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The Retail Building Essay


The Retail Building – Supply Industry remains to be going strong despite the slow economic growth in 2002; this is due to low interest rates and strong housing market. This industry with the size of $175 billion is expected to reach $194 billion after five years. In this consolidating industry, two key players are dominating: Home Depot, which is holding 29% of the market, and Lowe’s that has 10.8% market share.

Both wanting to improve their financial reports, the two retailers go head-to-head in finding means to boost their top and bottom lines. Home Depot and Lowe’s have both expanded to the professional market by catering to the needs of the targeted professional customers. Not only that, they are now both targeting the metropolitan areas which seemingly guarantees price wars between the two companies. They have also gone beyond the traditional home center by offering online stores and one-stop design and decorating shops.

Acquisitions have been made by both companies to further expand their businesses and to diversify their merchandise mix; like Home Depot purchased three flooring companies to hopefully become the largest flooring supplier to residential construction market. Home Depot’s advantage over Lowe’s is the international presence established through acquiring Canadian (Aikenhead) and Mexican (TotalHOME and Del Norte) retailers; meanwhile, Lowe’s has not explored this market yet.

To turn Home Depot around, the new CEO plans to make store operations efficient and to cut costs. Ongoing systems are also being implemented to manage the inventory and avoid it being stored. Also, the CEO will focus more on improving customer service, which gained negative criticisms, hoping that doing this would increase their sales.

These developments made by Home Depot seem to be perceived by Galeotafiore quite too positively. And this is in contradiction with other analysts’ perspective regarding Home Depot’s performance: the company is seeing diminishing returns from the promotional activity to boost comparable store sales. Meanwhile, Lowe’s management is more on the straightforward strategy by planning to continually open stores in the next three years. Alongside with this, their revenue is also expected to be growing by 18 – 19% in the next two years. Also, comparing the share returns of the two retailers, Lowe’s is performing better than Home Depot. The historical-performance comparison suggests that investors are skeptical of the ability of Home Depot to maintain its performance trajectory, yet projects sustained improvements for Lowe’s.

Statement of the Problem

Carrie Galeotafiore works as an analyst for the Value Line Publishing and is very much interested on the retail building – supply industry which she has been following for nearly three years. For next week’s publication, Galeotafiore must provide the 3rd quarterly report on the industry which includes a five-year financial forecast of the two key players: Home Depot and Lowe’s. Based on historical performance, analysis of trends and changes in the industry and in the macroeconomic level, and study on corporate strategy, Galeotafiore has already made an optimistic forecast for Home Depot and is yet to prepare for Lowe’s.

The following are the main problems found in this case:

1. In 2001, who performed better: Home Depot or Lowe’s?
2. Is Galeotafiore’s optimistic outlook for Home Depot made under sound assumptions?
3. What would be the assumptions made for Lowe’s forecast?

Porter’s Five Forces Model

Threat of New Entrants | LOW THREAT

The already existing independent hardware retailers are already struggling in order to maintain their competence in the industry due to the penetration of large Home Depot and Lowe’s warehouse-format stores. It is reasonable to state that businesses who would like to enter the retail building-supply industry will experience great difficulties in acquiring some of the market shares already hoarded by the two leaders and current businesses. Not unless if they will pursue aggressive marketing strategies coupled with huge risks, which may incur them huge expenses. All of these factors can support the assumption that threat from possible emergence of new competitors in the industry is low.

Threat of Substitutes | LOW THREAT

The industry is engaged in retailing, which means that businesses in it are not mostly engaged in manufacturing. An inference can be made that threat from introduction of substitutes will have a low effect because no matter what products are being newly introduced in the market by the manufacturers; the retailers can sell each and every one of them.

Bargaining Power of Buyers | HIGH THREAT

Due to the cutthroat competition in the industry, there is an intense price competition between businesses engaged in it like what happened to Home Depot and Lowe’s. Due to the latter having expanded into the metropolitan markets from the rural areas where it was previously concentrated, it captured a portion of Home Depot’s market shares. Being retailing as the nature of the industry and products being sold may be the same across different stores, consumers would want to buy on a retailing store with better prices. It can be safely inferred that bargaining power of buyers is high.

Bargaining Power of Suppliers | LOW THREAT

It can be assumed that bargaining power of suppliers is low because a business engaged in retailing can have many suppliers. They can choose to which supplier they should buy with the cheapest price possible, and manufacturers cannot rely solely on direct customer sales and therefore also need to supply their products to retailers in order to sell better.

