove shoppers away.

"It used to take 13 weeks to do kitchen resets," she sighs. "Now we can do it in five days. And we're touching every single store this year with resets." The secret? "We got a group of people together to reengineer the process. It dawned on us that prefab houses, well, they go together quickly. Why don't we do our [kitchen displays] that way too? So now, we just roll them in and then screw the sections together. They come pre-wired, so you just put in the lights, plug them in, and they're ready for business."

Not all the changes afoot are visible to the eye. Back in the bathroom department, Tomé points to a series of large black orbs mounted on the ceiling. "Real-time surveillance cameras," she says. In the past couple of years, Home Depot has dropped $40 million on security cameras to reduce what Tomé calls "shrink" -- retailspeak for shoplifting and the otherwise unexplained disappearance of merchandise.

SUBSIDIZING COMPETITION.

  "We've lowered our shrink levels, but we know we're still not best in class," she says. (How good are the cameras? A Home Depot employee following Tomé notes that when detectives in Florida discovered a murder victim had been buried with a Home Depot shovel found near the grave, they gave the price-tag bar code to Home Depot officials, who tracked the shovel to the store that sold it, determined the time of purchase from sales records, and then gave the security tapes to detectives -- who immediately spotted their suspect.)

Tomé explains how Home Depot has gotten much smarter about its purchasing, in part by consolidating its many regional buying offices into one team that can negotiate bigger discounts from suppliers. And it has gotten wiser about managing its cash: "We used to pay our vendors faster than any other retailer -- and a lot faster than Lowe's (LOW ). We really were the First National Bank of Home Depot. And I'm sorry, but we were subsidizing Lowe's [growth]. Our 'days payable' is now 50, and before it was less than 30. Some of our vendors said to us, 'You know, we always wondered how long [it would be] before you changed your policy.'"

She's convinced Home Depot is better positioned for growth than before. "We've got a strong brand that people are immensely passionate about. We put two years into this incredible transformation that was distracting. We had the fallout from a war, from the risks of terrorism, an uncertain economy, and yet we accumulated a tremendous amount of cash during this period. Our store employees are more productive."

"BETTER BOX."

  Among the workers' ranks, "there's more alignment," notes Tomé. "We didn't have that a year ago." And while archrival Lowe's has been embraced as the new Wall Street darling, Tomé is adamant that Home Depot hasn't lost ground to its smaller competitor. "There has been no market-share loss to Lowe's," she says firmly. "We're still running a better box."

Perhaps, but while Home Depot execs have long tweaked Lowe's as being adept at copying their own innovations, in a few areas Home Depot is playing catch up to its smaller rival. One instance: Home Depot is now moving the lighting department by the front entrance -- giving the stores a more inviting feel than before. Lowe's began adopting this layout several years ago. And some analysts contend that it has matched or outpaced Home Depot in its service levels. Roughly 75% of store clerks at Lowe's are full-timers, vs. 60% for Home Depot.

And moves by Home Depot management to optimize store staffing to what Tomé calls the "power hours" -- the peak shopping periods between 10 a.m. and 2 p.m. and 6 p.m. and 8 p.m. -- mean that customers shopping outside those times might struggle to find help.

HELP WANTED.

  Case in point: As Tomé leads me outside for a brief tour of the gardening department, an elderly couple inside the store is clearly searching for a clerk. Ten minutes later, when we walk back in, they're still groping for help -- prompting a member of Tomé's entourage to sprint off in search of a sales hand.

That suggests all these renovation efforts remain a work in progress. But after two tough years of preparations, 2004 could be the year when the curtain finally goes up on the new Home Depot.

Foust is BusinessWeek's Atlanta bureau chief

Edited by Beth Belton

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