by Meridith Levinson

Home Improvement

Aug 01, 200419 mins
Data Center

Home Depot is betting its $1 billion investment in IT infrastrucutre will boost growth and earnings, while fending off rival Lowe's. Can a strategy designed to improve efficiency also increase customer satisfaction?

Bernie Marcus and Arthur Blank tapped into America’s love for size, choice and bargains when they envisioned a chain of retail warehouses stacked floor to ceiling with everything and anything a builder or homeowner could want or need. In 1978, The Home Depot was born. At last, men could experience the same sense of wonder that overcomes kids let loose in Toys “R” Us.

With its then-unusual, big-box format and its knowledgeable, helpful clerks clad in construction-sign-orange aprons, Home Depot rapidly became an icon of American culture alongside Harley-Davidson, Coca-Cola and Ford.

It also became an icon of American business. By 1986, with 60 stores and 6,600 employees, Home Depot reached a billion dollars in sales. From then until 2000, revenue nearly doubled every two to three years. The company’s success coincided with the increasing suburbanization of middle-class America, the nesting of the baby boomers, the real estate boom of the 1980s and the popularity of the TV sitcom Home Improvement. Home Depot was the right idea arriving at the right time. In 1989, it surpassed the then-37-year-old Lowe’s as America’s number-one home improvement retailer. Today, the company is America’s second largest retailer (trailing only Wal-Mart) and the biggest home improvement chain in the world, with $64.8 billion in revenue and 11 percent of the vaguely defined U.S. home improvement market. The company opens a new store somewhere almost every other day.

Battle Of The Titans

Home Depot VS Lowe’s
1,635 Number of stores 952
50 Number of states 45
22 million Customers per week 10 million
40,000+ Products carried 40,000+
299,000 Employees 147,000
$64.8 billion 2003 revenue $30.8 billion
$342 million 2003 IT spending $275 million
$300 million 2004 IT spending $300 million
$80.7 billion Market Capitalization* $41.7 billion
T1 lines with an ATM backbone Network Frame relay network with back-up provided by a satellite-based WAN
Sources: HOME DEPOT AND LOWE’s *AS OF JUNE 22, 2004

What helped fuel Home Depot’s dizzying growth (besides a historic economic boom) was a decentralized business model that made store regional and division managers responsible for the mix and quantity of the products on their shelves. Marcus and Blank believed that the people closest to the customer ought to be making those critical choices, not the muckety-mucks at headquarters.

IT also played a significant role. Home Depot relied heavily on homegrown systems. By building its own applications, it didn’t get bogged down in customizing off-the-shelf software and didn’t invest time and money in endless enterprisewide implementations. In addition, a standard database design and an application architecture that reused software components allowed the IT staff to develop applications, such as the company’s mobile ordering system (a cart equipped with a computer and printer that clerks could wheel around the store to reorder products and change prices), lickety-split.

But the glory days didn’t last. As the millennial malaise set in across the country, Home Depot faltered. The entrepreneurial strategies of the ’80s and ’90s suddenly began to look old-fashioned. With more than 1,000 stores in the United States, Canada, Puerto Rico and South America, local-level decision making had led to a hodgepodge of store layouts, confusing customers who shopped at different Home Depots and wanted to find the same product in the same place in each store. The systems on which Home Depot prided itself became too costly for the chain to support because they required so much elbow grease to change. Even the warehouse format that was so closely tied to Home Depot’s identity was showing wear and tear. As Lowe’s, Target, Wal-Mart and warehouse clubs added stores, Home Depot became just another big box on the increasingly homogenized American retail landscape. The thrill was gone.

