Home Depot Case Study - Alex Kalafatides PDF

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Connolly 1 Michaela Connolly Professor Kalafatides INTB 200-901 May 24, 2015 Home Depot Case Study Issue In this case study we reviewed an article in the Wall Street Journal, which discusses Home Depot’s international expansion into China and examines why its big-box stores failed in China. Home Depot is the largest home improvement retailer in the U.S. and its success is attributed to its ability to market to small home contractors and to consumers who want to do home improvements themselves and offering products for every imaginable home improvement project with a focus on customer service. The company was founded in 1978 in Atlanta and grew to more than 2,250 big-box stores by the end of 2013. Its growth is due to several distinctive characteristics, including the warehouse feel of its stores, with low lighting, cluttered aisles, inventory stacked high with a philosophy focusing on sales growth; and allowing store manager autonomy, aimed at spurring innovation and allowing managers to act quickly when they sensed a change in local market conditions. When Home Depot expanded into China they did not fully understand the Chinese market and they imported into China their U.S. business model of the big-box stores aimed at do-it-yourself consumers. Home Depot entered China by opening 12 bigbox stores in China six years ago and they are now shuttering the remaining seven stores. The following issues caused Home Depot’s failure in China: 

Cultural differences related to consumers

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Lack of understanding the local markets

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Using a business model designed for U.S. markets

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Being too rigid

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Slowing economic growth in China

Analysis Home Depot misread the Chinese consumers and assumed they would be similar to U.S. do-it-yourself consumers. They did not anticipate the cultural differences in consumer needs, tastes and wants. In China labor is cheap and many people live in apartments, these two facts lowered demand for do-it-yourself products. The Chinese consumer prefers to have someone do it for them. Home Depot is experiencing the same phenomenon that Ikea experienced and that is Chinese people will pay someone to do the work for them. Home Depot should have focused on small contractors than the do-it-yourself consumer in China. Also apartment living limits home improvement, as apartment dwellers are more interested in home decorating. Home Depot’s product offerings in this area are limited as their focus is more on major home improvements than home decorating. China is a geographically large country with many regions that vary culturally, economically and socially. What may work in one part of the country may not work in another region. Home Depot in opening their twelve big-box stores in China did not take into account differences in local markets and basically plopped down twelve generic stores in the various regions in China. Home Depot did not understand differences in consumer needs and assumed that all market regions would want their home improvement product offerings. In areas where apartment dwelling is greater Home Depot failed to tap into the home decorating market for that area.

Connolly 3 The U.S. business model of the big-box store did not work in China. Home Depot in rolling out its big-box stores assumed this type of store would work in all local markets within China. Home Depot assumed one size fits all and imported its U.S. store model without tailoring the stores to the local markets. The company assumed that Chinese consumers in all regions would want to have available to them all do-it-yourself products for all types of home improvement projects. Carrying this inventory for Home Depot is costly since inventory turnover in do-it-yourself products is low resulting in a low return on its inventory investment. Operating big-box stores is costly in terms of real estate costs, staffing costs and overhead costs. With sluggish to low sales and the high operating costs associated with the big-box stores, profit margins suffered in China and the stores incurred losses. Home Depot was very rigid in entering the Chinese market. They went into China with their U.S. business model and did not adapt or modify their approach to the Chinese market. In order to succeed in China a company needs to be quick and willing to react to changes in the market. Home Depot prides itself in allowing autonomy to U.S. store managers but that autonomy somehow was not seen in the Chinese stores. Home Depot adhered to the big-box store concept and did not allow their managers to implement a more drastic change from the U.S. store model offering all home improvement products to a business model of a specialty store offering limited products aimed at home decorating. Finally the impact of the slowing growth in the Chinese economy also had an impact on sales in the Home Depot stores in China. Slower economic growth requires Home Depot to be more strategic in site selection, store design, square footage of stores and efficiency. A robust economy would promote sales where as a slowing economy will reduce sales growth.

Connolly 4 Alternatives Despite having failed in China with its big-box store concept, Home Depot has learned a lot about the Chinese market over the past six years and can leverage that knowledge to alter their strategy in China. Home Depot has recognized that they need to change their strategy and they are now focusing on specialty stores and online operations. Furthermore they can focus on selling to small contractors, a market which they had ignored. 1. Specialty Stores Specialty stores represent a huge shift in its big-box store business model. To be successful in China, Home Depot recognizes that the Chinese consumer is very different from U.S. consumer in that they are more into home decorating and not do-it-yourself home improvement projects. By focusing on specialty stores that are geared to home decorating Home Depot will meet consumers’ needs and the market demand. Specialty stores such as paint stores, flooring stores and home decorating stores offering products such as window coverings, rugs, shelving, and other products that enhance life style could be opened in strategic markets. These stores would cater to the specific needs and preferences of the Chinese consumer in their regional market. Home Depot would also give the store manager the autonomy to respond to consumer needs and allow the store manager to tailor the product offering to their local market. The specialty store would have a smaller real estate footprint and its operating costs would be lower as well as lower inventory carrying costs. 2. Online Operations Home Depot is interested in partnering with a Chinese partner to provide online operations. China like the U.S. is a geographically large country and online operations

