Home Depot

Topics: Financial ratios, Cash flow, Balance sheet Pages: 7 (2275 words) Published: October 27, 2012


Home Depot’s Business Strategy
Home Depot's target market is individual homeowners/small contractors. Even though the traditional ideology is that cost leadership and product differentiation business strategies are mutually exclusive, Home Depot was successful at using a combination strategy. First, Home Depot optimized the cost leadership strategy by offering low and competitive prices to its customers by emphasizing higher sales volumes with lower margins, while instituting a high inventory turnover. Home Depot successfully offered a warehouse product strategy to the individual consumer for the first time. Previously, this type of price discounting was only available to professional contractors who earned product price discounts due to large quantities of raw material purchases. Secondly, Home Depot utilized the product differentiation strategy by promoting quality products in its merchandise inventory, as well as, championing excellent customer sales assistance. The company boasted a 90% full time employee utilization, which allowed the company to properly train these employees in technical matters. Customers were able to buy products that were cheap, while under the guidance of knowledgeable Home Depot staff. This allowed Home Depot to employ both the cost leadership and product differentiation strategies. Home Depot will be able to maintain this combination strategy in the long run, since these two strategies do not complete with one another in normal business operations. Training employees will not cause product margins to increase dramatically. Since the company launched this dual business strategy at the onset of its business life cycle, the company has already factored in the cost of training/retaining quality employees in its product margins. Therefore, the company is fully prepared to absorb the cost of this employee quality, while maintaining low product prices to offer to its customers. Home Depot – Key Ratios (1983-1985)

Home Depot suffered a drop in ROE from 18% to 9%, between 1984 and 1985. However, Gross Margin held steady year over year for the 1983-1985 periods. This is a significant accomplishment, since the push for rapid expansion in 1985 was hypothesized to erode short term profit margins. However, the expense category, pre-opening expenses, increased dramatically year over year, almost doubling in 1985, due to this expansion strategy. The decrease in ROE was mainly attributable to a significant increase in leverage from 1984 to 1985. This was due to higher debt borrowings to provide cash flows needed for new store openings. Home Depot supported its expansion plan with cash generated through operations and borrowing debt. Even though the Home Depot took an advantage of a lower tax rate in 1985, its rate of interest expenses was more than half of that its 1984 rate, and thirty five times more than the rate in 1983. Overall, Home Depot’s net earnings in 1985 was much lower than the prior two years, primarily due to its debt obligations.

Although Days’ Receivables increased from 7.9 to 11.2 days in 1984 to 1985, respectively, this customer collectability is still quite healthy considering most businesses operate on a Net 30 day receivables plan. However, Home Depot should be cautious and closely monitor the 11.01 days increase of the Days’ Inventories ratio, since this indicates that the company is having issues with its Inventory Turnover management, which is one of its prized business operating strategies, as described in Question #1.

Sales per Square Feet steadily declined during the 1983-1985 periods. The company should verify whether this was due to increased competition or cannibalization from new store openings. The most likely answer is that the erosion was due to new store openings, since the Sales per Store ratio steadily increased during the same period.

Home Depot vs. Hechinger Co.

Hechinger’s ROE analysis had four drivers:

1. Profit before taxes/sales...
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