What lessons can Australian home improvement retailers glean from the recent experiences of the US home improvement industry?
There have been both strong contrasts and strong resonances between the two national industries during this pandemic year of 2020. What is different is that many areas in the US have been directly affected by the pandemic, with more than 210,000 dying nationwide. In Australia the main effect has come from severe restrictions, aimed at preventing a similar ratio of deaths.
What is very similar, however, is the strong performance of the DIY retail segment, though the US retailers also report a surge in "pro" (tradie) sales as well.
That increase has given rise to the key question the industry faces in both nations: will this surge in sales prove to be a pull-forward of regular annual sales? Or does it represent real, incremental growth, as the pandemic makes customers reconsider the role of their dwellings in their lives?
Speaking to Australian retailers, from Bunnings all the way down to smaller independents, the overall sense is that what we're experiencing is more of a pull-forward than an incremental change. They expect some increase in sales, but they also expect to see a moderation in some of the seasonal summer activities. When Bunnings managing director, Michael Schneider was pressed on this issue during the company's recent full-year results announcement, he noted that paint had been selling well in May, but that people tend not to paint their houses twice in rapid succession.
The view from the US is, however, notably different. The top executives at both the Home Depot and Lowe's Companies see signs of what is almost a generational shift. It's as though the pandemic has kickstarted the Millennial generation's interest in home DIY projects, as well as motivated a broad range of homeowners to make significant changes to their houses.
In looking at the US experience, we have the benefit of both the results for the second quarter (roughly from May to July) for both Lowe's Companies and the Home Depot, as well as a conversation each company recorded at a Goldman Sachs Retail Conference in early September 2020.
Looked at in overview, the two companies are in quite different situations. Lowe's is in a turnaround situation with Marvin Ellison brought in as CEO in May 2018. The situation he inherited included some fraught personnel problems (including the disastrous investment in Woolworths' Masters Home Improvement), and a company that tended to publicly pursue far-fetched technologies (store robots, etc) while not getting the basics of near-field technologies to work, including its ecommerce website which failed under high demand loads.
But, certainly, Mr Ellison is viewed as being motivated. A long-time executive at rival Home Depot, he left after being passed over for the top job there, moving to JC Penney, the struggling US mid-low range department store.
The Home Depot, on the other hand, has made all the right investments in ecommerce and technology, but somehow has not always managed to take best advantage of them. It has performed better than Lowe's overall, but has yet to establish a significant lead. Alongside the well-established CEO Craig Menear, Home Depot has recently moved Ted Decker up to the position of chief operating officer (COO).
Lowe's had a truly outstanding Q2. The company reported USD27.3 billion in sales, an increase of 30.1% over the previous corresponding period (pcp) which was Q2 of 2019. US comp (store-on-store) sales were up 35.1%. In terms of ticket (basket) sales, the USD50 to USD500 range grew by 43.5%, while sales over USD500 and under USD50 both grew by over 20%. Growth in online sales was particularly strong, at 135%, reaching 8% of total revenues.
According to the company's executive vice president for merchandising, Bill Boltz:
We delivered strong growth across all merchandising departments. In fact, all 15 merchandising departments generated positive comps exceeding 20%. As customers continue to spend more time at home this quarter, we saw an acceleration in both indoor and outdoor project activity, including core repair and maintenance, along with projects to repurpose home space for work and study, as well as discretionary indoor and outdoor projects to increase customers' enjoyment of their homes.
Two new services that Lowe's has rolled are JobSIGHT and program to rent tools. JobSIGHT is a video streaming service that enables pro's to conduct virtual onsite visits with customers, enabling them to develop a quote without having to arrange a visit. The company sees tool rental as not only useful to pro's, but also offering the potential of a higher return on capital.
The Home Depot
While Home Depot did not reach quite the percentage growth of Lowe's, it did report some outstanding numbers. Sales reached USD38.1 billion, with comps up by 23.4%, and US-only comps up 25%. Digital sales grew by around 100%, with 60% of orders picked up in store by customers.
According to Mr Decker, speaking at the results announcement:
During the quarter, comp average ticket increased 10.1 percent, and comp transactions increased 12.3 percent. The growth in our comp average ticket was driven by both an increase in basket size, as well as customers trading up to new and innovative items.
During the second quarter, big-ticket comp transactions, or those over USD1,000, were up approximately 16 percent. We saw very strong performance across a number of big-ticket categories like appliances, riding lawn mowers, and patio furniture; however, this strength was partially offset by softer performance in certain indoor, installation-heavy categories like special-order kitchens and countertops.
