Office Depot: Fall From Grace
01 March 2008
Fall from grace
by Heike DieckmannIt's been tough for Office Depot of late. And with all its divisions under fire for one reason or another, CEO Steve Odland is battling to keep the company on an even keel.
It never rains, but it pours. And for Office Depot, it has been nothing short of torrential over the past year or so.
A quick glance at Depot's share price is enough to set alarm bells ringing: $38.09 on the first day of trading in 2007, compared to a 52-week low of $11.54 in mid-January this year, and a slightly recovered $13.98 at the time of going to press. At its worst, that's a share price drop of almost 70 percent in just a year. The last time Depot's stock moved in that region was in 2003 - the year of the infamous Guilbert acquisition in Europe.
It's a far cry from that day in May 2006 when Depot's share price reached the giddy heights of $44.66 under the leadership of CEO Steve Odland. The honeymoon for Odland is long over, and indeed has turned into a nightmare that shows no signs of ending anytime soon.
Following the delayed release of its unimpressive Q3 results in November of last year after the highly publicised and embarrassing audit enquiry into its vendor programmes, Depot's expectations for Q4 and beyond are not looking very hopeful either. It expects slower sales, continued margin decline, lower vendor programme support and decreased EPS.
Part of Depot's difficulties, certainly in its North American Retail division, can be attributed to the slowing US economy. Much has been blamed on the state of the housing market in the US and its effect on the retail sector. It's a valid argument, if both analysts and senior executives within the industry are to be believed, but its importance should not be overstated.
Goldman Sachs analyst Matt Fassler says: "The US economy is clearly slowing and the OP sector has been feeling it for two to three quarters now. Office Depot has been caught in that trend. That said, while the derivative impact of the housing market on an OP superstore would be noticeable, it should not be inordinate."
He points to other reasons why Depot is underperforming compared to its rivals: "Office Depot has a good deal of exposure in the softer US markets, mostly Florida and California [author's note: where about 20 percent of its US stores are based]. Also, and this is a company-specific issue, Depot has a more diverse chain of stores than Staples or OfficeMax with a number of different prototypes in terms of size and layout. This has made life a little harder for the company."
Macro impact
Staples and 'Max on the OP side as well as other broadline retailers have also been feeling the pinch, albeit on a different scale. But analyst Dan Binder from investment firm Jefferies & Co warns against overstating the macro factor and advises instead to also look at company specifics.
He says: "Over the last couple of years, Depot's pricing strategy has become less sharp versus the competition. Also, its private label penetration has perhaps moved up a bit quicker than it should have. Combine that with a big focus on technology hardware at a time when consumer spending is slowing and technology hardware sales are slowing, and it's come back to hurt the company."
In a Securities and Exchange Commission (SEC) report filed on 18 December, Depot outlined a seven-point action plan for its North American Retail division. This, interestingly, includes further expansion of its private label brand, higher store productivity, better marketing programmes, plus a number of initiatives that aim to attract small business customers that typically go down the retail rather than the delivery route.
The short-term outlook remains gloomy, however. Depot maintains a conservative outlook for its Q4 as well as the first half of 2008 and predicts flat sales. However, it is hoping to deliver improved sales and margins with the aforementioned action plan later on in the year. Analysts meanwhile forecast comp sales to be down by seven percent in Q4, compared to minus five percent in Q3.
Nobody disputes that macro factors have had a hand in Depot's retail performance, but the picture looks somewhat different on the delivery side, where company-specific issues appear to be more prevalent. The most recent blow for Office Depot came in mid-February when the state of Georgia decided to end its office supplies contract with Office Depot, ending the protracted state of Georgia saga that had been going on for several months.
Depot has long been an avid pursuer of high revenue General Services Administration (GSA) contracts like the one with the state of Georgia and has received much press coverage and also criticism - notably from the independent community - for its campaigns in that area. Its deals with the states of Florida and California are also under the microscope at present.
That said, as far as the company's current performance of its Business Services Division (BSD) is concerned, Depot has been chiefly blaming slow growth in its small business customer segment. The general perception is that, on the contract side, the big boxes have little penetration in the small to mid-market, with independent dealers - and Staples as the exception - taking the bulk of this business.
