Renovating Home Depot
COVER STORY PODCAST
Don D. Ray is one tough hombre. The 39-year-old Kentucky native spent three years with the 82nd Airborne Div., one of the U.S. Army's elite units, serving at the head of a maintenance crew during the first Gulf War and an additional seven years on active duty. Then, after the September 11 terrorist attacks, Ray suited up for service again, this time as the commander of a special forces A-team that followed the U.S.-led invasion into Afghanistan. His 12-man squad of snipers, demolition experts, and communications specialists hunted renegade al-Qaeda and Taliban. Combing mountain villages, he grew a thick beard, wore traditional Afghan garb, and rode on horseback to blend in with local Muslims. Ray and his men never killed anyone, he says, but they arrested dozens of suspected militants.
Nowadays, Ray commands a different kind of operation. He has replaced crack-of-dawn physical training and green Army fatigues with sunrise store openings and an orange Home Depot apron. A store manager in Clarksville, Tenn., Ray runs a 110,000-square-foot box with 35,000 products and a 100-member staff, 30 of them former military. Many days start at 4 a.m. That's when he wakes, eats breakfast, catches some CNBC news, then heads to the store, where the doors open at 6. Although Ray's bookish round glasses and pressed khakis make him look more like a teacher than a onetime terrorist hunter, he exudes a steely confidence. Former soldiers on his staff call him "sir." "In the military, we win battles and conquer the enemy," says Ray. At Home Depot, "we do that with customers."
Military analogies are commonplace at Home Depot Inc. (HD ) these days. Five years after his December, 2000, arrival, Chief Executive Robert L. Nardelli is putting his stamp on what was long a decentralized, entrepreneurial business under founders Bernie Marcus and Arthur Blank. And if his company starts to look and feel like an army, that's the point. Nardelli loves to hire soldiers. In fact, he seems to love almost everything about the armed services. The military, to a large extent, has become the management model for his entire enterprise. Of the 1,142 people hired into Home Depot's store leadership program, a two-year training regimen for future store managers launched in 2002, almost half -- 528 -- are junior military officers. More than 100 of them now run Home Depots. Recruits such as Ray "understand the mission," says Nardelli. "It's one thing to have faced a tough customer. It's another to face the enemy shooting at you. So they probably will be pretty calm under fire."
Built like a bowling ball, Nardelli is a detail-obsessed, diamond-cut-precise manager who, in 2000, lost his shot at the top job at General Electric Co. (GE ) to Jeffrey R. Immelt. He is fond of pointing out that if Home Depot were a country, it would be the fifth-largest contributor of troops in Iraq. Overall, some 13% of Home Depot's 345,000 employees have military experience, vs. 4% at Wal-Mart Stores Inc. (WMT ) And that doesn't even count James E. Izen, 38, a lieutenant colonel in the U.S. Marine Corps stationed outside Nardelli's door, is part of a Marine Corps Corporate Fellows program that Home Depot joined in 2002.
Importing ideas, people, and platitudes from the military is a key part of Nardelli's sweeping move to reshape Home Depot, the world's third-largest retailer, into a more centralized organization. That may be an untrendy idea in management circles, but Nardelli couldn't care less. It's a critical element of his strategy to rein in an unwieldy 2,048-store chain and prepare for its next leg of growth. "The kind of discipline and maturity that you get out of the military is something that can be very, very useful in an organization where basically you have 2,100 colonels running things," explains Craig R. Johnson, president of Customer Growth Partners Inc., a retail consulting firm.
Rivals such as Wal-Mart are plunging deeper into home improvement products, while archenemy No. 1, Lowe's Cos. (LOW ), is luring Home Depot customers to its 1,237 bright, airy stores. Even as other companies seek to stoke creativity and break down hierarchies, Nardelli is trying to build a disciplined corps, one predisposed to following orders, operating in high-pressure environments, and executing with high standards. Home Depot is one company that actually lives by the aggressive ideals laid out in Hardball: Are You Playing to Play or Playing to Win?, the much discussed 2004 book co-authored by Boston Consulting Group management expert George Stalk.