We saw strong sales growth with both our Pro and DIY customers, with DIY sales growing faster than Pro sales. Sales to our Pro customers accelerated meaningfully compared to the first quarter, and grew double-digits compared to the second quarter of last year. Looking deeper into our Pro sales, we saw notable strength with our smaller Pro customer. As markets continue to reopen, we see increasing demand from all our Pro customer cohorts.
The well-known Goldman Sachs hardlines retail analyst Kate McShane played host to the executives from both US companies during a virtual retail conference on 10 September 2020.
Describing the situation when he first came to Lowe's, Mr Ellison said:
When we arrived [in 2018], Dave Denton [chief financial officer] and I, along with other members of management, it was very obvious that fundamental things that really world class retailers do very well were absent here. You know, things like an efficient supply chain, a robust and dynamic e-commerce platform, having good operational mechanisms to manage labour effectively based on a rate of sale, having efficiency around how we operate to drive productivity.
One of the key changes Mr Ellison brought in was to modernise Lowe's online platform, and that proved to be strong growth driver during the first half of 2020. This has encouraged the company to invest more in omni-channel sooner than initially planned, according to Mr Denton:
So as we think about the next several years, we're pulling forward some of those investments, getting them done more rapidly so that we can come out of this pandemic [with] a better company having better service levels and actually working to capture additional market share in the future.
Asked about the key question, whether DIY spending would prove "sticky" for 2021, or if it was more circumstantial to the pandemic, Mr Ellison responded:
Well, [that spending] remains high. And you don't have to take an overly sophisticated analysis to understand why. I mean, most of us are spending more time in our homes than we probably ever have. And so as you spend more time at home, as a do it yourself customer, you're going to find projects that you are going to invest in to make your home more functional. If you just take a snapshot of the normal American household right now, you have individuals finding ways to repurpose their home. They have to create a workspace because many people are fortunate enough to work from home. They have to create space for their kids in many cases to go to school from home. So they're repurposing space for that.
One pointer towards the spending being maintained, Mr Denton suggested, was the change in the overall pattern of expenditure:
The only other thing I'd add to this is it's not so much the home environment, but if you look at discretionary spending and you look at what's happened, there's been a reallocation of the discretionary spending [that] used to go to restaurants, entertainment, maybe travel. Now for households, the opportunity to do that is limited. So you're seeing a pivot, if you will, to moving discretionary spending more into the home.
One area where Lowe's sees continued growth is in gardening, and particularly cordless outdoor power equipment (OPE). Mr Ellison made much of the exclusive deal that Lowe's has closed with cordless OPE company EGO:
We just announced that we're going to have the number one brand in outdoor power equipment in battery operated. EGO will be exclusive to Lowe's starting in December. We're extremely excited about that because it's going to give us the ability to have in our assortment the number one brand in battery operated push-mowers, riding lawnmowers and all outdoor power equipment exclusive to us.
One of the very interesting outcomes for Lowe's has been that the pandemic has reduced both the desire and the need for promotional activities, helping it to change up its pricing model, as Mr Denton explains:
The environment has enabled us to pull back a little bit from a promotional cadence perspective. Our plan historically was always to move more to an EDLP [everyday low price] platform. The current environment has allowed us to accelerate that movement. So I think we're never going to get back to this high-low environment again. We clearly want to be relevant and be promotional in certain holidays and events. So we're not going to back off completely. But I do think the level of promotions and the quantity of promotions will be modest compared to what it was last year.
The Home Depot
One of the points that Mr Menear made was just how difficult it was to gear up a supply chain to account for an additional USD9 billion of growth over the first half of 2020. That was particularly the case with the company's online business, causing it to repurpose some of its distribution assets, he told Ms McShane:
I think when you think about the tremendous growth in the digital space, having the flexibility to be able to adjust to handle that kind of volume, particularly the volume that we've seeing not only through the stores with BOPIS (buy online, pickup in store), but direct to customer, having the flexibility to adjust and deal with that volume was pretty important as well.
We did that by shifting a fulfilment centre that we had opened in the Chicago area that was going to be a market delivery centre and in a matter a couple of weeks, we converted that temporarily to a direct fulfilment centre shipping product direct to customers from our dotcom business so that we could support the triple digit growth.
Asked about the growth in DIY, and if this is sustainable, Mr Menear's answer was similar to that of Mr Ellison:
I think I'd start with the pro customer is always an important customer at the Home Depot, but we never lose sight of the fact that we have a USD60 billion DIY business that has been pretty important to the company for its 41 year existence. And so we're excited about seeing the engagement of the DIY customer in our space. And, you know, over the years I've been asked a lot about what this ... looks like long term at the Home Depot with all this focus on the pro customer. And my answer to that always is that, today we have kind of a 55/45 DIY mix. And at the end of the day, if we end up with an 80/20 pro, we haven't really done our job because we want to grow the DIY business at the same time we're growing the pro business...
