Distribution Evolution - Jan/Feb 2007

By FRANK O'NEILL, Publisher

The big buzz about a possible $100 billion buyout of Home Depot two months ago got me thinking about the kind of value the company actually represents. Of course, the buyout buzz has died down, and Home Depot has more serious issues to contend with now, but it once again got me thinking about the independent floorcovering retailer’s biggest competitor.

If you look at Home Depot’s assets, which include lots of cash and some of the best real estate in the nation, the deal is probably worth $100 billion. When you look at Home Depot as a long term growth prospect, though, the picture gets a lot murkier. The Big Orange must think it can no longer grow by expanding its traditional cash and carry warehouse store concept, so it’s been looking at other growth possibilities ranging from fancy catalogs to HD Supply, the three year old builder supply business. Thanks to an onslaught of acquisitions, HD Supply has grown into a $12 billion business and now accounts for more than 15% of total sales. About 6% of those sales belong to Creative Touch, the firm’s builder flooring business. But those businesses are much more service oriented than the retail business, and that’s going to spell trouble for Home Depot. The company is already stumbling over its installed floorcovering business, and it’s going to stumble over HD Supply. Service is something Home Depot just doesn’t understand.

CORROBORATION

I wrote the above early in December, a week before the San Diego firm Relational Investors bought 13 million shares of Home Depot and launched an assault on its business practices, including CEO Bob Nardelli’s obscene $30 million compensation package and the woeful performance of Home Depot’s stock, which was down since Nardelli took over the top spot six years ago, at least until a few weeks ago.

“We attribute the stock performance to deficient strategy, operations, capital allocation and governance,” Relational co-founder Ralph Whitworth said in a letter to Home Depot. Whitworth criticized HD Supply as a low return, more cyclical business than the firm’s core retail business, and suggested that the company spin it off and concentrate on retail.

Whitworth is hardly a kook who’s just trying to stir up trouble for the Big Orange. His company has had great success in the past influencing ailing companies he invests in. He’s managed to get on the boards of Mattel, Waste Management, Sovereign Bancorp and a number of other high profile companies, and in the process create changes that have boosted the firms’ stock—and his company’s, as well.

THE ISSUE OF HONESTY

As if Home Depot doesn’t have enough troubles, did you see the investigative report by Joel Grover of KNBC TV in L.A.? Grover’s shocking nine and a half minute undercover report details how hundreds of Home Depot customers were scammed by salespeople in the company’s remodeling businesses. You can see it by going to youtube.com and searching Home Depot Investigation.

One of the most telling parts of Grover’s report is his interview with a former salesman who says there’s big pressure to get the sale. “Even if you have to lie to do it?” Grover asks. “Yeah,” the salesman says.

Grover’s report documents one nightmare after another. A woman who was five months pregnant when she contracted with the company to get her kitchen remodeled was told the job would take two weeks to complete. Her child was three years old when the job was finally completed.

As for Home Depot’s 100% guarantee on all remodeling jobs, another customer said she made over 100 calls to the company and still got no resolution to her problem. A former Expo Design Center designer who spoke to Grover said that when something goes wrong, no one has any authority to do anything about it. So if you have a problem with work you get done by their remodeling service, good luck on getting it fixed.

This is what the small businessman has to contend with these days. It would be one thing if the competition was fair, but when you have to deal with dishonesty, too, that changes the ballgame completely. You have an obligation to yourself and your customers to tell everybody you know to go on YouTube and watch this report. Then they can decide for themselves who they want to buy from.

THE FINAL WORD?

Just a few days after I wrote all of the above, Bob Nardelli resigned as CEO of Home Depot, packed his bags and left. I guess I’m not the only one who’s had a bone to pick with him.

As everyone probably knows by now, Nardelli left on the same terms he had while he was running the company—with his pockets full of cash. A $210 million adios payoff is ridiculous. It seems obvious to me that the board of directors that gave him that payoff should pack their bags, too.

Frank Blake, who had been executive v.p., takes over as chairman and CEO. Blake joined Home Depot four years ago. Interestingly, he’s an alumnus of GE, where Nardelli worked before he took the top job at Home Depot, and like Nardelli, he’s had no previous retail experience. Does that mean he’s a Nardelli clone who’s going to take the company down the same path as Nardelli? Or is he going to try to correct all the mistakes Nardelli has made?

As long as the existing board is there, don’t expect big changes. But then, that’s not something independent retailers should be concerned about. The less change, the less Home Depot is going to get in your way.

THE GREEN EDGE

For years now, Shaw Industries has been creating some of the most exciting environmental initiatives on the planet, but the company has been very low key about it because its modest CEO didn’t want to blow his own horn. That’s the way Bob Shaw’s been about everything in his extraordinary life. He just didn’t boast about anything on his way to creating a world class corporation.

But soon after Bob Shaw retired, the new management team began looking at all the company’s environmental achievements, and decided it was time to let the world know what Shaw Industries has done. That was the genesis of the firm’s new Green Edge brand umbrella for the hundred-plus environmental products and projects the company has developed in the past decade.

Shaw’s environmental efforts actually began nearly 15 years ago, when the firm started recycling carpet waste for use as filler in concrete for roadways and buildings. It began to take on a much greater degree of sophistication about six years ago with the development of the EcoWorx recyclable backing, which was followed by EcoSolution Q recycled content fiber. Then in 2004, the company got together with Siemens to build a $10 million gasification plant, a plant that would not only reduce the company’s post industrial carpet waste to zero, but also consume 6,000 tons of wood waste from the firm’s laminate plant, and another 1,000 tons of post consumer carpet. All that waste is converted into gas that runs one of the company’s main plants, saving it some $2.5 million in energy costs.