The cultural overhaul is taking Home Depot in a markedly different direction from Lowe's, where managers describe the atmosphere as demanding -- but low-profile, collaborative, and collegial. Lowe's does not have formal military-hiring programs, says a company spokeswoman, nor does it track the number of military veterans in its ranks. Observes Goldman, Sachs & Co. (GS ) analyst Matthew Fassler: "Bob believes in a command-and-control organization."
In Nardelli's eyes, it's a necessary step in Home Depot's corporate evolution. Even though founders Marcus and Blank were hardly a pair of teddy bears, they allowed store managers immense autonomy. "Whether it was an aisle, department, or store, you were truly in charge of it," says former store operations manager and Navy mechanic Bryce G. Church, who now oversees 30 Ace Hardware stores. And the two relied more on instincts than analytics to build the youngest company ever to hit $40 billion in revenue, just 20 years after its 1979 founding. In the waning years of their leadership in the late 1990s, however, sales stagnated. The company "grew so fast the wheels were starting to come off," says Edward E. Lawler III, a professor of business at the University of Southern California. These days every major decision and goal at Home Depot flows down from Nardelli's office. "There's no question; Bob's the general," says Joe DeAngelo, 44, executive vice-president of Home Depot Supply and a GE veteran.
Although he has yet to win all the hearts and minds of his employees, and probably never will, Nardelli's feisty spirit is rekindling stellar financial performance. Riding a housing and home-improvement boom, Home Depot sales have soared, from $46 billion in 2000, the year Nardelli took over, to $81.5 billion in 2005, an average annual growth rate of 12%, according to results announced on Feb. 21. By squeezing more out of each orange box through centralized purchasing and a $1.1 billion investment in technology, such as self-checkout aisles and in-store Web kiosks, profits have more than doubled in Nardelli's tenure, to $5.8 billion. Home Depot's gross margins inched up from 30% in 2000 to 33.5% last year. But fast-growing Lowe's is still Wall Street's darling, in large part because analysts are only now getting comfortable with Nardelli's strategy. Based in Mooresville, N.C., Lowe's has seen sales grow an average of 19% a year since 2000, and it has narrowed the gap in gross margins vs. Home Depot. Since the day before Nardelli's arrival on Dec. 14, 2000, Lowe's split-adjusted share price has soared 210%. Home Depot's is down 7%.
One way Nardelli plans to kick-start the stock: move beyond the core U.S. big-box business and conquer new markets, from contractor supply to convenience stores to expansion into China. On Jan. 19, Home Depot announced plans to scale back the growth of new stores from more than 180 per year to about 100. The slowdown will let him plow extra resources into beefing up Home Depot Supply (HDS), a wholesale unit hawking pipes, custom kitchens, and building materials to contractors and repairmen. It's a fragmented market worth $410 billion per year, according to Home Depot, where Wal-Mart and Lowe's are AWOL and the only competitors are regional companies. Already, Nardelli has spent $4.1 billion buying 35 companies to bulk up HDS, and it plans to plunk down a further $3.5 billion to buy Orlando-based Hughes Supply Inc. (HUG ) By 2010, HDS sales are expected to reach $23 billion, accounting for 18% of Home Depot's total, up from 5% in 2005.
The scope of the task is staggering. Nardelli, in essence, is building a whole new company -- in a market twice the size of do-it-yourself retail -- to service a prickly customer: professional contractors who want low prices, great quality, and instant service. Success in this field will require pinpoint execution, and Nardelli knows it. But his ambitions make some analysts nervous. "He's moving out of retail into services," says Deborah Weinswig, an analyst at Citigroup (C ). "If it was just retail, a lot of us would be more comfortable."