So we're super excited to see the engagement from the DIY customer. I think that customer has spent a lot of time around their home. They see a lot of things that they want to do. And at the same time, there's more wear and tear in the home. Our customers tell us from surveys that home is never more important than it is today.
Mr Decker followed up that answer by outlining how digital is changing the way the company sees the DIY customer:
There's so many good things going on in our segment with the DIY customer engaging. You've heard us talk a lot about pro over the years and the things we're doing with pro customers. Craig just said DIY is the hallmark of the company and still [represents] the majority of sales. We need to keep that business growing. And the engagement we're seeing with DIY customers and with the engagement with interconnected and digital, it's allowing us to know that customer better than we have in the past.
The DIY customer, had traditionally been sort of a "mass anonymous". But with the advent of interconnected and digital, we have a lot more signals now that we can start to know the consumer customer to a much greater extent ... As we build out abilities to track engagement, we like to see new customers, we like to see what customers talk about, are they shopping one aisle over, are they shopping two aisles over? Are they engaged in projects? How many items per basket per transaction are they purchasing with Home Depot?
The information Home Depot is able to track has convinced Mr Decker about one thing: the Millennial generation is on track to follow a similar pattern the Baby-Boomers when it comes to DIY - albeit at a comparatively older age.
As you can imagine, as people start to engage with more capabilities, as they start to shop one and two aisles over, as they start to gain the same confidence of the newer DIYer, [we see] the millennials launched on their journey. We're starting to see that same behaviour as the baby boomer back 30 and 40 years ago. And as they engage their spend and share of wallet goes up with the Home Depot.
Later, when asked whether the changing demographic patterns in the US, particularly urban vs suburban was having a material effect on Home Depot's strategy, Mr Menear picked up this theme related to the Millennials.
You know, it's interesting because there's a lot of talk and a lot of dynamics, and it takes me back to 2015 and earlier when there was a lot of conversation around the fact that, you know, the whole Millennial generation, everybody is going to move to inner cities and the Millennials are never going to own anything, they were only going to rent. They would never have a car. They would never have a tool. You know, that's what we heard through all of this. And our deep research in 2015, indicated that that none of that was actually factual based on the research that we had with the millennial generation, and that they would, in fact, act the same way other generations had. It was just a delayed cycle.
And we're actually seeing that play out, by the way. So as the Millennial generation got married, kids come along, you need more space, they moved from the city centre to a more suburban environment.
Home Depot has long been known for its approach to innovation, and both Mr Menear and Mr Decker helped to spell out what that means in the current era. Mr Menear boiled down what the core purpose of innovation needed to be for the retailer:
So when you think about innovation and what the merchants are focused on at Home Depot, it is: how do you bring product to market that makes it easier for the consumer to be able to do a project? And/or how do you bring product to market that allows the pro to be more efficient and gives them confidence and no call backs? And that innovation is hugely important in the business.
Following on from Mr Menear, the statement that Mr Decker made about innovation was seeming simple, but very interesting:
So in product, authority is what we stand for in merchandising at Home Depot. Innovation is the hallmark of that.
Mr Decker went on to describe the new innovations coming in areas such as cordless OPE, and then - in that half-embarrassed way familiar to everyone in hardware - described one of the exciting innovations that had come to Home Depot in grout.
We just - I mean, something you might not get that excited about, but we do at Home Depot. We just reset our entire grout bay, and we have an exclusive relationship with Custom Building Products, which has by far the largest share in the category. And they've just come up with an incredible array of floor levellers, large format tile, quick adhesion, grouts that are ANCI approved for dust emissions, which is required for nursing homes and hospitals, premixed grout for either a quick job for a DIYer or making a job easier for a pro. We have colour consistency, all the great values. So we just finished resetting our entire grout in the tile set material bay over the last several weeks. The performance is incredible.
One of the most interesting comments that Mr Menear had to make, however, was about the independent hardware retailers in the US.
We've shared in the past that when you aggregate up independents in pretty much any category that we play in, they own the lion's share of the market. And so that's always an opportunity and part of what we're investing in to create this interconnected experience, hopefully will give us an edge to be able to gain share and grow faster than the market.
Second comment that I'd have is, look, when you when you look at independents and independents that came through in the 2008, 2009, 2010. Right. Those are really good business operators, people that survive that environment, people that will survive this Covid environment are really good operators that have to gain a lot of respect for. And so there's always going to be independents and competition. But we're investing to position the Home Depot to grow faster than the market in any environment that we get thrown into, whether it's good or whether it's bad. And that's really what we're trying to get done.