When Robert Nardelli took over as CEO in December 2000, he made some dramatic changes—including the centralization of merchandising, store planning and marketing—that shook up the company. Home Depot also faced increased competition from its closest rival, Lowe’s, which was aggressively expanding. At a time when Home Depot should have been prospering (with mortgage rates reaching historic lows), at a time when consumers—scarred by the 9/11 attacks—were spending more time at home, the company went into a tailspin. For 10 straight quarters, from the second quarter of fiscal 2001 through the third quarter of fiscal 2003, same store sales and net earnings growth paled in comparison with Lowe’s. Home Depot’s stock dropped from $67 in December 1999 to $20 in January 2003. And Lowe’s customer satisfaction ratings from the American Customer Satisfaction Index were higher than Home Depot’s for both 2002 and 2003.

Something had to be done.

The question was, what?

Home Depot’s answer was infrastructure, infrastructure and more infrastructure.

A Billion-Dollar Bet on IT Infrastructure

Now more than 25 years old, Home Depot is going through a late adolescence. CEO Nardelli and CIO Bob DeRodes, who joined the company in February 2002, assert that the company has outgrown its homegrown systems, that the IT that got it to its first $50 billion won’t get it to its next; new technology is needed to support the company’s expansion improve store operations and customer service (not to mention compete with Lowe’s, the bogeyman across the street). To that end, Home Depot in 2002 announced an almost $1 billion overhaul of its IT infrastructure. The move is part of a massive, $7.7 billion modernization effort that includes remodeling existing stores and opening new ones. The transformation involves replacement of its more than 10-year-old point of sale (POS) system, including the installation of self-checkout counters (completed in 2003); a LAN upgrade; an IBM data warehouse for sales and labor management, which was launched in late 2002; price optimization software from ProfitLogic; SAP financials (went live in the end of May 2004); PeopleSoft ERP (went live in February 2004); two-way cordless scan guns (rolled out in April 2004); and other new applications designed to streamline price check and receipt lookup services.

The I.T. that got home depot to its first $50 billion won’t get it to its next, say CEO Robert Nardelli and CIO Bob DeRodes.

While Wall Street largely has applauded Home Depot’s IT initiatives (along with its recent sales and earnings growth), not everyone is convinced that it’s out of the woods. In her February assessment of the company, Barbara Allen, an equity analyst with broker-dealer Natexis Bleichroeder, wrote, “We remain concerned about execution risk and competitive pressures during Depot’s dramatic internal changes.” She warned investors not to get too excited about Home Depot’s recent comparable store sales growth, which was an important factor influencing analysts from Buckingham Research and Smith Barney to give Home Depot strong buy ratings. Allen noted that the fourth quarter fiscal 2003 growth figures were flashy only when compared to the previous year’s dismal results.

And George Whalin, president of Retail Management Consultants, doesn’t accept Home Depot’s assertion that all this technology will improve customer service. In his view, the company is using technology to eliminate workers and cut labor costs, thereby improving profit margins. “Home Depot built their reputation, they built their business, on a customer being able to talk to a plumber or an electrician or someone who could answer questions for them,” says Whalin. “That’s not the case today. They’re running these stores with fewer people than they’ve ever run them with.” (In fact, based on a review of the company’s annual reports, Home Depot went from 200 associates per store in 2000 to 175 associates per store in 2003.) Indeed, CIO DeRodes says that with the new self-checkout lanes, “One person can effectively clear four lanes much more efficiently, and that reflects in the cost of business.”

It’s a retailing truism: Strategies that improve the bottom line and inspire investor confidence don’t always make customers happy.

Ultimately, says Whalin, “their ability to distinguish their stores [from their competitors] is going to be badly damaged the more they go to this model of more technology and little in the way of service.”

It’s a retailing truism: Strategies that improve the bottom line and inspire investor confidence don’t always make customers happy.

Fixing the Crunch at the Registers

Self-checkout stations were installed in 2003 in over 800 stores to improve customer service by (theoretically) shortening lines and wait times, and getting employees who would otherwise be working registers onto the sales floor. That line-shortening strategy doesn’t appear to be working here at store #2669 in Natick, Mass., which is mobbed on a warm Saturday in spring, the home improvement retailers’ Christmas season. In the outdoor garden center, lines nine customers deep form at the two open checkout lanes; people pushing flatbed shopping carts stacked with bags of mulch and potting soil can barely squeeze past each other in the narrow aisles; a male customer helps a woman load some of those heavy bags of soil onto her cart because Home Depot employees are too busy.