"CULTURE OF FEAR"
The high stakes of Home Depot's services gambit is one of the main reasons Nardelli has pushed his cultural makeover so hard in the five years since he has been at the helm. But not all have embraced him, or his plans. BusinessWeek spoke with 11 former executives, a majority of whom requested anonymity lest the company sue them for violating nondisclosure agreements. Some describe a demoralized staff and say a "culture of fear" is causing customer service to wane. Nardelli's own big-time pay package, $28.5 million for the year ended Jan. 30, 2005, rubs many workers the wrong way. His guaranteed bonus, the only locked-in payout at the company, rose to $5.8 million in 2004, from $4.5 million in 2003, at a time when Home Depot's stock price finished below its yearend price in 2000, when Nardelli took over.
Before he arrived, managers ran Home Depot's stores on "tribal knowledge," based on years of experience about what sold and what didn't. Now they click nervously through BlackBerrys at the end of each week, hoping they "made plan," a combination of sales and profit targets. The once-heavy ranks of full-time Home Depot store staff have been replaced with part-timers to drive down labor costs. Underperforming executives are routinely culled from the ranks. Since 2001, 98% of Home Depot's 170 top executives are new to their positions and, at headquarters in Atlanta, 56% of job changes involved bringing new managers in from outside the company. Says one former executive: "Every single week you shuddered when you looked at e-mail because another officer was gone."
As a manager, Nardelli is relentless, demanding, and determined to prove wrong every critic of Home Depot. He treats Saturdays and Sundays as ordinary working days and often expects those around him to do the same. "He's the hardest-working guy you'll ever see," says his former boss, Jack Welch. "If I was working late at GE and wanted to feel good at 9 p.m., I would pick up the phone and call Bob. He would always be there." Privately, Nardelli admits that the move to Home Depot has sometimes been a tough slog. When he first took over -- having no retail experience and replacing the beloved Bernie and Arthur -- he often felt as though he were fighting a lonely, uphill battle to convert Home Depot's legions of workers to his new vision for the company.
Nardelli's history of surrounding himself with military recruits goes back to his GE days. At GE Transportation in the 1980s, he pioneered a program of hiring junior military officers, in part because few people were willing to move to "Dreary Erie, Pa.," where the unit is headquartered. Former grunts, used to sitting in mud holes, found the locale less of a problem. William J. Conaty, senior vice-president for corporate human resources at GE, says: "Places like Erie or Fort Wayne, Ind., didn't look desolate to these guys." Welch soon expanded the program throughout GE.
Welch characterizes Nardelli as "an unusual patriot...a true flag-waving American." Nardelli's father, Raymond, served in Europe during World War II with the Pennsylvania Keystone unit of the National Guard. As a freshman at Rockford Auburn High School in Rockford, Ill., Nardelli joined the Reserve Officers' Training Corps (ROTC) and eventually became company commander and a member of the rifle team. He also played football. "You could either take gym class or ROTC," recalls Nardelli. "I took ROTC and enjoyed the hell out of it." When it came time for college, he applied to the U.S. Military Academy at West Point, N.Y. But the Army academy accepts applicants in part by congressional district, and the young Nardelli missed the cut by one person: He was the first alternate from his region of Illinois. Instead he attended Western Illinois University in Macomb. After graduating in 1971, his draft number was called, but, he says, he did not pass his physical. Later he went on to the University of Louisville for an MBA.
As an adult, Nardelli's passion for the military persists. At Home Depot headquarters, 1,800 "blue star banners" hang in the main hallway in honor of employees serving in Afghanistan, Iraq, and elsewhere. He is frequently shadowed by Marine Fellow Izen. During one recent project to help Home Depot hone its motivational message to 317,000 store troops, Izen consulted the Marine Corps Doctrinal Publication 1 on "War-Fighting." MCDP 1, as it's called in the Marines, includes a chapter on "developing subordinate leaders," which Izen found a handy guide for Home Depot workers, too. "It's about how to out-think your enemy," says Izen.
