Home Depot: One Foot In China

The home improvement chain wants in -- but is it being too cautious?

When will Home Depot Inc. (HD ) make its move in China? The home improvement market on the mainland is the most promising in the world: $50 billion in sales in 2005 and growing at 12% a year. Homeownership has skyrocketed, from near zero two decades ago, when there was virtually no private property, to 70% of all housing today. Home Depot CEO Robert L. Nardelli has labeled China a top priority: A successful strategy there would offset the challenge of sustaining strong sales growth back home and could even boost the stock. Chuck Elias, Home Depot's China head, is studying the terrain. He has visited 25 Chinese cities in the past 14 months, scouring competitors' outlets and prowling the traditional markets. "China is an incredibly exciting opportunity," says Elias.

Sure looks like something is up. Rumors about a pending Home Depot deal have been building steadily. The latest is that the Atlanta-based company will buy a 49% stake in Orient Home, a well-managed local chain and a strong presence in northern and northeastern China with $350 million in sales. Home Depot would not confirm that it's in talks with Orient Home. "We're going to make the prudent decision," says Elias. "We're going to make sure we have the right business model."

Is Home Depot blowing it? Or is it biding its time for the right reasons? The China home improvement market is a lot trickier to navigate than those hot growth numbers would indicate. For starters, it barely resembles the do-it-yourself market back in America, where Home Depot workers dispense advice, then send customers back home to lay their own tiles and install some track lighting.

In China, purchasers of newly constructed homes don't have bathrooms to tile. They don't have bedrooms or kitchens. Or even interior walls. Chinese contractors just build concrete shells: They do no finishing work. "Imagine in the U.S. if you bought a home with just interior framing studs and cement floors," says Elias. "You have no doorways, or even wiring or pipes."

So Chinese homeowners fix up these shells themselves. They have to hire handymen to install everything. The home improvement stores already operating in China provide those workers. When first-time home buyer Angeline Xu took possession of her new Shanghai apartment last July, she found herself staring at a shell without plumbing, flooring, doors, or windows. Travel agent Xu headed over to B&Q, a British home improvement chain. B&Q staffers helped her design a floor plan and choose materials, and then performed all the installation work. The retailer offers a complete package, with installation included, which is aimed at entry-level property buyers and priced at around $6,000 for a two-bedroom, 900-square-foot apartment. "I bought everything here," says Xu.

If Home Depot decides to take the plunge, it would have to train thousands of its staffers to do such floor-to-ceiling installation, something it doesn't do in the U.S. Meanwhile, it faces stiffening competition from the likes of B&Q and homegrown players, including Homemart, Homeway, and Orient Home. Homeway, which had a brief dalliance with Home Depot in the mid-1990s, has adopted much of the Home Depot model, right down to the orange work aprons. These chains have spent years cultivating relationships with local suppliers and have already grabbed prime retail locations in the big cities.

FENG SHUI FARE

In B&Q especially, Home Depot faces a rival that has already learned many lessons about operating in China. The chain, a subsidiary of Europe's do-it-yourself giant Kingfisher, inaugurated its first Chinese store in Shanghai in 1999 but soon realized that a cookie-cutter version of its British stores would not pass muster. Chinese shoppers, who like to handle the merchandise before buying, were frustrated that products were stacked high on shelves. Many never ventured far into the store at all because they were intimidated by the prices of the most expensive goods that B&Q traditionally displays at the head of each aisle. Now everything is within easy reach, and the bargains are front and center.

Since those wobbly first steps, B&Q has hit its stride in China. Its 49 stores on the mainland rang up $542 million in sales in 2005, a 48% increase over the previous year. B&Q China President David Wei says his company plans to double its store count in the country by 2010.

B&Q's Chinese outlets bear little resemblance to the cavernous warehouses filled with piles of drywall, paint, and potted plants typical of a Home Depot in the U.S. It's more like the macho big-box store meets Queer Eye for the Straight Guy. Designer chopsticks compete for space with professional-grade power tools. For feng shui followers, there's an extensive selection of aquariums (Chinese believe fish bring good luck), with some costing as much as $3,000. Not your standard Home Depot fare.

As they try to gauge the risks and rewards in China, Home Depot executives don't want to get off on the wrong foot. While the retailer has found success in Canada and Mexico, forays into more distant markets have ended badly. After a half-hearted expansion into Chile and Argentina, Home Depot sold off its stores there in 2001 and has not ventured into any other countries since.

It's likely that Home Depot will try some mix of building its own stores and buying share in China through an acquisition. Yet the longer it waits, the tougher it will be to break in. Securing the best locations requires good government connections. Getting to know the market and forging relationships with local suppliers can take years. Says Tian Guanyong, CEO of CGen Media, a company that installs flat-panel screens that play ads in retail outlets: "Home Depot had better make up its mind about China before it's too late."

By Frederik Balfour, with Brian Grow in Atlanta

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