The most exciting phase of Shaw’s environmental program, though, will begin in a few months, when the company re-opens the Evergreen recycled fiber plant that the company acquired from Honeywell and DSM Chemicals. That plant will be able to recycle a hundred million pounds of used carpet a year and convert it back to caprolactam, the basic ingredient in nylon fiber. When that plant gets going full bore, it will bring the carpet industry’s carpet recycling efforts to a new level.

Until now, the carpet industry’s environmental efforts have been primarily in the commercial market, but there are signs that consumers are finally becoming interested in green products. Shaw has begun making Anso residential carpets that contain post consumer nylon, and the Epic engineered hardwood floors being made in the company’s new Tennessee plant have cores made from reclaimed wood waste, so they’ll use half the amount of harvested wood as traditional engineered floors. Retailers who target the Main Street market will also now have a selection of carpet tiles made with the EcoWorx backing and Ecosolution Q fiber.

All these green products will be grouped under the Green Edge umbrella, and you’ll see the Green Edge ID on all Anso products introduced this year. Take a look at the new website, shawgreenedge.com, for a great overview of all the initiatives in the Green Edge program.

JUST HOW BAD IS THE HOUSING SLUMP?

I haven’t said much about the housing slump because all the so-called experts have such extreme positions on it. Some say housing will begin to recover in the second half of 2007. Others say the downturn will be “protracted,” which translates to 2008 or later.

I think both schools may be close to the mark, depending where you live and do business. If your business is in Florida, Arizona, Nevada or parts of California, be prepared for a long, brutal downturn. If you’re in a more stable Metro Market, you probably won’t have to wait so long for a turnaround. Here’s what my good friend Patrick Molyneaux of the Pittsburgh retailer Molyneaux Tile, Carpet & Wood has to say about his market:

“Pittsburgh is historically very low in population growth, employment growth and building permit growth. Our market has been a brutal slugfest for the past few years because the dealer base is well managed and because Pittsburgh never experienced the employment and housing bubbles. Since it doesn’t have as many speculative excesses to work through, we hope and pray that the pent up demand on remodeling will break loose by mid 2007.”

If your city’s demographic and economic profile is close to Pittsburgh’s, and if you haven’t had a lot of investors buying houses with the intent of flipping them, your market’s going to recover a lot faster than places like Miami and Las Vegas. A full 30% of all the money invested in the latest real estate spike was spent on condos and other properties that were bought for investments only, not for living in, and most of that money went into a handful of hot markets. Unfortunately, if you live in one of those Metro Markets, you should be looking for ways to trim costs. The past few years have been a great party for you, but now comes the hangover.

A NEW RETAIL FORMAT

If I ever thought about getting into the retail or wholesale flooring business, I’d take a serious look at the pro design showroom category. You sell product, but the installation is handled by the buyer or the buyer’s agent.

Design centers have been popular for years with California builders who wanted to have a single place for their customers to go to for choosing floors and other interior finishes. Then CCA Global Partners came along with ProSource, a franchise that catered strictly to builders and designers. That was followed by Floorco, a similar franchise concept from Alliance Flooring.

Today there are more than 150 ProSource showrooms in North America. Most are 20,000 square foot spaces that show a huge range of products from carpet to stone, and most are located outside major cities. This year, though, ProSource moved into four big cities—Baltimore, Chicago, San Diego and Houston—with smaller 7,000 square foot centers that are more appropriate for high priced metropolitan real estate.

The company plans to open 20 new locations by the end of 2008. The first will open in Bellevue, Washington next month. Other target markets: Miami, D.C., L.A., San Francisco and Orange County, California.

The initial cost for becoming a ProSource owner? $46,450.

MAINTENANCE AND THE GREEN ISSUE

Regular maintenance is not only critical to keeping carpets looking good in high traffic commercial settings, but it also prolongs the carpet’s life, and the longer a carpet lasts, the longer it stays out of a landfill.

With those criteria in mind, the California manufacturer Bentley Prince Street has formed a unique alliance: it made a deal with StarNet to give all its customers access to the big contract dealer group’s nationwide Maintenance Services system. A good move on Bentley Prince Street’s part. StarNet’s top flight dealers are a great asset to any manufacturer.

THE NEXT EVOLUTION?

McKee Floor Covering, the Minneapolis based distributor owned by Tarkett, was recently merged with Kraus Carpets’ Chicago based distributor Royal Scot under the name Kraus Floors LLC. The clever new arrangement merges the two distributors’ sales, service and logistics operations and creates a distribution system that could make the two companies as cost competitive in the Midwest as Shaw and Mohawk. The new company will carry a complete line of Tarkett hard surface flooring and the complete line of Kraus carpet products.

Keep your eyes on this one. Here are two companies that may have found a unique way to compete directly with the floorcovering industry’s juggernauts. It could be the blueprint for future joint ventures.

ANOTHER (EVEN BIGGER) BIG BOX?

Pergo just became the sole supplier of laminate flooring to Sam’s Club Mexico. Even more interesting, next month the big laminate producer will begin testing the waters for selling laminate to all 570 Sam’s Clubs in the U.S.

And if that marketing venture is successful, will we soon see laminate flooring being sold by Sam’s parent company, Wal-Mart? Hmmm.

If you have any comments about this month’s column, you can email me at foneill898@aol.com.

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