Inside the store, only four out of 10 cash registers are open; one of the four self-checkouts is out of service. The lines are long. The store, in its busiest season, seems understaffed.

Still, self-checkout has reduced wait time by one-third across Home Depot stores, according to the company. John Simley, a former spokesman for Home Depot, says opening registers is an inefficient use of labor and argues that it can take 10 minutes to open one up.

“If we hired every electrician in the United States, we wouldn’t have enough people to staff our electrical departments,” says Home Depot CIO Bob DeRodes. “That’s how big we are.”

To address the staffing issue before the lines start to form, Home Depot in 2002 launched a 48 terabyte IBM DB2 data warehouse that runs on new Regatta p690 servers and contains three years of sales history. The warehouse is intended to take the guesswork out of labor scheduling as well as inventory planning. Lowe’s has had a Teradata warehouse with that functionality since 2000. Steven Baumgarten, a research analyst with Parker/Hunter, says not having such a warehouse put Home Depot at a competitive disadvantage.

DeRodes says that while the company has improved its ability to mark down merchandise and manage its margins, he couldn’t quantify the data warehouse’s ROI. “It’s hard to say the new merchandising approach added this percent and the technology added that percent [to the bottom line]. We don’t make ourselves crazy [determining those numbers] as long as we’re making the right progress. Our numbers are all moving in the right direction as a company, so we know these tools are helping,” he says.

DeRodes also replaced Home Depot’s ancient green-screen POS system with color, touch-screen, Web-based POS terminals from NCR to move customers through checkout more quickly. The upgrade of the company’s five highly customized POS systems to the NCR terminals cost tens of millions of dollars, according to DeRodes. He says the new registers have decreased the average time it takes a customer to check out from 6.7 minutes to 4.9 minutes.

“This system will give us better metrics on cashier performance,” says DeRodes. “That’s important because we want to train cashiers who aren’t performing as well.” By using analytical software to study the number of items in each customer’s purchase, the type of items (are they heavy and cumbersome such as lumber or bags of cement?), and the time it takes the cashier to process the order, the company can identify if an individual cashier is unusually slow and needs more training on the register.

A Project Portfolio to Speed Customers on Their Way

Store #121 sits diagonally across the street from Home Depot’s Atlanta headquarters. This is where the company is piloting a bunch of new applications collectively known as FAST (front-end accuracy and service transformation) intended to improve cashier accuracy and enhance customer service. The other purpose of the FAST projects, according to John Beasley, Home Depot’s former director of operations strategy, is to close or even leapfrog the technology gap between Home Depot and other retailers like Wal-Mart and Target. Two FAST applications that will be rolled out to stores this year are an electronic product catalog, called Online UPC, and an online receipt lookup service that will be in stores this month.

Online UPC. This is essentially an electronic catalog of products that don’t have bar codes on them—such as nuts and bolts, bales of hay and drywall—and therefore can’t be scanned at the POS. The application runs on the POS system and is intended to replace three-ring binders filled with pictures of products, their bar codes and stock-keeping unit (SKU) numbers that every cashier has at his register. Online UPC will make determining prices on unmarked items easier for cashiers. Beasley says that while only about 3 percent of transactions require the electronic catalog, the application will save 23 seconds of customer wait time per product over the binder—not an inconsiderable amount of time when one imagines a customer twiddling her thumbs while a cashier runs a price check.

Online receipt lookup. This lets customers who’ve paid for merchandise using a credit card, debit card or check return an item even if they’ve lost or forgotten their receipt. When the customer’s card is swiped, or his checking account number entered into the POS, the application searches through 90 days of transactions to find an electronic copy of the customer’s receipt. This should also help the company cut down on fraudulent returns, which cost the retail industry millions each year.