Connolly 5 gives Home Depot the opportunity to reach all consumers in this very large geographical expanse. Furthermore, Home Depot already offers online sales in the U.S. so it has experience in this area. By joining with a Chinese partner, they will be able to develop their Chinese online operations with primary research and direct input on the Chinese consumer, Chinese market and Chinese web design. For the online operations to be successful the Chinese partner will bring knowledge as how to best reach the Chinese consumer. 3. Small Contractors Supply Stores In the U.S. sales to small contractors account for 35% of Home Depot’s U.S. sales. Given that the Chinese consumers have a do-it-for-me attitude with respect to home improvements they are more likely to hire a contractor to do home improvements for them. The Chinese consumers’ preference to hire a contractor is based on the fact that labor is cheap and the contractor has the expertise. The small contractor represents a marketing opportunity for Home Depot, which was not exploited when Home Depot was operating their big-box stores in China. The small contractor stores will carry supplies that are focused on home improvement such as lumber and other building supplies including cabinetry, plumbing and electrical supplies. Home decorating, appliances and landscaping items, which are typically offered in the big-box stores, would not be available in these small contractors supply stores. Decision Criteria In analyzing Home Depot’s alternatives in its international expansion in China the following key decision criteria will be considered in evaluation of the alternatives: 1. Does the alternative meet the consumers’ needs?

Connolly 6 In this criterion the focus is on ensuring that the product offerings meet the consumer wants. Home Depot prides itself on customer service and meeting customer demands and it was the criteria that they missed in their initial expansion in China. 2. What are the financial costs associated with the alternative? In this criterion the financial costs and risks are analyzed and evaluated. The initial expansion in China was using the big-box store model. The operating costs for the bigbox stores’ footprint was high and this criterion focuses on minimizing and controlling operating costs. 3. Does the alternative provide flexibility to react to changes in consumer demands, economic growth and competition? Home Depot initially failed in the Chinese market because it was not quick and agile to react to changes in the market and economy. This criterion will evaluate the alternative’s ability to adapt to changes. Analysis of Alternatives This section uses the above decision criteria to evaluate each alternative to determine if it is a viable option for Home Depot’s expansion in China. Expansion Alternative: 1. Expansion Through Specialty Stores a. Does the alternative meet the consumers’ needs? Specialty stores will allow Home Depot to meet the local market’s needs by establishing stores with specific products to meet local consumer demands. For example, if the market is in an area with high apartment dwellers wanting to decorate their apartments then the specialty store should focus on the home

Connolly 7 decorating need of that market. Alternatively, if there is a market need for a paint store or flooring store then that is the store that should be opened. By assessing the market before opening a store, Home Depot can determine the type of store to open and the type of products to carry. b. What are the financial costs associated with the alternative? The specialty store will have a smaller real estate footprint and will carry fewer products. Specialty stores are smaller than the big-box stores and have a lower financial risk because a smaller investment is made in a specialty store due to the smaller space and smaller inventory needed. This will lower the operating costs of the store compared to the big-box store operating costs including lower inventory carrying costs. The lower operating costs will improve profit margins. On the downside, with fewer product offerings not all of the market is captured and the focus is on niche markets within the home improvement industry. c.

Does the alternative provide flexibility to react to changes in consumer demands, economic growth and competition? Smaller specialty stores by focusing on the local market needs will allow Home Depot to be more flexible and to be able to react more quickly to changes in the market demand and the economy. Their inventory has fewer product offerings and they can easily change product offerings to local market demands. With fewer product offerings it will be more evident to the staff at the specialty store to identify what products are selling and which are not. The staff will interact on a more personal level with the customer providing a high level of customer service. With the information they have learned from the consumer and knowledge of the

Connolly 8 economic conditions the specialty store can quickly respond by adjusting their product offerings. Specialty stores may face local competition and they will need to differentiate themselves with quality and exclusive products coupled with exceptional customer service. 2. Expansion Through Online Operations a. Does the alternative meet the consumers’ needs? Online operations will allow Home Depot to meet the local market’s needs by shipping directly to the consumer the product requested. Inventory can be held in a centralized warehouse and shipped upon request based on online orders placed. Online operations are the ultimate customization as the product is only shipped when an order is placed online. There are huge savings to Home Depot as big-box stores do not need to be maintained to meet consumer demand and operating costs are minimized by have a central warehouse. Online operations also will provide a wealth of market information as Home Depot can gather consumer information on each order placed. The only drawback to online orders is the cost of shipping, but with cheap labor costs in China this cost might not be overwhelming. b. What are the financial costs associated with the alternative? The costs associated with maintaining multiple big-box stores will disappear and maintaining a central warehouse with all product offerings lowers overall costs. This will improve profit margins as lower operating costs will be incurred because of a single warehouse location reducing inventory carrying costs, real estate costs and staffing costs. Additional expenses relating to shipping, web design, information technology, order processing will be incurred but these should be

Connolly 9 significantly less than the operating costs of the twelve big-box stores Home Depot had previously maintained. There is additional risk with this alternative as Home Depot is partnering with a Chinese partner and it is unknown if this partner will deliver on promises made. Shipping logistics also present another challenge and risk, not only with respect to cost but also reliability. c.