The military, says Nardelli, trains its recruits to be leaders and think on their feet, skills he wants in Home Depot stores. "Having personally been on the flight deck of an aircraft carrier where 18-year-olds are responsible for millions of dollars worth of aircraft," says Nardelli, "I just think these are folks who understand the importance of training, understand the importance of 'you're only as good as the people around you.' In their case, their life depends on it many times. In our case, our business depends on it many times."
Indeed, the Home Depot of Bob Nardelli is being run with military-style precision. These days everyone at Home Depot is ranked on the basis of four performance metrics: financial, operational, customer, and people skills. The company has placed human resources managers in every store, and all job applicants who make it through a first-round interview must then pass a role-playing exercise. Dennis M. Donovan, Home Depot's executive vice-president for human resources and a GE alumnus, measures the effectiveness of Home Depot workers by using an equation: VA = Q x A x E. Its meaning? According to Home Depot, the value-added (VA) of an employee equals the quality (Q) of what you do, multiplied by its acceptance (A) in the company, times how well you execute (E) the task. The goal is to replace the old, sometimes random management style with new rigor. "Bob's creating a second culture [at Home Depot]," says DeAngelo.
While Nardelli is careful to say that the military is just one pipeline of talent into Home Depot -- the company also recruits senior citizens through the AARP and Latinos through four Hispanic advocacy groups -- he is clearly imbuing the company with "Semper Fi" spirit. If Nardelli is the four-star general, then Carl C. Liebert III is his chief of staff. A graduate of the U.S. Naval Academy at Annapolis, Md., where he played college basketball with NBA star David Robinson, Liebert, 40, stands 6 ft., 7 in. and is every bit as intense as his boss. After running Six Sigma programs at GE's Consumer Products unit, followed by a stint at Circuit City Stores Inc. (CC ), he took over Home Depot's stores in the U.S. and Mexico in 2004. Now, with Lowe's and Wal-Mart picking off Home Depot's customers, Liebert is moving quickly to whip the troops into shape. "What worked 20 years ago may not work today," says Liebert. "It's as simple as warfare. We don't fight wars the way we used to."
To win the customer service war, Liebert has adjusted his tactics. At the annual store managers' meeting in Los Angeles on Mar. 8, Home Depot plans to roll out a 25-page booklet dubbed How To Be Orange Every Day. All store employees will be expected to keep it in their apron pocket. It contains aphorisms such as "customers cannot buy what we do not have," "we create an atmosphere of high-energy fun," and "every person, penny and product counts." Liebert hopes such simple slogans will help shore up Home Depot's once-vaunted customer service. To Liebert's mind, they recall the four basic responses to an officer's question in the Navy: "Yes, sir"; "No, sir"; "Aye, aye, sir"; and "I'll find out, sir." He calls it an effort to "align" all Home Depot workers on the same page when it comes to serving customers. "I think about that line from A Few Good Men when Jack Nicholson says: 'Are we clear?' and Tom Cruise says: 'Crystal,"' chuckles Liebert. "I love that."
But drilling workers in how to treat customers may not be enough. The University of Michigan's annual American Customer Satisfaction Index, released on Feb. 21, shows Home Depot slipped to dead last among major U.S. retailers. With a score of 67, down from 73 in 2004, Home Depot scored 11 points behind Lowe's and three points lower than much-maligned Kmart. (SHLD ) "This is not competitive and too low to be sustainable. It's very serious," says Claes Fornell, professor of business at the University of Michigan and author of the 12-year-old customer satisfaction survey, which uses a 250-person sample and an econometric model to rate companies on quality and service. Fornell believes that the drop in satisfaction is one reason why Home Depot's stock price has declined at the same time Lowe's has soared. A former executive who spoke on condition of anonymity says that Nardelli's effort to measure good customer service, instead of inspiring it, is to blame: "My perception is that the mechanics are there. The soul isn't."
