The Home Depot Investor & Analyst Conference held on 8 December 2015 gave the major US big box home improvement company a chance to explain how its "connected retail" strategy will develop over calendar 2016.
The main difference between Home Depot and its competitors such as Lowe's, Menards and Sears, is the degree to which the company has committed itself to "connected", "omnichannel" retail, mingling together its online sales push with its established physical store fleet. This combination is something that the company is now referring to as "One Home Depot".
In realising the One Home Depot vision, the company has made several large investments. This is particularly so as regards the logistics infrastructure necessary for home delivery of often bulky objects.
Home Depot has, over the past three years, opened three dedicated distribution centres for online. It has also worked hard to build a system of product sourcing and transport that can seek out the most efficient and timely means to dispatching goods to customers. This can mean directly from a distribution centre, from the stock held at a store close to the customer, or from a distribution to a store and then to the customer.
It is interesting to examine the Home Depot strategy a little more closely. We would have to assume that it is built on the following two strategic considerations: that the consumer push for combine/online shopping services is going to increase quite sharply sometime in the next two to three years; and that this increase is likely to take place at a rate best reflected in a steeply climbing exponential curve.
This latter point means that when the strong consumer push for an integrated online/physical shopping channels does take place, it will happen so rapidly that major retailers will not be able to adapt quickly enough to meet the changed channel demand.
In that scenario, smaller retailers might pick up more market share. This might also open up possibilities for established online retailers such as Amazon to move into physical retail as well. One such scenario would see Amazon acquiring a relatively under-valued US national retailer such as Sears with its 1500+ stores, and building that into its physical distribution channel.
Other US home improvement retailers such as Lowe's, Menards, Sears and Ace Hardware are proceeding based on different strategic predictions. Their attitude indicates that they expect the shift to omnichannel to take place post-2020, and that the rate of take-up will be a much shallower exponential curve.
One aspect of this difference that often gets missed by analysts is that, if this description is true, then Home Depot's approach is actually the less risky option, overall. If the Home Depot strategic prediction proves wrong, and omnichannel take-up is delayed, its loss will have been through a less than optimal allocation of capital resources over a period of five years.
If its prediction turns out to be true, then the consequences for its competitors could be surprisingly severe. They would be faced with making very large (and slightly inefficient) investments in online resource capacity, during a period when they were experiencing ongoing losses of market share.
If you look back through the capital allocation and market activities of Home Depot for the past 30 years, you can see this particular "move" occurring in other places as well. It's part of the company's core strength that it can find fundamentally conservative investments that seem a little radical, but have quite a large upside, and a surprisingly small downside.
It's an equation that not only retail analysts but overall market analysts seem to have trouble bearing in mind. Home Depot has a trailing price/earnings ratio of 26.04, compared to Lowe's 25.06, but the forward price/earnings rations are respectively 22.44 versus 22.80.
As with most home improvement retailers, Home Depot faces the situation where the vast majority of its customers (over 95%) are DIY consumers, but the "Pro" (construction and tradie) customers far outspend them on an individual basis.
The business logic that develops from this is that it is worthwhile pursuing the growth of the Pro segment. Home Depot has identified three different types of Pro customer:Transactional Pro: these are Pro's who treat Home Depot like a hardware "7-Eleven", dropping in to pick up the items they need for individual smaller jobs. This category includes general handymen, and some general trades.Complex Pro: this category accounts for half of all Home Depot's Pro sales. These are renovators, builders and installers. Typically they have a crew of people working for them or may even run multiple crews.B2B: These are Pros who do not sell services, but provide services to a larger company, often as a division of that company.
Home Depot's CEO, Craig Menear, also noted that the typical consumer was rapidly evolving, and their needs consequently changing as well:
People are also changing the way they are using their homes. More and more people are telecommuting. People are staying in their homes longer as they age. And The Home Depot has an opportunity to provide our customers with innovative products that make their homes smarter. And we think about smarter homes in three key pillars -- protection, convenience and conservation.
The relationship between the store and the customer is also evolving. As Marc Powers, the company's executive vice-president for US stores put it:
In addition, the baby boomer grew up with The Home Depot as an active, hands on, do-it-yourselfer. Now their expectations of The Home Depot are changing. Now people like me have less time and less energy to do it myself like The Home Depot taught us to do. Now I want someone to do it for me.
