1

Home Depot`s business strategy is centered on cost leadership, coupled with elements oI
diIIerentiation. The company concentrated their operations in the Home Remodeling industry, and its
customers are predominately individual homeowners and small contractors. Founded in 1978, Home
Depot operates 50 'Do-it-YourselI retail stores in 15 markets across the United States. They oIIered
high quality nationally advertised brands and lesser known brands careIully selected by merchandise
managers. All oI the products sold at its stores were guaranteed.
The company`s cost leadership strategy centered on supplying the same products and services at a
lower cost. The warehouse Iormat oI their stores allows their inventory to be stored in the merchandise
aisles, reducing overhead costs which are subsequently passed on to consumers. Instead oI Iocusing on
higher proIit margins, the company emphasized a higher turn oI their inventory, which Iurther reduced
costs. Home Depot utilized most media to aggressively advertise its low prices, assortment and depth oI
its products, and a quality that cost leadership companies rarely specialize in: superior individualized
customer service.
The central element oI diIIerentiation is Ior a Iirm to be unique in its industry along some dimension
that is highly valued by customers. The company`s sales assistance was the dimension that
diIIerentiated its business. Due to their target customers` lack oI technical expertise, Home Depot
emphasized unmatched customer service. A vast majority oI their sales personnel were Iull time, and
were compensated at a level above their competitors. Furthermore, the sales Iorce was specially trained
in the store`s home improvement products. This allowed the average homeowner to get their questions
answered, while getting the appropriate products they needed.
The company expanded quickly in 1985 by opening 20 stores. They predicted that their store growth
would moderate in the coming year (nine new stores), and all but two stores would be in existing
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markets. The company seems to be Iocused on orderly growth to achieve market dominance while
expanding into new markets. We believe that Home Depot`s business strategy is viable in the long run,
due to the unique mixture oI low pricing and specialized customer service. However, their claim that
homes consistently appreciate is troublingit may indicate that they don`t have a plan iI prices decline
and homeowners delay ongoing maintenance and improvements.
Home Depot`s Iinancial perIormance declined precipitously Irom FYs 1983-85, and they were
consistently outperIormed by their key competitor. The company`s gross proIit margins declined subtly,
however they remained below Hechinger. Alarmingly, Home Depot experienced a 42 decrease in net
income in 1986, while its competitor realized a 10.5 increase. Similarly, Home Depot`s steady return
on its shareholder`s equity was steeper than Hechinger`s modest decline. On a positive note, Home
Depot`s cash Ilow Irom operations and inventory turnover were respectable compared to Hechinger.
Gross rof|t Marg|n 1986 198S 1984
Pome uepoL 239 264 273
Pechlnger 293 301 321

-t Incom (M) 1986 198S 1984
Pome uepoL $82 $141 $103
Pechlnger $231 $209 $162

1986 198S 1984
Pome uepoL 97 194 243
Pechlnger 138 189 191

ash I|ow from s (M) 1986 198S 1984
Pome uepoL $137 $181 $119
Pechlnger $122 $190 $31

Invntory 1urnovr 1986 198S
Pome uepoL 46 31
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Pechlnger 43 43

During 1985, Home Depot had two obstacles as a company to overcome: Iierce competition in
the Do It YourselI retail warehouse market segment while growing rapidly. It seemed as iI the company
was able to manage the transition oI growing and investing in the company`s long term success, while
still being able to maintain its position as a low cost provider to compete with the Iive other DIY
warehouse home good stores. Net Sales grow 173 during the years, Irom $256 million to $700 million
while the number oI costumers shopping grew at a similar rate Irom 8.5 million to 23.3 million. The
company expanded into eight new markets while adding thirty-one new stores and more than doubling
its staII in only a two year period.
While sales were rising at an extremely high rate, net earnings actually declined in 1985, down
20 Irom 1983. This decline in earnings per share lead to a signiIicant reduction in stock price in 1985,
making Iinancing by equity very unattractive, so the company was Iorced to Iinance its rapid growth by
debt. Home Depot then took on a massive amount oI debt, changing its capital structure Irom 38 debt
in 1983 to 77 debt in 1985. By Iiscal year end oI 1985, Home Depot total long term debt was
$199,943,000 up Irom just $236,000 in 1983.
However, the addition oI debt Iinancing did not make Home Depot more productive. The
inability to control cost became an issue and the bottom line suIIered Ior it. Individual store sales grew
at only 4 over the three year period while store expenses grew at 7. ProIit margins were shrinking
Irom 4 to 1 and net earnings per store were reduced to $160,000, down 70 Irom two years earlier.
Even though the number oI employees was rising, the company reduced the number oI employees per
store, down 15 Irom 1983. Since part oI their strategy is excellent sales assistance, this reduction in
staIIing might not be a good move to their long term success because even though more customers are
shopping at Home Depot, the average purchase amount remained Ilat. Home Depot was successIul at
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expanding operation extremely quickly, overall store productivity declined while accumulating a large
amount oI debt to do so.
1983 1984 198S hang (83 8S)
-t Sa|s (5 |n m||||ons) 23620 43280 70070 173
-t arn|ngs (5 |n m||||ons) 1030 1410 820 20
Stockho|drs u|ty (5 |n m||||ons) 6330 8020 8910 36
1ota| Assts (5 |n m||||ons) 10330 24940 38020 260
ustomr ount (m||||ons) 830 1430 2330 174
Suar Iootag (m||||ons) 140 240 400 186
-umbr of Markts 700 1100 1300 114
-umbr of Stors 1900 3100 3000 163
-umbr of m|oys(thousands) 240 400 340 123
rof|t Marg|n 402 326 117 71
Sa|s r Stor (5 |n m||||ons) 1348 1396 1401 4
1ota| Dbt (5 |n m||||ons) 4020 16920 29110 624
a|ta| Structur ( Dbt) 38 68 77 101
Annua| nss (5|n m||||ons) 24390 41870 69230 182
Annua| nss r Stor(5 |n m||||ons) 1294 1331 1383 7
-t arn|ngs r Stor (5 |n m||||ons) 034 043 016 70
m|oys r Stor 126 129 108 13
ustomrs r Stor 447368 461290 466000 4
Avrag urcahs Amount 3014 3027 3007 0