Office Depot's vice president of corporate communications Brian Levine begs to differ, saying that the company is a significant player in the small and mid-sized market. He attributes slow growth in that customer sector to the underperforming results. "In terms of Depot's Business Services Division, total Q3 sales were $1.2 billion and while the company grew double digits in the large contract and public sector business in Q3, sales to small businesses were not as strong as we had hoped."
The slowdown in small customer spending is undoubtedly an industry-wide phenomenon, but for Depot there is a whole different dimension to be taken into account in the overall context.
The crucial factor here is called 'Viking'. Historically part of Depot's contract division, when the company decided to drop the Viking brand, merge operations and consolidate the catalogue with that of Office Depot, the results were disastrous. Indeed, Depot's decision to drop the Viking brand, first in the US and then in Europe, is widely regarded as a grave mistake (see also 'Viking: End of an era').
As one seasoned reseller puts it: "Dropping the Viking brand in the US is one of the most insane examples of bad strategy in the history of our industry. Office Depot took a business with enormous brand equity and destroyed that brand because of cost-cutting - and ended up losing everything.
"Domestically in the US, Depot only retained a small portion of its customers when it consolidated the Viking brand into the Depot catalogues. Viking customers did not want to be dictated to go to Office Depot."
Depot is unlikely to agree with that statement. Abolishing the Viking brand was one of the first big cost-cutting moves under Odland's rein, and while it clearly made sense from a financial point of view, strategically it was a disaster.
The jury is out on whether Depot simply underestimated the power of a brand like Viking and the unwillingness of Viking customers to be told what to do, or whether it was sheer stubbornness to think merely of short-term financial gain rather than long-term strategic benefit.
Depot itself reiterates the macro-economic as well as financial issues. Levine says: "In the US, the Viking transition was completed this past summer. The company received cost savings from the transition. However, the larger issue is the overall slowdown in small business spending, as small business customers comprise a large portion of Viking sales. Moving forward, Office Depot has plans in place to rejuvenate sales coming from small business customers."
In the meantime, chief rival Staples - and its mail order business Quill - has presumably been laughing all the way to the bank in the fallout that followed the consolidation of the Viking catalogue into that of Office Depot.
It doesn't bode well for Depot's interests in Europe, where the Viking/Depot integration is still in its infancy. With a current indefinite period of co-branding whereby the tagline "An Office Depot Company" is placed below the Viking logo, the planned removal of the Viking brand is already receiving a similarly negative reception.
Says one former Depot European senior executive: "When Depot bought Viking and went to Europe with it, it was way ahead of Staples in Europe. Viking did a very good job of defending its territory in Europe under Graham Cundick. Perhaps there is a limit of how much you can grow a mail order business in some countries as you increasingly look to the web.
"But it is insane to kill that brand. It's the crown jewel that creates considerable profit in several markets. Why would you screw around with it, rather than wrap it in cotton wool and treat it very carefully? It's a cash cow that should be protected, stroked and looked after and not killed."
Just last month, Viking's standing in Europe as a much loved brand was reaffirmed when Opticom International Research named Viking Direct as 'The Top Supplier of Office Paper in Europe'.
Back across the pond, just months after dropping the Viking brand in the US, Depot decided to make a high profile acquisition on the contract side soon after Staples bought Prime Office Products. The target was Allied Office Products, the $300 million mega dealer in the north-east of the US.
It's been an uphill struggle ever since. The integration didn't go to plan, Allied's salespeople voted with their feet and, unfortunately for Depot, took a lot of business with them. Regional super dealer WB Mason and Staples have been the main beneficiaries along the way.
Depot remains upbeat about salvaging some of the customers that it lost - estimated to be in the 50 percent range - and says: "Office Depot is now seeing positive trends in Allied customer recovery, and we continue to aggressively work to re-acquire that business. Steve Schmidt joined our organisation in August as president of the North American Business Solutions Division and has implemented a north-east turnaround strategy, which includes customer re-acquisition, a new contact strategy and a new service model."