The Home Depot currently performs more than 2 million installs a year and those installs are done by over 100,000 Pros that work with us. Bill Lennie will explain later in his presentation how this relationship, with both the baby boomer and the Pros, positions us well for future growth.
This is how Mr Menear described the sectors of the market Home Depot seeks to address:
The home improvement market is estimated to be a US$300 billion market. This includes Pro as well as consumer purchases with Pros representing approximately 40% of this market. You are going to hear more about each of these customer groups.
Next, the services market where a Pro comes into the home to install or build a project is a US$200 billion market. Approximately 70% of this market is estimated to be labour costs and the remaining 30% is product pull through.
And finally, our addressable maintenance, repair and operations, or MRO market, is estimated to be US$50 billion. This market includes residential, multi-family, hospitality and institutional customers.
So in the past we used to say that we owned about 27% of the addressable home-improvement market. With the addition of services and MRO we now believe that our market share in the US is about 15%, so there is plenty of opportunity for growth.
The online sector of the Home Depot business continues to grow. For the past two years online sales have grown by around US$1 billion each, and sales are set to increase by around that amount for 2015. At the moment, online sales account for 5% of all Home Depot sales, and the sector's growth rate is around 26% per year.
The company has continued to improve its offering. This year, Home Depot has received the award for Internet Retailer of the Year as awarded by the Internet Retailer portal.
The economic conditions
Home Depot's chief financial officer, Carol Tome, remains optimistic regarding the potential of the US economy. She sees three main sources of growth for the home improvement industry: steady growth in the US gross domestic product (GDP); an overall housing market that remains below the levels reached before the market collapse in 2008; and the ageing of the US housing stock, with a consequent need for more renovation and maintenance expenditure.
In terms of the GDP, Ms Tome believes that this will continue to grow at the modest rate of 2.5% per annum. She sees this as being complemented by an additional 1.5% lift in the housing market, to provide an overall growth rate for the industry of 4.0%.
As far as the ongoing recovery in the housing market, Ms Tome notes that there has been a historic ongoing slowdown in the rate of new household formation, with many of the millennial generation remaining at home for longer than previous generations. She sees this as a sign of pent-up demand, which she believes is beginning to unwind, and exert a positive influence on the housing market.
In terms of the ageing of the US housing stock, Ms Tome points to statistics that indicate only 37% of this stock was over 30 years-old in 1995, while today the proportion is now 63%.
Speaking of just the current financial year, Ms Tome is forecasting an overall sales increase of 5.7%, with a 4.9% lift in like-for-like sales. (These estimates include further earnings declines due to the rising US dollar exchange rate.)
During the Investor & Analyst Conference, Home Depot outlined a number of core strategic moves that will be rolled out in 2016 and likely strongly influence the retailer through to 2018. The areas that were detailed included:Customer delivery logisticsStore-stocking delivery logisticsSync logisticsSmart home productsGrowth strategies for the Pro businessDeeper integration with suppliersUse of data to develop marketsUse of data to better serve customersGrowth of service-based business lines
If a general theme emerged from all these strategic moves, it was the notion of adopting an "end-to-end" approach. Inefficiencies are typically found where some functions operate in siloes freight trucking does not take into account unloading, for example. By exploring the dependencies between different functional areas, and establishing mutual responsibility, Home Depot is seeking to better integrate its performance and execution.
Customer delivery logistics
Home Depot has a number of acronyms it uses to describe the various forms of delivery that online ordering of its products has opened up. These are:BOPIS: Buy Online Pickup In-StoreBODFS: Buy Online Deliver From StoreBOSS: Buy Online Ship to Store
BOPUS is familiar in Australia as a "click and collect" means of ordering products. BODFS means that a product that has been ordered online can be delivered directly from the store nearest the customer. This saves both on shipping costs, and time.
BOSS is in some ways the most interesting of these, and a delivery option that the company says is gaining rapidly in popularity. Previously, if an item was not held in stock in a local store, the only other option would be to have the item shipped from one of Home Depot's distribution centres.
BOSS opens up the option of having the item delivered to a local store instead, and then picked up by the customer. As shipping to the store is going to be much less expensive than shipping directly to a home address, it is a far cheaper option.