Rivalry among Competitors | HIGH THREAT

There is a fierce competition between the retailing businesses in the industry particularly the Home Depot and the Lowe’s, being the two leading companies. The former has recently implemented various important activities in order to capture more customers such as establishing new retail formats like urban stores and one-stop shop. Also, since Lowe’s is targeting the metropolitan areas (which used to be reigned on by Home Depot), the two companies will tend to cannibalize each other’s sales; hence, competition between two is intensifying. Due to Lowe’s outpacing Home Depot due to its systematic expansion plans, the latter is expected to fight back using an increase in promotional activities and more aggressive everyday pricing.

SWOT Analysis

Strong market position
Stable company sales and margins
No international presence
Similar product offerings
Strong housing market and low interest rates
Acquisitions and extension of target market
Expansion and enhancement of product mix
Intense price war
Strong market position

Lowe’s currently has 10.8% share in the market, claiming itself as one of the key leaders in the retail building – supply industry. Stable company sales and margins
From having sales of approximately $10 million in 1997 to $22 million in 2001, this just proves that Lowe’s experienced positive sales growth during the past five years. This may be due to the rapid expansion strategies they implemented. Through the years, Lowe’s managed to increase their operating margin. This indicates that the company was able to decrease their operating costs relative to its sales.


No International Presence
Lowe’s has not explored the international market yet. This can be seen as a weakness as the limited consumer base may be a hindrance for company’s potential growth.

Similar product offerings

Having similar products may be a reason for the costumers to change their patronage. In this situation, customer loyalty may be at risk since Home Depot and Lowe’s just offer the same array of products. Also, since both companies offer similar products, the buyers have an advantage over the pricing of these products and this can be viewed as a weakness of the company. They cannot easily raise their prices because they have to meet the competitors’ prices as well.


Strong housing market and low interest rates

Lowe’s is operating under a positive economic environment – with low interest rates and strong housing market. This can be an opportunity to boost up their sales by offering various products in the market. Also, with low interest rates, consumers are willing to spend more on credit based purchases. They are more inclined to get housing loans and invest more in this; this would be good for the industry where Lowe’s in. The health of sales will also be affected by the state of the housing market – which is in this case is strong. This can be viewed as a prospect for the company to prosper.

Acquisitions and extension of target market

Having been previously focused on rural areas, Lowe’s is now targeting the metropolitan areas, such as New York, Houston, and Los Angeles, to sustain its growth. Also, Lowe’s has implemented strategies that would attract professional customers. The company probably saw this market as an opportunity to increase its sales. Addition to this, Lowe’s previous acquisitions is the company’s straightforward strategy to drive its sales. Expansion and enhancement of product mix

By offering wide array of products and services, Lowe’s can enhance their market standing. This strategy is made to improve their sales and margins.

A very tight competition ensues when the industry leaders are facing
head-to-head with each other. Applying similar strategies in attacking the market, it might cause growing competition between the two.
Intense price war

As previously mentioned that Lowe’s slowly targeting the metropolitan areas, the intense price wars are to be feared since Home Depot and Lowe’s will be competing in the same area. Lowe’s comparable store sales have been greater than Home Depot’s and this might provoke Home Depot to lower its prices to attract customers.

Alternative Course of Actions

Three questions were established in this case and the following are the team’s solutions:

1. In 2001, who performed better: Home Depot or Lowe’s?

Based on Table 2 (appendix), return on capital for Home Depot was 15.22% while Lowe’s only have 10.1%. Based on their Weighted Average Cost of Capital amounting to 12.33% and 11.55% respectively, which is their benchmark, it can be inferred that Home Depot has performed better and was more efficient than Lowe’s in terms of costs because a return that is higher than the WACC signifies that a company incurs more cost in respect to its capital funding compared to its limit standards.

Financial ratio analysis for both companies (see Table 1 and 3) shows that Home Depot has a better profitability. Its 5-year average ROC of 15.2% and ROE of 17.53% signifies a positive profit as a percentage of overall company value and ownership, and better profitability in terms of the average shareholders’ equity, compared to Lowe’s that only have 5-year average ROC and ROE of 12.82% and 16.09% respectively. Using such values as benchmark, an investor would want to invest in a company that has better average.

Table 2 also shows that Home Depot have higher gross margin and operating margin than Lowe’s, which signifies that the former performed better than the latter in terms of earning profit. In terms of movement, Lowe’s showed a steady increase in operating margin across the 5-year period compared to Home Depot, which shows an increase in 1997 to 1999 then a decrease and stabilization in 2000 to 2011. This indicates that Lowe’s earned more dollars per sales from 1997 to 2011 compared to the former.