Nardelli angrily disputes the survey. "It's a sham," he says, jabbing his finger in the air for emphasis. Nardelli notes that, in 2003, Fornell shorted Home Depot stock in his personal portfolio, before his survey results came out. Fornell says the trades were part of his research into a correlation between companies' customer-satisfaction scores and stock price performance. The University of Michigan banned the practice the next year. Home Depot executives add that internal polling shows customer satisfaction is improving, but they won't release complete results. They point to Harris Interactive's 2005 Reputation Quotient, an annual 600-person survey that combines a range of reputation-related categories, from customer service to social responsibility. The survey ranked Home Depot No. 12 among major companies and reported that customers appreciated Home Depot's "quality service." Still, Home Depot appears to know it has serious customer-service problems. Store chief Liebert's back-to-basics plan includes a push to improve even the "genuineness" of the greeting that customers receive at the door.
Some of the same former managers who blame Nardelli's hardball approach for corroding the service ethic at Home Depot describe a culture so paralyzed with fear that they didn't worry about whether they would be terminated, but when. One night last year, an unnamed executive in the lighting department at Home Depot headquarters left fliers on desks and in elevators containing a litany of complaints about Home Depot, including Nardelli's giant pay package and the high level of executive turnover. The rebel, say other former executives, was tracked down by security cameras and immediately fired. Citing concerns about the employee's privacy, Home Depot declined to comment on the incident. In break rooms, the company pipes in HD-TV, short for Home Depot television. But employees have mocked it as "Bobaganda," referring to Nardelli, for its constant drone of tips, warnings, and executive messages. Every Monday night, for example, store chief Liebert and Tom Taylor, executive vice-president for marketing and merchandising, host a 25-minute live broadcast for senior store staff on the week's most important priorities called The Same Page. "These are [their] marching orders for the week," says Liebert.
COMMAND OF DETAILS
Still, it's hard even for Nardelli critics, including ones he has fired, not to admire his unstinting determination to follow his makeover plan in the face of scores of naysayers. They describe being "in awe" of his command of minute details. But some of them question whether the manufacturing business model that worked for him at GE Transportation and GE Power Systems -- squeezing efficiencies out of the core business while buying up new businesses -- can work in a retail environment where taking care of customers is paramount. "Bob has brought a lot of operational efficiencies that Home Depot needed," says Steve Mahurin, chief merchandising officer at True Value Co. and a former senior vice-president for merchandising at Home Depot. "But he failed to keep the orange-blooded, entrepreneurial spirit alive. Home Depot is now a factory."
Can his plan work? "Ab-so-lute-ly," says Nardelli. "This is the third time this business model has been successful." He rejects the idea that he has created a culture of fear. "The only reason you should be fearful is if you personally don't want to make the commitment," says Nardelli. "Or there's a bolt of reality that you're in a position, based on the growth of the company, that you can't deliver on those commitments." He says Home Depot is dealing with the challenges of being a more centralized company just fine. And he makes no apologies for laying off the ranks of underperforming store workers and executives to achieve aggressive financial objectives. "We couldn't have done this by saying, 'Run slower, jump lower, and just kind of get by,"' insists Nardelli, hardening his gaze. "So I will never apologize for setting the bar high."
John N. Pistone, 35, is on the elite team. A graduate of West Point and former company commander in the Army's First Cavalry Div., he served in Kuwait in 2000 and was an ROTC instructor at Boston College. Now a district manager running eight Home Depot stores on the east side of Atlanta, with 1,200 staffers, he's on the fast track, in part because of his cool demeanor and always-on smile that endears him to employees. "A private in the Army is a lot like an $8-an-hour cashier," he says. But there's another reason Pistone is on the rise: As he clicks through his BlackBerry on a Monday morning, he remarks, with a sigh of relief, that his eight stores "made plan" the previous week. "This is a quarterly business that we worry about hourly," he says. As Bob Nardelli builds his new army at Home Depot, that's a sentiment he loves to hear.
By Brian Grow, with Diane Brady in New York and Michael Arndt in Chicago