BODFS is also of some importance. This is how Mark Holifield the executive vice-president for supply chain and product development describes the opportunities provided by this facility:
Another new capability to meet our customers' needs for improved fulfillment and delivery capability is Buy Online Deliver From Store, or BODFS. While we've delivered orders taken in our stores and on the phone for years, we have not been able to take orders online and drop them to the appropriate store for fulfillment and delivery, this new capability provides that.
In addition, with this new capability we are implementing the ability to select a two or four hour delivery window for a fee. With this, customers will be able to count on us to deliver when they need the product as opposed to waiting all day for an all-day delivery window. We think this will be particularly valuable for our Pro customers with crews on the job site awaiting delivery to start work.
This will also open up many more products stocked in our stores for delivery from online orders, providing new options for our customers. And the new system is more intuitive and simple for our store associates compared to the existing delivery systems.
Store-stocking delivery logistics
At many retailers it is simply an accepted fact that when the truck or trucks pull up at a store from the distribution centre, something pretty close to contained chaos ensues. Even well-planned systems for removing goods from trucks and getting them into storage and then out on the store floor commonly waste a lot of time and effort.
Home Depot has applied itself to this situation, and has come up with some major productivity improvements that it will be rolling out during 2016. Most of these improvements are driven by data, and the "First Phone", a device issued to Home Depot associates.
This is how the combination of different in-store logistical functions will work, as described by Mr Powers:
Currently across all our stores there is still not a defined efficient process to move freight off of the trucks, into receiving areas, from our receiving areas to shelves, and if need be from our overhead stocking shelves down to the customer facing shelves.
We are currently in the process of rolling out several documented processes to all stores to start driving operational excellence concerning freight handling in 2016. First we will implement Smart Sort.
Smart Sort is software that can be accessed by the store associate which defines exactly what is on every inbound rapid deployment centre load. And not only does it show the carton counts of the load, it tells the store how many freight moving carts they will need for small cartons and how many pallets they will need for larger products.
Combined with Smart Sort we will implement Engineered Unload. Engineered Unload is a diagram delivered through the same system showing the stores how to stage the carts and the pallets in the most efficient way designed to reduce product touches and footsteps to stage product. These two systems and processes have proven in pilot to reduce 90 miles of walking for each receiving associate a year.
A third element which will be implemented is called Directive Pack Out. This software tells the associate the exact order in which they should put the product on the shelves. This process has shown to eliminate 1 to 2 feet of walking per carton per night. And let me remind you, our stores receive on average over 4,500 cartons of freight per week. Now that is a lot of footsteps taken out of the process.
Next, we are addressing the efficiency of moving product from our overhead shelves to our selling shelves with Bay Directed Pack Down and Smart List. Both projects will also be implemented in 2016.
Currently our associates are asked to pack down any visible shelf outs as well as executing a rotating schedule of predetermined areas to pack down throughout the store. Now with Bay Directed Pack Down our associates will only focus on the areas that matter.
We will leverage our new First Phone 2 to deliver data that will identify heavily shopped areas from the previous day. The list will be store specific. Additionally, the areas will be sorted by department and aisle to minimise travel and drive productivity.
The second project will be implemented we call Smart List. Once again, we will leverage the First Phone to deliver to our associates' pictures and attributes of a limited amount of products that are exceptions, meaning their selling patterns have changed over the last several days and should be investigated.
Of all the logistic developments, this is certainly one of the most exciting. To understand the opportunities in the Home Depot supply chain, it is necessary to know a little about the system. A primary feature of the system is what Home Depot calls rapid deployment centres (RDCs). These do not provide any warehouse facilities, but instead use information systems to manage the flow of goods from suppliers to stores. There are 18 of these in the US, and they handle around 50% of the dollar-value of Home Depot goods.
These are backed up by a dozen stocking distribution centres (SDCs). These can hold a set amount of stock in items which either have an inconsistent source of supply, or are subject to sudden spikes in demand due to seasonal demand.
Finally, there are the bulk distribution centres (BDCs). These are responsible for distributing loose items such as timber and other building materials.