The price oI The Home Depot stock rose $2.40 on Feb 1, 1985 closing at $19.00 per share, it
then Iell 23 over the Iollowing 12 months closing at $14.50 on Feb 3, 1986.
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It appears that the company is already in violation oI the debt covenants (using debt to total
stockholder equity as the ratio).

Debt/Net Worth Ratio
not more than 2 to 1
1985 1986
0.19 0.22
Using Current Assets to Current Liabilities The Home Depot is within its restrictions, but there is
a signiIicant trend lower. The total ratio Iell Irom 3.1 to 2.3 over the one year period.
Current Ratio not
less than 1.5 to 1
1985 1986
3.1 2.3
While earnings are oII nearly 40 percent the total interest and tax expense increased less than 10
percent. So in 1985 The Home Depot was close to its required ratio but with the signiIicant reduction in
earnings the ratio Iell to less than halI the requirement.


arn|ngs bfor
|ntrst and tas
198S 1986
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not |ss than 2 to 1
Larnlngs 26232000 9886900
lnLeresL 1114000 8723000
1axes 12130000 3400000
Sub1oLal 13244000 12123000
8aLlo 198 082

The company plans to open nine new stores in 1986 at $6.6 million per store Ior site acquisition
and construction with an additional $1.8 million per store Ior inventory, a total oI $8.4 million each.
This will require a total oI $75.6 million over the course oI the year. This works out to $6.3 million per
month.
II it`s assumed that The Home Depot can return to its 1984 level oI proIitability oI $0.45 million per store
($14.1M/31 stores $0.450M) then it will have $22.7M (50 stores x $0.450M$22.7M) or $1.9M per month
available Ior equity Iinancing. Leaving a need Ior an additional $52.9 million in debt Iinancing. This would lower
the current ratio under 2 and violate a debt restriction. The Home Depot must Iind some other way to Iund
additional growth. It is unlikely to achieve proIitability level to equity Iinance, it`s questionable iI lenders will be
willing to renegotiate loan agreements to less restrictive terms

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To achieve continued sales growth and increase proIitability the company should re-examine the
number oI employees per store. StaIIing per store has declined in recent years Irom 126 in 1983 to 108
in 1985, a 14 decrease. Increasing the number oI employees should be considered as well as training
new and current employees about the products and materials and up selling` skills to increase the value
oI each customer transaction.
To reduce expenses the company should consider an earlier closing hour on week nights,
especially Sunday through Thursday. Reducing the outlay Ior payroll, and operating costs Ior low
volume hours is a reasonable course oI action. Exact hours could be leIt to the local manager to make
the best decision Ior that particular location.
Slow the rate oI expansion. The interest burden is signiIicant and will only get worse iI the
company continues on its present course. Focus on expanding into new markets, not on markets already
having a Home Depot presence. The company expends in markets where it already has at least one store,
it would seem likely that those two (or more) stores are competing with each other and cannibalizing
some sales Irom each other.
Take a closer look at inventory purchases. Is replacement merchandise arriving Just In Time? Or
is there some overstock happening. Also, is there suIIicient diIIerentiation between product oIIerings
and those oI the competition? II there is then is that being communicated to the customer base, and iI not
then perhaps the product base should be expanded. Being a warehouse, an investment in new inventory
technology would also help the company be more eIIicient in what sells vs. what doesn`t and making
sure all products are in stock.
Don`t lose Iocus on the core business success, the novice home improvement attempt. This
requires training oI both employees and customers to insure they have the conIidence to take on
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increasingly more sophisticated projects. It will require continuous Ieedback Irom customers as to how
well products work (or don`t work).