Wireless scan guns. The company is in the process of replacing its corded scan guns with wireless ones that cashiers can use to ring up merchandise and that workers on the floor can use to check inventory. Although some supermarket chains and wholesale clubs such as Albertsons, B.J.’s and Sam’s use cordless guns already, what makes Home Depot’s unique is their two-way communication feature. For example, when a cashier scans the UPC for a barbecue grill at the checkout, the gun transmits the SKU number to the point of sale system. Using business rules, the POS identifies the product and whether it requires assembly, and sends a message back to a small screen on the gun prompting the cashier to ask the customer whether they want Home Depot to assemble the grill for them for an additional charge. (DeRodes says he doesn’t yet have numbers on the amount of money Home Depot has made through cross-selling opportunities identified by the gun, but says the scanner has paid for itself on the basis of checkout accuracy alone.) The maintenance costs for the wireless guns will also be lower than they were for the corded guns, according to Ray Allen, Home Depot’s former director of store systems, who worked on the FAST projects with Beasley.

Web-based kiosks. One of the more gee-whiz technologies the company rolled out in mid-2003 is its color solutions centers. These Web-based kiosks in the paint department help customers color-coordinate the rooms they’re decorating. The kiosks contain a computer, a touch-screen monitor and a lens used to scan fabric, upholstery, rug or wallpaper swatches. Following prompts on the screen, a customer holds a swatch against the lens, and then the computer prints out a selection of matching paint colors. The customer can have Home Depot mix paints according to the colors on the printout. DeRodes says it’s difficult to pinpoint how much sales of the company’s Behr brand of paint are driven by the kiosks, but he says that customers tell Home Depot that the kiosk plays a positive role in their shopping experience.

E-Learning. “If we hired every certified electrician in the United States, we wouldn’t have enough people to staff our electrical departments,” says DeRodes. “That’s how big we are. When you get to this scale, you can’t rely on the retired electrician to stand in the aisle. We have to train the people.” To that end, Home Depot rolled out Web-based training courses for its 299,000 store employees in 2003 and delivered 23 million hours of Web-based training last year. The e-learning courses are delivered via dedicated PCs located in stores. They cover everything from basic sales and customer service skills to specialized product and brand knowledge. DeRodes maintains e-learning is “paying tremendous dividends in terms of higher customer satisfaction numbers.”

While Home Depot under Nardelli and DeRodes seems to be distancing itself from its past by saying the old infrastructure won’t support the company’s new business and expansion plans and that the IT needs to be replaced. In fact, a lot of what they’re doing—including the kiosks, the wireless scan guns and the mobile ordering system—continues plans conceived by Ron Griffin, DeRodes’ predecessor.

A New IT Strategy to Meet the Competition

Because individual Home Depots were responsible for keeping track of which products sold or did not sell, as well as determining how to attract and retain customers, the company needed systems throughout the ’80s and ’90s to help managers make these decisions. To that end, and to support the company’s expansion, former CIO Griffin introduced in the early 1990s a corporate data model and an application architecture based on a set of reusable software components. The components represented different kinds of commands or functionalities, such as inventory checks and price changes, that could be plugged into new applications. This component-based application architecture allowed the IT department to create applications quickly, without having to rewrite a lot of code.

Michael Starr, who is CIO of software provider Agilisys and former senior manager of application development at Home Depot, says Home Depot always felt that its business and operations were so unique that no packaged application could provide the stores with what they needed without huge, expensive, drawn-out customizations. But as the company grew, building systems in-house became less cost-effective. As Home Depot saturated markets with stores, sales growth at individual stores began to slow. As a result, says a former Home Depot vice president, the amount of technology and manpower that Home Depot could afford diminished. “You started to see a need for a less costly organizational and systems infrastructure,” he says.