Does the alternative provide flexibility to react to changes in consumer demands, economic growth and competition? Online operations provide the ultimate response to consumer needs. Product demand can be analyzed in real-time as consumer orders are placed, and comments are received directly from consumers. The central warehouse can adjust inventory quickly based on market demand and economic factors. By providing high customer service and having inventory available and on hand with minimal or no back orders, Home Depot should be able to set itself apart from competition.

3. Expansion Through Small Contractor Supply Stores a. Does the alternative meet the consumers’ needs? Since the Chinese consumer prefers others to do home improvement work this is a market segment that Home Depot needs to exploit. These stores would carry building supplies and would have a narrower product offering than the big-box stores. The store location is critical as it needs to be in an area where there are residential homes requiring improvements where there is a demand for contractor supplies. b. What are the financial costs associated with the alternative?

Connolly 10 The small contractors supply store will have a smaller real estate footprint and will carry fewer products that are geared to building supplies than the big-box stores. This will lower the operating costs of the store compared to the big-box store operating costs and will lower the inventory carrying costs. This will improve profit margins however this alternative will be more costly than the specialty stores, which have the narrowest product offerings. This type of store will require a larger investment than the specialty store or online operations alternatives. c. Does the alternative provide flexibility to react to changes in consumer demands, economic growth and competition? The market here is different than the retail consumer and it is important that Home Depot recognizes this and has specialists on hand to interact with the small contractor. Home Depot has experience in the U.S. with this market segment but they need to be mindful of cultural differences and have staff on hand that understands this market segment in order to serve it and be able to respond to changes. This may be more challenging than the other two alternatives. This segment may face existing local competition but Home Depot should be able to set itself apart with high customer service and quality products. Preferred Alternative The one thing that Home Depot learned in its initial expansion into China is that one size does not fit all especially in a country as large geographically and diverse culturally as China. In evaluating and selecting an expansion strategy each of the expansion alternatives presented are

Connolly 11 not mutually exclusive and can be used in combination with each other and reach and serve different market segments. For heavily populated areas specialty stores tailored to the local market demands for home decorating present a good opportunity for Home Depot. These stores will carry product focused on the consumers’ needs and wants. The smaller real estate footprint, fewer product offerings and a defined marketing message as to what the store is selling will result in profits due to sufficient sales and lower operating costs. Providing high customer service will enhance brand recognition and allow Home Depot to grow and establish more specialty stores. Online operations will fill in the consumer gap for products not offered by the specialty stores or the small contractors supply stores as well as reach consumers in less populated areas of the country. This alternative complements the other two alternatives. Since maintaining a single central warehouse controls costs, operating costs are minimized. There is risk with bringing in a partner and ceding some control to him as well as risk due to shipping logistics and reliability. Small contractor supply stores would serve the do-it-for me home improvement market in China, which is currently underserved in China and represents a great opportunity for Home Depot. There is greater risk with this alternative, as product offerings would be greater and the store larger than the specialty store. In summary the recommendation is that all three alternatives should be part of Home Depot’s expansion strategy in China. Implementation Plan The renewed Home Depot expansion into China should proceed as follows: with an initial opening of 5 specialty stores and 5 small contractors supply stores in the first year as well as establishing the online operations.

Connolly 12 1. Identify urban areas based on demographics with population living primarily in apartments for specialty stores. a. Select cities with populations greater than 250,000 people b. Select cities with apartment dwellers representing more than 50% of the population. 2. Evaluate market potential for the specialty stores. a. Identify what market segment is currently underserved: flooring, paint, wall coverings, home decorating b. Identify what products are needed and wanted by the consumer. c. Identify and evaluate any competitors. 3. Prepare a specialty store plan a. Identify and evaluate store locations and size of stores. b. Identify product offerings tailored to each specific specialty store. c. Develop a store opening plan to include capital investment requirements, timeline, products, marketing strategy (initial and long-term), staffing, and training. 4. Develop a plan for online operations a. Finalize partnership agreement. b. Identify and quantify market by geographic regions. c. Identify and evaluate possible location of warehouse based on proximity to largest regional markets being served. d. Determine product offerings and shipping arrangements. e. Develop web page and order processing system. f. Develop marketing plan, staffing and training.

Connolly 13 5. Prepare a small contractor supply store plan. a. Select cities with populations greater than 500,000 people b. Select cities with residential homes representing more than 50% of the population. c. Identify and evaluate any competitors in the building supply market. d. Identify and evaluate store locations and size of stores. e. Ident...