Lack of due diligence
Schmidt has yet to prove his mettle, but as far as Allied is concerned, the chances of 'rejuvenating' that business are stacked highly against Depot, and that goes back to the company's overall strategy. An industry expert from the reseller channel says: "If management had done its due diligence, it would have found out that Allied was paying extremely high commission rates and bonuses to salespeople. That would not be sustainable in a public venue and you should realise that normalising those commission rates would make those salespeople vote with their feet. Lack of due diligence and intellectual perspective led to an acquisition that had to fail - there was no way it could succeed.
And that failure is as true for the Allied acquisition as it is for a number of other strategic moves the company has made, a US-based analyst agrees: "Maybe it's a case of not doing your homework properly. If you plan a strategy but don't think about the implications enough, perhaps that strategy is not completely thought out. I think Depot totally underestimated the competitive landscape in the US. For every move it made, Staples had already thought about it and positioned itself accordingly.
"The economy is a valid comment in all this, but you have to benchmark yourself against your competitors. If they manage to do things rights, so should you, otherwise it's a case of execution. If you've got a clear and obvious recession, of course it's difficult to make money, but if you've got a competitor that's beating you on all fronts, you should focus on that rather than on the economy."
International outlook
With the economy in mind, looking to Depot's global presence and particularly Europe, and the outlook doesn't look too rosy either, with consumer demand particularly in the UK market slacking and a big question mark over the future of Viking.
That said, in Depot's Q3, the company's International division marked its seventh consecutive quarter of sales growth in local currencies. At almost $1 billion, the division reported a sales increase of 13 percent compared to the same period a year ago (5 percent in local currencies).
Levine says: "We have made strategic decisions which are currently resulting in the contraction of margins short-term, but will ultimately position us for margin expansion and deliver additional shareholder value. Some examples for this are establishing regional offices in Asia, centralising support functions in Europe and opening a global sourcing office in southern China."
There's no doubt that Odland is the man who finally put the company's global division on a growth curve back in 2006, three years after the ill-fated acquisition of Guilbert which continues to haunt parts of its European markets to this day. In its current international action plan, Depot plans to:
• Curtail discretionary operating investments, reduce capital spending and acquisitions and aggressively manage support costs
• Improve the UK's financial performance
• Maintain focus on execution to get more productivity from existing businesses
• Increase private brand penetration and expand direct imports into Europe.
Here again, much of the strategy revolves around cost cutting. Warehouse closures and the centralisation of job functions - in many cases to a so-called single shared service centre in Romania - have meant hundreds of staff redundancies in several countries.
The net result of Depot's European strategy has been deep concern und unhappiness among its workforce. Many staff-related issues go back much further, however, way back to the troublesome Guilbert era that began in 2003. Starting then and continuing during the short-term vacuum that followed the departure of CEO Bruce Nelson in 2004, there was a slow but steady reeling in of decisions back to a centralised US approach.
There have been plenty of casualties along the way in Depot's European operations, several in senior executive positions, many of whom have been frustrated by the approach taken and being told what to do.
The consensus is that many of Depot's problems emanate from the very top. As one analyst says: "Odland is very analytical, but what gets the better of him is his hard-headed unwillingness to listen to others. He's a cost cutter and an efficiency driver, but if you're not executing well, then that's no good. Certainly at the moment, his operating ability doesn't stand out to me."
The final comment goes to Depot itself: "No one at Office Depot is pleased with the stock price. However, the company remains committed to executing our turnaround plan and doing everything possible to cut costs and get growth back on track. Each division is also executing back-to-basics plans which focus on optimising the company's existing customer base, and implementing initiatives designed to drive results. Though economic conditions have not been favourable, Office Depot is focusing on the things that we can control such as reducing discretionary spending and capital spending."
Despite the fact that Depot has been very accommodating in OPI's quest to provide a balanced picture of events, nothing suggests to us for now that the company is going to grow aggressively in the near-term future and pose a major headache for its competitors. That said, if chief rival Staples takes its eye off the ball for just a moment in its current takeover bid for Corporate Express, this may well give the beleaguered OP giant a bit of breathing space.
The long goodbye?