Net Operating Profit after Tax (NOPAT) of Home Depot in Table 1for the 5-year period shows that there were changes in its operating efficiencies, whereas Lowe’s showed a steady increase, which indicates there was improvement in its operations across the years. That’s why in terms of performance in the stock market, Lowe’s outperformed Home Depot, because investors appeared to have lost confidence on Home Depot in maintaining its profit-and-growth trajectory and existing-store growth given the magnitude of its retail space and ability to find new markets.

In summary, Home Depot performed better in terms of operational performance given its higher margin ratios compared to Lowe’s. Also, given its higher ROC to WACC and its ROE, Home Depot has better company value than Lowe’s and is more efficient in generating income in relation to its equity.

2. Is Galeotafiore’s optimistic outlook for Home Depot made under sound assumptions? Galeotafiore formed her assumptions through analyzing its historical performance, trends of the industry and economy, and understanding of the strategies employed. Galeotafiore’s assumption in the existing-store sales growth is a bit far-fetched and difficult to sustain. During 2004 to 2006, the existing-stores sales growth is seen to be at 8.3%; meanwhile, its historical data showed a growth rate not greater than 4%. In this case, to meet the forecasted growth rate, Home Depot should be able to increase its share in the professional market and to successfully attract professional customers.

Also, her confidence on Nardelli’s strategies can be seen especially in the increasing margins of Home Depot throughout the five years. This being said, she expanded the gross and operating margins by reducing operating expenses (as mentioned by Nardelli). However, this can be an issue when the competition between the two leading players would be considered. Competition gives rise to higher operating costs since heavy promotional costs will be incurred to further establish the brand and its products. Also, expenses might go up when Home Depot is trying to boost their criticized costumer services.

With this, it may be difficult for Home Depot to maintain these forecasted margins. As for its inventory turnover, though it seems that her assumption is sound and reasonable, there can be seen inconsistencies in the model such as the inventory grows faster than the revenue. This should not be the case. 3. What would be the assumptions made for Lowe’s forecast? Growth in new stores was computed in relation to the increase in number of stores stated in the case, being Lowe’s plan for its store expansion, for years 2002 to 2004. Succeeding years were assumed to have the same growth with 2004.

Growth for existing stores was assumed using the annual industry growth rate for years 2002 to 2006 of 2.22% which was computed by computing the total market’s sales growth for 2006 to 2002 and dividing it by the respective number of years. Rate for 2001 was multiplied by the computed value to arrive to the forecasted rates for the next 5 years.

For the gross profit margin, a growth rate of 3% was assumed, which was inclined with the industry growth rate for the years 2002 to 2006, to reflect its expanding sales and margins. A declining rate of -1% per year was also assumed as a basis for the cash operating expenses over sales ratio in order to reflect Lowe’s steady increase in operational efficiency.

Depreciation was treated as constant for all years. Income tax rate was assumed to be the same with Home Depot because they are just in the same country where they operate. All other rates such as efficiency ratios, cash and short-term investments to sales, and other current liabilities to sales, were assumed to be the same for 2001 to 2006.

From these assumed values, items from the forecasted Income Statement and Balance Sheet for 2002 to 2006 were computed. Other items were forecasted based on the analysts’ own judgment like the constant deferred income taxes, other long-term liabilities, proportion of shareholders’ equity to the total capital, among others.


As for the first question, the students recommended these alternative courses of action for the two companies deemed necessary:

For Home Depot, they should (1) minimize operational inefficiencies by reducing expenses like energy costs without affecting productivity; (2) realign existing store growth to its profit-and-growth trajectory through enhancing its store efficiencies, sales and inventory turnover; and (3) diversify their target markets – not just only small-professional markets but large ones too.

However, it is a different case for Lowe’s: the company should be able to enter densely populated markets in order to possibly capture more customers and they should establish an international presence to expand its current market and gain new opportunities.

In relation with the second question, there should be adjustments on the margins of Home Depots, as well as its inventory. The analysts believe that Galeotafiore’s declining forecast for the inventory turnover is somehow inappropriate because it is expected that inventory should not grow faster than sales, for it may be deemed contradictory to the idea that a growing business should not have inventory piled up. In order to improve inventory turnover, Home Depot should cut its inventory days reasonably enough that it should be consistent with the revenue growth, which in effect, would increase inventory turnover.

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