Asked about promotional events, the Home Depot executives agreed with what the Lowe's executives had said in terms of promotions. But Mr Decker added a further comment, about the responsibilities of the retailer during the pandemic:
The other thing we're doing is we're expanding the timeframe. So you think of a Black Friday, while we're not as big a Black Friday player as some other retailers, we've built up quite an amount of business and foot traffic and excitement around Black Friday. We'll try to limit that single day focus, and you'll see us having that product in those values over a much longer period of time.
There'll be a few things that we do on Black Friday, but things like you having to come to the store during this specific period of time, with very short quantities. We just think today that that might not be as responsible from a safety perspective as it could be.
So we'll still have events. We'll still have great innovative product. We'll still have great values. They'll just be shown over a longer period of time. And be an opportunity to really leverage our interconnected experience. So all these are available online as well for ship to home or buy online and pick up in store. So we'll have events just slightly different going forward.
Another very interesting bit of real retail wisdom was offered by Mr Menear when he was asked about the retailer's plans for the holiday (Christmas and Hanukkah) season.
One of the learnings we've had over the years from storm situations - in the earlier days, we used to think about a storm hitting a particular area that we would go in and extract holiday decor from those markets, thinking that for those customers that's not where their mindset was going to be. And what we learned over the years is actually where they're headed is they want some form of normalcy in their life. And so they actually focus in that area.
So we didn't really pull back our thought process around the events in Q4 as it relates to holiday, because we suspected that the customer would react in the same way that they do in a storm situation and that they'd want that kind of normalcy overall.
Asked about how Home Depot continued to improve its offer for the pro market, Mr Decker mentioned the move the company is making into deliveries from flatbed trucks.
We're really excited about the capabilities that we are building out around delivery for our pro customer and particularly in the flatbed network that will allow us to deliver big and bulky type products for them.
That will also take pressure off of our stores. If you walked our stores any morning at six o'clock, you'd see lots of deliveries lined up in the aisles of the store, which isn't great for the pros that are actually shopping in those aisles during that morning. The flatbed delivery network that we're building out will give us the capability to remove that pressure from the stores to be much more efficient and be able to open up capacity for delivery and begin to narrow down windows to get to specific time slots for our pros. That's the work that we're doing over time. So we're super excited about that. We've got a couple of these facilities up and running and there will be more coming towards the latter part of this year. Plus expansion in the next year.
Overall, the attitude of the two biggest home improvement retailers in the US is broadly similar: they remain hopeful that the upsurge in DIY sales will prove to be something of a structural change, and they see their pro businesses hopefully continuing to thrive.
However, neither retailer is counting on DIY sales as their sole source of growth. Both realise that they need to improve certain fundamentals, and both see opportunities in introducing new products and services, and, most importantly, better embracing digital opportunities.
Yet, as good as their plans are, one has to wonder if they are good enough. Looming in the background of these results are those for Amazon in the same quarter: A sales increase of nearly 50%, and revenue of USD90 billion for the quarter, more than the two companies combined.
While it is tempting to see this in terms of digital versus physical stores, it's possible there is a more serious pattern at work here. The level of innovation in home improvement, by current standards, is good, but it's really not great. To get where it is today, Amazon had to do more than just make the best use of available innovations on the market, it had to go out and innovate itself.
Take, for example, the Kindle book reader. Amazon couldn't wait for another company to develop that reader for two, interconnected reasons. The first was that the problem with book readers wasn't really the hardware that reads books, it was the software, the actual books themselves, which Amazon was uniquely positioned to provide.
The second was that no one was going to innovate a book reader for Amazon. That is because its business model called for the reader, at least the most basic model, to be as cheap as possible, with next to no margin.
The same thing held true - only more so - for Amazon's range of Echo personal assistant devices. The real value of those to Amazon wasn't the device itself, but the way in which it further integrated the user into Amazon's shopping systems.
In a different form we've seen the same thing take place at Microsoft. Pretty much the last thing Microsoft wanted to do was to get into making actual laptops, tablets and desktop computers. Yet it had to, because, for a time, laptop manufacturers had ceased to be competitive with Apple.
What has happened in each of these cases is that one part of the manufacturer-to-consumer supply chain begins to capture way more of the real value of a product than any of the other participants.
There is a real danger that hardware-home improvement retail, especially where larger retailers are dominant, is heading in that direction. This applies especially to the DIY part of the business. There has been some innovation at the trade end of the business, but innovation in DIY has slowed dramatically over the past decade. Retailers have become more powerful than manufacturers in that area and they always demand the same things: low prices, good margins, and familiar tools that are easy to sell to familiar customers.
The truth likely is that the burst of DIY activity is, for the moment, neither a temporary phenomenon or a structural change. It's really going to depend on what retailers offer DIYers, and if it is not really innovative and engaging, then this opportunity well end up being squandered - until Amazon or another tech company gets serious about the category.