Accordingly, Griffin began embracing a strategy that relied more on packaged applications. In 1999, he announced that Home Depot would implement SAP financials in South America and later in the United States and Canada to replace its aging financial system. When Nardelli took over as CEO in December 2000, the move to packaged applications became even more pronounced. Griffin (who, citing nondisclosure agreements, declined to be interviewed for this story) announced in November 2001 that he’d leave the company by the first of the new year, and many of the projects he’d announced, such as the North American SAP implementation, in-store kiosks and wireless scan guns, were postponed until Nardelli found a successor. When DeRodes took over IT in early 2002, he had Nardelli’s blessing to do whatever was needed to get the company back on track, and Home Depot’s IT department started to change. Former Director of Store Systems Allen says the IT department under Griffin was less strategic and more reactive to store needs. He says this was a result of being constrained by the company’s infrastructure and its freewheeling operations.

Former Director of Operations Strategy Beasley says, “I think the current group in IT is both more willing to tackle big transformational change and moving more to partner much better with the business.”

High-Tech Vs. High-Touch

Along with the IT group, the notion of what constitutes good service has also changed. For years, good service at Home Depot meant high-touch service—employees interacting with customers. Now it means self-service. In the old days (as Home Depot employees refer to the pre-Nardelli days), if a customer entered a store and wanted to know where to find drain pipe fittings, an employee would walk him to the aisle and shelf. This is part of the reason why Home Depot had few signs in its stores, says Simley. But Nardelli decreed that a thousand signs should bloom. Better signs, he believed, would be a cheap, non-labor-intensive way for the company to move customers in and out quickly and to make those cavernous spaces seem less bewildering, especially for the female customer who Home Depot was trying to attract in response to Lowe’s successful appeal to women.

Today, Ray Allen says Home Depot gets high marks if customers can find things on their own (thanks to signs) and scan them on their own (thanks to self-checkout), without having to interact with a salesperson. “Service used to mean whether I can get an associate to help me. Now service means I can do it myself,” he says.

But is self-service the same thing as good service? Retail Management Consultants’ Whalin begs to differ. If Home Depot’s goal is to get customers in and out of their stores without ever having to speak with a clerk, says Whalin, “then Lowe’s is going to continue to hand them their head.”

With the possible exception of the two-way wireless scan guns that allow employees to cross-sell merchandise to customers, the technologies Home Depot is installing in its stores are not high on the personal touch. Lowe’s is currently trying to differentiate itself from Home Depot on high touch. A big sign above the entrance to the Lowe’s store in Saratoga Springs, N.Y., reads, “Lots of stuff by yourself? We’ll load it.” Another sign reads: “More than three in line? We’ll open another checkout.”

Which is not to suggest that Lowe’s isn’t increasingly using technology as well. At an investor conference in September 2003, Lowe’s announced it would begin installing self-checkout this year. And during 2003, Lowe’s created an electronic product catalog and links to its vendors through EDI interfaces. By automating the order taking process, the company says it has reduced errors and the length of time customers have to wait to receive their orders.

Striking the Right Balance

The surest way for Home Depot to improve its earnings growth, market share and stock price is to move more products more quickly through more stores with fewer associates and lower overhead than in the past. The ability to do that hinges on increased efficiency—but also a better shopping experience for customers. Better store layouts, more signs and brighter lighting will help, and technology can too. While Home Depot is using more packaged software, the IT department still does plenty of application development in house, particularly for customer-facing technologies like Online UPC and receipt lookup. “Every time we help a customer, satisfaction goes up and so do sales,” says DeRodes.

Conversely, every time a customer even thinks he or she needs to talk to a knowledgeable person and can’t find one, satisfaction plummets. The most critical thing Home Depot needs to get right is to drive efficiency while enhancing the customer experience—and these two things don’t always go together. With Lowe’s hot on its heels, Home Depot’s home improvement effort has got to be a home run.