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The Home Depot Pro, Cost Structure, & Growth Opportunities

Former District Manager at The Home Depot

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Executive Bio

Former District Manager at The Home Depot

The executive is a Former District Manager at The Home Depot where he was responsible for three states across the Midwest for over 6 years. Prior to The Home Depot, the executive enjoyed over has over 15 years with Walmart where he was responsible for over $2bn in annual revenue.Read more

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Interview Transcript

Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

My questions are focused around Home Depot but tend to be retail management questions, except for a few of them. I know you were there a decade ago and have more recent experience with other retail, so to the extent that these are not relevant, let me know.

When I was at Home Depot, I was a direct report of Marvin, who left to JCPenney, and is now the CEO of Lowe's. Some of the things I am discussing with you are public information. Even though I have been removed as far as being on their salary, I have a variety of close friends who are still at Home Depot that I converse with weekly. Lowe's have actively recruited me for two years, based on my background with Marvin. I can speak well to 90% of the things you would ask, because of conversations I have had with current Home Depot folks but also Lowe's who are actively trying to recruit me.

Great. Thinking about this SG&A cost algorithm at both those firms, what limits them? They have got great leverage and if we assume transactions keep growing below revenue because basket size has increased, they should continue to get leverage. However, it seems like in Home Depot's case, they are already at quite low levels, so how much further can they go?

There are many pressure points centered around what is actually in the news, which is the ability to source product from overseas and eliminate the log jam on coast lines. Much of that is increasing the cost because of the speed to fulfill customer demand. Last summer there was never a shortage of lumber, it was a shortage of people being able to get it to the big boxes, and in turn, everyone thought there was actually a lumber shortage. We still had the same amount of trees and wood.

The shortage was caused by the inability to get product to the job site or brick and mortar stores. Covid has put pressure on the ability of these big companies, which you can include Menards, especially on the building materials side. They continue to blame Covid for the lack of product and lumber prices are decreasing because customers refused to pay what I call gouging, during the pandemic. All three major players contributed to that. One example is the 12 to 16 week lead time to get fence posts to build a deck last year, which was maintained for 10 months. It has created a spotlight on the weaknesses all those companies.

In a single store you can easily see, as transaction and traffic levels increase, you need more people. That is straightforward but when we consider that the basket size is also increasing at Home Depot, all of that is dropping. The gross profits start with the bottom line because it does not seem to affect SG&A much. We are trying to understand how much further that can go. If you were operating a single Home Depot or Lowe's, and were thinking about what the maximum SG&A leverage you could get, what is the lowest level to target for a fully optimized store?

I will give you an example because you are asking a very specific question. As sales and transactions increase, they are not adding labor and are leveraging that to profit. The consumer's experience is what suffers from that standpoint, because they are not putting more people in the store, even though they are increasing their revenue. It was 50%, but it is now 62% of the product purchased from Home Depot that goes directly from vendor to job site.

That plays to the business model whereas they are able to increase sales but, at the same time, not increase their largest expense which is labor. By not increasing the labor spend, it improves their overall bottom line.

Home Depot recently said that the supply chain ecommerce investments they have made, including delivery job sites, has added 10% to their store base. Does that seem correct based on what you just said? Is that the right way to think about it?

Since at least 15 years ago, Home Depot leveraged the fact that they could include their product on the pro side. In 2010, the customer viewed Lowe's as a prettier place to shop, catering more to female shoppers who still make 82% of shopping decisions. Home Depot leveraged pro customers because they already had their own delivery system in place.

They have continued to leverage that strength against Lowe's by adding a second truck or delivery person. They will do two shifts, 6 AM to 2 PM, and 2 PM to 8 PM. There are definitely workarounds to improve and to build on Lowe's lack of strength. As a result of Covid, Lowe's are trying to add their individual private delivery system.

Lowe's are emphasizing the pro customer now; is their ability to ramp up pro as a percent of business reasonable? Could they reach the Home Depot levels or is Home Depot so much more entrenched that Lowe's will not be able to do that?

Pro customers are not loyal; they are out to make their job easier. At the end of the day, they are not so concerned about price because pro customers simply transfer the cost to their current job. Lowe's are trying to add delivery trucks which they had 15 years ago, whereas Home Depot has already established that but also have the second truck or shift.

One of the big differences in the overall stock price is their ability to take care of that pro customer. Again, it is not so much cost. If I call Home Depot and tell them I have to have something by tomorrow morning 8 AM, they can achieve that request at a higher percentage than Lowe's or Menards. Menards do not own their own delivery system but subcontract to local jobbers, and are at the mercy of the person they hired locally to deliver their product on that individual's semi with their Moffett.

Pro customers have different needs than do it yourself home owners so how was Home Depot able to build a successful pro business while continuing to satisfy their do-it-yourself home owners? Is there any color you could add to that question, as typically a business serving two different customer sets does not always go so well?

I will give you some of my history which will shed light on your question. I covered Southern Indiana and Northern Kentucky which was not an area of growth for population. For my district to achieve our goal of being number one in overall sales growth out of 72 districts or a third of the country, we had to take market share from the local lumber yards. In my case it was a very strong player in three states, called Kite Lumber, who had 12 locations.

Our entire plant business growth was centered around growing the pro business. Lowe's was a great competitor, but Kite Lumber had the majority of the pro business locked up for 15 to 20 years. When I came to that market we strategized against this local lumber yard, who had six locations in three states.

If you met a certain threshold as a pro customer spend, they would fly you and your significant other to Hawaii for 10 days, all expenses paid. They used this trip as a catalyst to keep these pro customers loyal to their lumber yards. We set up a meeting with a home builder who built 20 homes a year on spec. I asked him why he wouldn't give Home Depot a shot on the pro side, and his response was that he was loyal to Kite because of this trip.

I asked what he thought that trip was worth to him and his response was $20,000. The cost of an average house was $200,000 and I told him I could save him $4 million by reducing his cost by 10%.

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