Mr Holifield details the system like this:
As we have looked at our supply chain, there remains breakthrough opportunity to optimise our supply chain and we call that next phase Project Sync. We have actually begun this process and are in pilot now in our Houston, Texas, RDC and the stores in its service area.
So first let's take a look at our supply chain as it runs in large part today. You can see the various nodes in the RDC supply chain along the arc shown here. The truck is at the top of the arc, as transportation is the dominant cost of operating our supply chain.
While our RDC program has made vast improvements in our truck utilisation, there is still a large opportunity here. And our ordering of product is not optimised to fill trucks. And our order days aren't as predictable and consistent as they could be.
As a result, there is lead time and inventory embedded across the supply chain to buffer for that variability. Our supplier lead times vary from 2 to 10 days. Our inbound transportation transit times vary from 1 to 5 days depending on the distance.
Because of further buffers in our DC schedule it might take a few days for freight to be processed at our RDC. And because of all that variability, that creates challenges in our stores with unpredictable and lumpy freight flow. The result, as you see here, is an 11-day lead time on average.
But all this can be optimised through more collaboration and rigour around our schedules, and we are doing this in our Houston RDC today. With these changes we can reduce the lead time dramatically -- in this case to as low as five days. By optimising our ordering through better planning and collaboration with suppliers we reduce the variability and unpredictability there.
Now using intelligent truckload rounding algorithms, making data driven optimisation decisions on inventory and transportation costs, we order in full truckloads. Working with suppliers we can find opportunities to ship direct from plants, perhaps bypassing supplier DCs.
Through better collaboration with and predictability for our suppliers, we arrange for next day or even same day shipping and coordinate loading configurations more closely. Transit times are optimised to avoid delays, and those full trucks are able to be more timely than less-than-truckload shipments.
Through more collaboration and rigour on scheduling, product is received immediately on receipt at the RDC. That product then flows to the store in a much more orderly and level fashion, allowing our store associates a more predictable and stable flow of freight.
These efforts have shown the ability to reduce lead time to as low as five days from supplier to store shelf, and lower lead times means faster replenishment with lower inventory and cost.
Smart home products
Home Depot has made a strong commitment to smart home products, and intends to grow this sector of its business. This was announced in the initial remarks by Home Depot's executive vice-president of merchandising, Ted Decker. He said:
In addition, we'll maintain our momentum by helping our customers create a smarter home. A smarter home is connected but it is also safer, more energy efficient and more convenient. So, we are introducing products that help our customers protect their families, save money, and improve their homes.
We ve introduced new products like intelligent smoke detectors, motion sensors, cameras, and door locks to help make homes safer. And, products like LED lighting, thermostats that learn patterns, and fixtures that save water help save money. Our customers can also choose to purchase products like wireless speakers and colour-changing lights to make their homes more enjoyable.
We anticipate the demand for smarter products in the home will continue to grow. An industry study estimates that there will be over 500 smart home products in a typical family home by 2020. Therefore, we offer open platforms and related products, so our customers can select the best solution that meet their needs rather than be locked into one protocol. Today, we offer hundreds of products in our stores, with a continuous stream of product launches in the works.
Growth strategies for the Pro business
The Pro business received a particular focus all through the presentations. One of the primary drivers of the Pro business in the future will be the special programs Home Depot is implementing for them, including its Pro Xtra services, and an extended credit offering.
Mr Lennie describes what Pro Xtra has brought to Home Depot like this:
I would like to take a few moments to highlight the wins we're seeing from Pro Xtra, our Pro focused rewards program. Pro Xtra has over 3.4 million members, and it allows us to build loyalty with our best customers by providing valuable products and services that help Pros save time and money every day. These include purchase tracking, exclusive offers and several business tools.
These benefits help Pro Xtra deliver on its intended purpose, which is to strengthen bonds between the Home Depot and its Pro customers. We see the returns of this enriched relationship in the data, and I would like to highlight just a few metrics.
Pro Xtra members with registered tender on average spend 18% more in the first year after sign up. Pro Xtra members tend to be highly active, transacting more than two times the average Pro. Finally, sales to managed accounts, who are at the top echelon of Pro Xtra and covered by our PARs, continue to outpace the company average.
