Case Analysis of whether Home Depot should enter the China Market

Background information

The Home Depot is an American retailer of home improvement and construction products and services. Headquartered in Vinings, just outside Atlanta, The Home Depot employs more than 355,000 people and operates 2,141 big-box format stores across the United States(including the 50 U.S. states, the District of Columbia, Puerto Rico, The Virgin Islands and Guam), Canada(ten provinces), Mexico and China. The World’s second largest Home Depot opened November 14, 2007 on the island of Guam.

The Home Depot is the largest home-improvement retailer in the United States, ahead of rival Lowe’s and the second-largest general retailer in the United States, behind only Wal-Mart.

The Home Depot was founded in 1978 by Bernie Marcus, Arthur Blank, Ron Brill and Pat Farah. Its proposition was to build home improvement warehouses, larger than any of their competitors’ facilities. Investment banker Ken Langone helped Marcus and Blank to secure the necessary capital.

In 1979, the first two stores, built in spaces from J.C. Penney that were originally Treasure Island Hypermarket stores, opened in metro Atlanta. On June 22, two more opened not long after, and all four shared the space under the zig-zag roof with Zayre on its right side. The first headquarters was on Terrel Mill road on the southeast side of Marietta, Georgia, just down from one of the stores at the corner of Cobb Parkway.

Since the 1990s, its current headquarters is a high-rise building on Paces, on the western edge of the Cumberland/Galleria edge city in unincorporated Cobb County, Georgia, across Interstate 285 from the town of Vinings, and served by mail from Atlanta (Stores, July 2006).

In 2000, after the retirement of Marcus and Blank, Robert Nardelli was appointed chairman, president, and CEO. Nardelli was replaced in January 2007 by Frank Blake.

In 2007, the Home Depot sold its USD $13 billion revenue wholesale division, HD Supply, to a consortium of three private equity firms.

Home Depot stores are large, averaging 105,000 square feet and organized warehouse style, stocking a large range of supplies. The company color is bright orange, on signs, equipment and employee aprons.

Its 2006 sales totaled USD90.8 billion. Despite the 10% increase in revenue, it dropped three spots to number 17 on the 2007 Fortune Magazine’s Fortune 500 list. The Home Depot also owns Expo Design Center; a chain of higher-end home acquired Hughes Supply which is to be assimilated into HD Supply serving contractors. In September 2005, Home Depot Direct launched its high-end online home-furnishings store shortly followed by the launch of Paces Trading Company, its high-end online lighting store (Balfour and Grow, 2006).

In mid 2006, the Home Depot acquired Home Decorations Collection which was placed as an additional brand under its Home Depot Direct Division. Home Depot Landscape Supply, with only a few, with only a few stores each in metro Atlanta and Dallas, was founded in 2002 and closed in late 2007.

On January 2, 2007, the Home Depot and Robert Nardelli mutually agreed on Nardelli’s resignation as CEO after a six-year tenure. Nardelli resigned amid complaints over his heavy-handed management and whether his pay package of $123.7 million, excluding stock option grants, over the past five years was excessive considering the stock’s poor performance versus its competitor Lowe’s. His golden parachute severance package of $210 million has also been criticized because when the stock went down his pay went up.

Current members of the board of directors of the Home Depot are F. Duane Ackerman, David H. Batchelder, Frank Blake, Ari Bousbib, Gregory D. Brenneman, Albert P. Carey, Armando Codina, Brian C. Cornell, Bonnie G. Hill and Karen Katen. The Home Depot’s board consists of ten members with nine of them being outside directors.

The slogan “You can do it. We can help.” Has been used by the Home Depot since 2003. Other slogans used in the past 25 years include, “The Home Depot, Low prices are just the beginning” in the early 1990s and “When you are at the Home Depot, you’ll feel right at home” in the late 1990s and “The Home Depot: First in home improvement!” from1999 to 2003.

A major challenge Home Depot is facing is a legal tussle with one of its former employees. In July 2005, former employee Michael Davis, represented by attorney Mark D. Schwartz, filed a whistleblower lawsuit against the Home Depot, alleging that his discharge was in retaliation for refusing to make unwarranted chargebacks against vendors. The Home Depot alleges that it fired Davis for repeatedly failing to show up for work. Home Depot has settled the dispute in a stipulation of settlement dated March 28, 2008. In the settlement, Home Depot changes some of its corporate governance provisions. Home Depot also agreed to pay the Plaintiff's counsel $6 million in cash and $8.5 million in common stock (Stores, July 2006).

Analysis

The question of whether Home Depot should enter into the China market is an important one. It should therefore be addressed as soon as possible and with the seriousness it deserves.

Chinese home ownership is soaring, and with it the emergence of a market for related products and services that is growing fast in sophistication. Home ownership has traditionally been the dream of many in the West, and now it is much more within the reach of China's increasingly affluent urban middle class. With home ownership, comes increasing consumer demand for household appliances, furnishing, decoration, and a mass of secondary consumer items and services as well as financial services such as loans.

Four out of five of China's urbanites own their own residences and 94 per cent own some form of accommodation, according to the Ministry of Construction (http://www.asianmarketresearch.com).