The year has barely started and already it seems like another annus horribilis for Steve Odland. Less than a week into 2008, and the Wall Street Journal predicted the Depot chief to be one of the contenders for its Worst CEO of the Year award (of 2008!).
Odland's tenure at Depot has been a veritable roller coaster ride. Drafted in six months after his predecessor Bruce Nelson departed under a cloud of discontent, Odland came in tasked with turning around the company that has been trailing chief rival Staples ever since the planned merger in 1997 got thwarted.
And he did so with great gusto. In the year following his appointment, the company's share price rose from a then low of $21.70 to a high in the mid-$40s. Odland's strategy was one of cost-cutting - his forte and a good part of why he was chosen for the job in the first place.
And while this strategy was fundamentally applauded, its execution has received less favourable reviews. One industry expert who wishes to remain unnamed says: "The way you grow companies is by investing structurally in tomorrow. Odland hasn't done that. Part of the flaw is that he's outsourced everything that is capable of being outsourced on a purely financial basis without any thought given to the implications on customers or sales. It's all been about cut cut cut, and not about driving long-term value."
Wall Street's love affair with Depot finally soured last July when Odland told investors an eight-quarter "streak" of double-digit gains in EPS had come "to a halt".
An audit committee review into the timing of funds due to and received from vendors last autumn added to the negative outlook, further exacerbated by the disappointing delayed Q3 results. And that's not even to mention the company's ongoing challenges with some of its government contracts.
Analyst Dan Binder from Jefferies & Co says: "Office Depot is now faced with a tough macroeconomic situation while at the same time trying to fix the error of its ways. It's a challenge. Investors have fallen out of love with the company and its management team and it's going to be a very tough road ahead to get that credibility back. Ultimately, it may require a management change."
Despite all that, company director Neil Austrian pledged his full support for Odland, saying that "there are no plans in place for a change at the CEO level". If that is true, it's going to be a long hard year for Steve Odland.
Viking: The end of an era
A decade ago, Office Depot bought one of the best known brands in the OP business - Viking Office Products. Created in 1961 and later spearheaded by industry legend Irwin Helford with the aim of supplying small businesses with office supplies via catalogue and direct delivery, in 1998 Viking was already a global brand with an unblemished reputation. Add to that Depot's considerable purchasing power and the deal was regarded as a stroke of genius by then CEO Dave Fuente.
Depot paid handsomely for that brand and that reputation - $3 billion. After a few years of co-existence in the domestic US market, the costs of producing, maintaining and marketing Viking as well as Office Depot catalogues became untenable, particularly bearing in mind that, according to Depot, there was an 80 percent overlap in terms of products offered. It didn't help that sales in the catalogue channel also began to decline. Something had to be done, the strategists at Depot's HQ believed, and in 2005, the merger of the Office Depot and Viking catalogues was announced. The process was completed last summer - no more Viking in the US.
Internationally speaking, the picture looked somewhat different and the Viking brand lives on for the time being, albeit with a limited life expectancy. In Europe certainly - and the UK and Germany in particular - Viking is a very strong mail order brand. It's also in this channel and region where Depot as a company is thought to be ahead of arch rival Staples.
And beyond Europe, it was in fact the Viking brand that gave Depot entry into foreign markets, with Japan and Australia being just two examples.
But it seems history is repeating itself. A year ago, Depot announced its intention to follow the US example and remove the Viking name in Europe and focus on being a single supplier name. The name of the game for now is 'dual branding' to help customers understand the relation between the two entities.
But while the ultimate goal of a single Office Depot brand might be a way off, the end of an era is nigh.
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2 comments made by users
| Matthew | 06 Mar 2008 |
| Never, never, fool around with a winner. Viking was a great name. We hope to make www.officesalesusa.com a name to reckon with as well. |
| Michael DiGiacomo | 06 Mar 2008 |
| 3 years ago when Steve came to the company he stood in front of the organization...store manager's mtg and asked us to be patience...that 9 things out of 10 might be wrong...that's where he left me. Shared leadership model not working and some solid exec.'s left because Steve wanted to fall in love with wall street...instead he should have been store centric and appreciate our customer's...in the end they'll fired him just like Montgoemry Ward and Hechinger's fired their customers. |
