Softened office supply market gives Big Three cause for pause - Office Depot, Staples, OfficeMax - Brief Article - Statistical Data Included

DSN Retailing Today, April 2, 2001 by Mike Troy

NAPLES, FLA. -- Uncertainty is the order of the day in today's retail market, and nowhere is this more evident than among office supply superstore operators. Of the leading three chains--Office Depot, Staples and OfficeMax--all have closed stores and adjusted their expansion plans to cope with slower sales and ever-present concerns about how many superstores the North American market can profitably support. Contributing to the uncertainty is a brewing controversy over whether the North American marketplace is saturated and which superstore chain has the winning formula to capitalize on a still-fragmented $260 billion office supplies market.

For years, the Big Three were unanimous in their chest-thumping claims about how many stores the market could support. The number tended to edge higher every year as the three operators' total store count drew closer. Today, there are about 3,000 Staples, Office Depot and OfficeMax stores in the United States and Canada. Some estimates have suggested the market could support 5,000 units, but this seems a stretch given the retailers' recent performance issues and the $1 billion in charges taken during the past three years.

"To say there is not saturation in some markets is just not realistic," Office Depot ceo Bruce Nelson told attendees at a recent Deutsche Banc Alex. Brown conference.

Office Depot, which currently operates 818 stores following the recent closure of 70 units, expects to open 50 new units this year. Ten of those stores will be a new 20,000-sq.-ft. prototype design Nelson hopes will differentiate Office Depot from competitors and produce higher rates of profitability.

"If it does what we think it will do based on early consumer testing, it could be our prototype for the future," Nelson said. "If we can't find some way to be different, we are stuck with just being convenient."

The stores aren't open yet, and the company isn't revealing locations--especially since Staples and OfficeMax have been known to bring busloads of their employees through Office Depot's store near its Delray Beach, Fla., headquarters.

Nelson contends the new stores will make it easier for customers to find merchandise more quickly. This is also the goal of a store renovation plan underway this year. Since complexity increases operating costs, Nelson plans to reduce the number of products found in a typical Office Depot store from 9,000 to 7,000. At the same time, as the remerchandising of the pared-down product assortment is taking place, new lighting and signage will also be installed in stores.

Office Depot is probably in for a rough second quarter as these changes disrupt sales, but in the long term, the company is counting on its North American retail stores to produce the cash needed to fund growth in other areas of its business that produce higher returns. A key area which Nelson has high hopes for is international operations.

"There are more office supplies sold outside the United States. than inside, and one day Office Depot's sales will reflect that mix," Nelson said.

While Nelson suggested saturation has become an issue for North American retail, Staples cfo John Mahoney appeared at the same conference and offered a different perspective.

"Is it saturation or execution that makes the difference?" John Mahoney said when asked about the recent performance woes experienced by Staples' competitors.

Staples' performance suffered last year, but not as much as its competitors. Its fourth quarter same store sales were flat, up only 4% on the year. That was enough to cause the company to change its expansion strategy this year. Staples will open 140 stores, which is still a lot, but not as many as the 166 opened last year. Staples has entered 126 new markets over the past two years, but that will change this year as the focus shifts away from flag planting toward profits.

According to Mahoney, when Staples opens a store in a new market, it generates 25% of a mature store's profitability within one year. However, when a new store is added in an existing market, it achieves 44% of a mature store's profitability within the first year.

"If we get the improvements in North American retail we think are possible, there is a chance we can do better than most people are expecting us to," Mahoney said.

Right now, based on guidance that Staples has given to financial analysts, the company expects to grow profits at a rate of 20% to 25% annually. This is a healthy growth rate, but it is a downward revision from the approximately 30% growth rate Staples had until recently maintained it could achieve. "Even in a weak economy, we think we can hang on to that 20% or so growth rate," Mahoney said. "We still have a very small share and there are a lot of places we can get share."

He didn't offer a lot of specifics, except for an opportunity in the furniture category, one area where Staples has not done well. Mahoney reported that the industry grew at 4% last year, while Staples had negative same store sales. To remedy the situation, Staples is adjusting its mix regionally and adding more high-end products.