The home improvement market on the mainland China is the most promising in the world. In 2005, there was $50 billion in sales and is growing at 12% a year. Home ownership has skyrocketed from near zero two decades ago to 70% of all housing today. A successful strategy there would offset the challenge of sustaining strong sales growth back home and could even boost the stock

The China home improvement market is a lot trickier to navigate than those 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, purchases of newly constructed homes do not have bathrooms to tile. They do not have bedrooms or kitchens. Chinese contractors just build concrete shells with no finishing work. So Chinese homeowners fix up their homes themselves.

Should Home Depot decide to enter the China market, it would have to train thousands of its staffers to do floor-to-ceiling installation, something it doesn’t have to do in the US.

Home Depot faces stiffening competition from the likes of B&Q and homegrown players including Homemart, Homeaway, and Orient Home. Homeaway, 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 big cities.

In B&Q, Home Depot faces a rival that has already learned many lessons about operating in China. The chain, a subsidiary of Europe’s Kingfisher, inaugurated its first Chinese store in Shanghai in1999 but soon realized that a cookie-cutter version of its British stores would not pass muster.

Since those first wobbly 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 the year 2010.

B&Q’s Chinese outlets bear little resemblance to the cavernous warehouses filled with piles of drywall, paint, and ported plants typical of a Home Depot in the US. Designer chopsticks compete for space with professional-grade power tools. For feng shui followers, there is an extensive selection of aquariums with some costing as much as $3,000 (Balfour and Growl, 2006).

Property prices have dropped in Shanghai, the most active property market in China, as government measures such as raising taxes and restrictions on sales begin to be felt. Last week’s prices for Shanghai residential properties were down an average of 18.5% to USD 752.17 a square meter from the previous week (www.ehomeday.com).

The biggest fall in residential sales was in Pudong New Area, which registered an average decline of 49.3% in the week. Meanwhile the number of transactions have increased to 1.3% with 2516 properties changing hands in the week with low and mid end properties enjoying increasing popularity. The downtown area has seen fall in prices, while the prices of properties in outskirts have increased recently (www.ehomeday.com).

Shanghai’s combined index for housing prices rose by 1.1 per cent to 1,513 points in May. Sales of used homes rose in mid and late May as both buyers and sellers rushed to make deals before June 1st, the deadline for new government policies to come into effect. Measures were announced last month by seven key ministries and government authorities including the People’s Bank of China and Ministry of Construction to cool off the real estate market.

According to the measures, property owners who sell within two years of purchase will have to pay tax on the full sale price. The measures were mostly to prevent speculators investing in property, which artificially raised the overall market price, especially causing difficulties for mid to low income families.

Several real estate agents and research centers, including eHomeday, Centaline (China) Property Research Center and the Shanghai Index for Housing prices Office, however, declined to speculate on the future prospects of the Shanghai property market, saying it is a too sensitive a topic to talk about at the moment.

The real-estate market, especially in Shanghai, is a very sensitive area currently. Both local media and officials are following government guidelines in not causing 'market disorder.' This means they cannot offer official comment other than that specified by the government. Shanghai is especially sensitive as a property bubble has built up, following rampant speculation in housing. The government hopes to cool the market following its recent measures; though many market observers are not convinced the measures will work. Property prices in Shanghai have risen by more than 200% over the recent 2-year period. The speculation is compounded by the long-term slump in the stock market.

As China's social housing system develops, a growing number of people, especially in urban areas, will purchase their own houses with a combination of funds they accumulate themselves, the equivalent amount paid by their work units for housing, and bank loans. The latest statistics from the People's Bank of China show that housing loans issued by China's commercial banks in 2001 were 32.55 times those in 1997.

Housing loans issued by domestic financial institutions totaled US$80 billion by the end of June. Housing loans have become a critical part of the credit consumption of the Chinese people.

Moreover, a recent survey shows that 48 per cent of Chinese citizens plan to purchase or swap houses in the next couple of years.

Sixty-seven per cent of the people who have bought public housing want to improve their living conditions by purchasing new residences or exchanging houses. Low-rent or free housing used to be one of the benefits provided by the State or State-owned enterprises before the country launched its opening-up and reform. But the cost of the system made it increasingly hard for governments at all levels to build more and better houses. It became a headache for city residents to find suitable housing.

The central government began to reform the housing system back in the mid-1980s by selling luxury houses at market prices, by providing middle-income families with cheaper housing, and by accommodating low-income residents in low-rent apartments. Governments at all levels have provided various preferential schemes to improve living conditions in the world's most populous country. Developers of affordable housing can enjoy 21 tax-reduction and exemption programmes if they keep their profit margins below 3 per cent.

Conclusion

Home Depot executives should gauge the risks and rewards in China to avoid getting off on a 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.

Home Depot should try a mix of building its own stores and buying shares in China through an acquisition. The longer it waits the tougher it will get to break in. securing the best location requires good government connections. Getting to know the market and forging relationships with local suppliers can take years.

Reference

Stores. (July 2006).Top 100 Retailers: The Nation's Retail Power Players.

Wright, P et al (1996) Strategic Management: Concepts and Cases. Prentice Hall

Hill, J. et al (2006). Strategic Management: An Integrated Approach: Academic Internet Publishers Inc.

Balfour, F and Grow, B. (May 1, 2006) Business Week