Home Depot Case Study Analysis

The Home Depot opened in 1978 and targeted individual homeowners and small businesses, and sales were concentrated in the home remodeling market. They focused on providing for a growing DIY market for homeowners looking to boost the values of their homes. One of their key success factors was that their stores were also their warehouses, which allowed them to keep overhead costs low and provide affordable prices to the customers.

Emphasizing higher sales with lower profits and inventory turnover also allowed them to cut costs. Approximately 90% of the company’s employees were on a full-time basis and received higher salaries and wages than their competitors. Their key risk factors include their reliance on external debt and equity financing. As their earnings and stock price dropped in 1985, they became a less attractive investment. Their goal was to generate more cash from their stores to provide a sustainable way to grow their company. The home improvement industry had sales around $80 billion in 1985 and the industry had compounded at an annual rate of 14% over the previous 15 years.

The growth was buoyed by the increase in two-wage-earner households, as well as the increase in popularity of DIY activities. The success of Home Depot's brought competition into the industry, and their biggest was Hechinger Co., which had owned hardware stores before entering the DIY industry. Hechinger’s model was to run upscale stores and provide higher product quality aimed at generating higher profits. While Home Depot has more total sales and a larger percentage of the market share than Hechinger, their competitor has a higher ROA and ROE than them for fiscal year 1985. Their struggles are partially due to the aggressive rate of growth they undertook during the year. From the end of fiscal year 1984 until fiscal year end 1985, they expanded into 8 new markets, and increased their total number of stores from 22 to 50.

The percentage increase in operating expenses, around 80%, exceeded the percentage growth in revenue these new stores provided, 62%. Another key to their performance was a reduction in the gross profit margin of Home Depot. They went from 26.4% to 25.9%, which was mostly caused by the lower margins associated with establishing a presence in the new markets. To fund the new stores Home Depot believed it needed to gain a leg up on the competition, Home Depot entered into a $200 million revolving credit agreement. This increase in long-term debt hurts their stock price and shareholder returns in the short run, but should allow them to maintain growth prospects into the future. This allowed them to cover the approximate cost of $8.4 million per store it would need to fund their new stores. The heavy reliance on external debt and equity financing and the subsequent drop in stock price made investors less interested in the company, and they faced questions on how they would be able to fund further expansion into the future.

One of the areas Home Depot should look to improve at into the future is how to increase their inventory turnover. They can do this by focusing on ways to improve how they manage inventory levels. Expansion of the company led to them entering markets that were facing financial difficulties, such as Houston with the contracting oil industry. Moving forward, they should be more aggressive in struggling markets on how much inventory they keep on hand. Home Depot must prioritize efficiency as it increases its growth. It needs to conduct considerably more market research into which geographic locations where they can open stores and increase the market. Opening stores in their existing markets will allow them to share some of the advertising and operating costs required to earn a return on investment quicker than in markets they do not currently operate in.