The details of the extended credit offer were described by Ms Tome:
As you know, we have a private-label credit card program, and sales on our private-label cards make up about 24% of all of our sales. Importantly, our program is a financing program, not a discounting program. While our program is both for DIY consumers and Pros, as Bill mentioned, financing is really important for our Pros. We've been testing a new value proposition for our Pros, and we are ready to roll it out.
Beginning in January we are going to offer our DIY consumers an enhanced value proposition of 365-day return. But for our Pro, we will be offering 60 days to pay, a new fuel reward program and 365-day returns. We are excited about these new programs as we think they will truly meet our customers' needs and help drive sales.
Ms Tome later expanded on these comments in response to a question from an analyst:
So we are very excited about this because we have learned a lot about our Pro. And Bill, you can add to my comments when I am through. First, if you think about our private-label credit card, you know we have a great offering for our Pros. The average line is US$6800, over 71% of all the Pros who apply for our card get it. But they only use about 21.5% of the line.
Why? Because it is not a financing tool. Our Pros need a financing tool. So as we tested these 60-day terms we learned that we are providing working capital for our Pros. If they get paid before they have to pay us -- this is a good thing.
We very much liked the sales lift that we saw on our pilots. But it is more than just a sales lift, it was about getting stickiness with that Pro. So how big can it get? Well, we ll tell you as we continue to grow the program, but we are very excited about the future.
Mr Lennie added a comment to Ms Tome's response:
And just one additional comment. The Pros do have a varying degree of credit requirements from size of jobs week to week, the degree of business, the velocity that they are in. So it is good to give them that flexibility.
And then second, the 365 returns is important. It gives them more time on jobs. So I think that is also another benefit that rings solid with our professional customers.
Deeper integration with suppliers
Home Depot has always prided itself on having good relationships with its suppliers, and on getting involved in new product development at an early stage. During 2015 it has increased the level of its involvement, and intends to continue to focus on collaboration as much as possible.
One example of a successful collaboration that the company helped foster, Mr Decker suggested, was the way Home Depot helped Echo, a maker of outdoor power equipment, get together with cordless tool/battery specialists Techtronic Industries (TTI), to develop a new range of 58-volt products.
An example of collaborative planning is the work we did with Echo and TTI, two of our key strategic partners. As we have discussed, more and more product categories are migrating from corded or gas powered to cordless technology. Outdoor power is no exception, but offers unique challenges in power and run time requirements.
Recognising the market opportunity, we worked with Echo, a global leader in professional-grade outdoor power equipment, and TTI, a global leader in lithium ion battery technology, to develop a new cordless platform. The two companies leveraged their respective strengths to deliver revolutionary innovations.
The Echo 58 volt platform offers performance expected by our Pros through the power of gas and the convenience of cordless. The platform is a channel exclusive to Home Depot and demonstrates the power of collaboration.
Use of data to develop markets
Home Depot acquired a data analysis company, BlackLocus, three years previously, at the end of 2012. It has since been using the company's capabilities to help it shape products and markets.
Mr Decker provided one example of this, which has to do with the development of markets for Rheem water heaters:
Leveraging data and tools, we seek to better understand our customers, provide more localised assortments to fit customer demand, and optimise space to dedicate the right square footage to the right products in the right location.
Let's take water heaters as an example to demonstrate the capabilities we are developing. The work started with the basic blocking and tackling of attributing SKUs with the right product information and features, think gas or electric, size or quality. We then overlaid demographic insights and analysed sales performance, including demand signals from online.
Our BlackLocus subsidiary of data scientists then developed clusters of stores that sell similar penetrations of various water heaters. Once the clusters were defined, we built assortments for each cluster with our new, proprietary assortment planning tool to develop the appropriate line structure.
We also looked at macro space considerations to see if we should increase or decrease the number of bays in each store, while considering channel profitability to determine if we should shift certain products online.
Next we built plan-o-grams with an emphasis on micro space productivity to ensure we had the correct facings of each SKU. This ensures the right quantities on the shelf and also drives labour productivity in the store. Finally, we activated replenishment and launched a MET project to reset the store.
After following this process we grew the water heater category by double-digits. But, there is always opportunity to improve, so we refreshed the work a year after the initial reset and accelerated growth yet again. We want to make these types of improvements an ongoing process rather than an outcome of formal business reviews.
Use of data to better serve customers
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