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Yesterday, Lowe’s Companies Inc agreed to buy Orchard Supply Hardware Stores Corp for US$205 million. This agreement brings 60 of Orchard’s 91 stores under Lowe’s control and provides an option for the company to buy the remaining outlets. With an average selling area of only 4,100 sq m, Orchard Supply Hardware outlets are significantly smaller than Lowe’s traditional stores and – save two newly-opened stores in the Portland, Oregon area – are all located in California.
Lowe’s hopes that the addition of Orchard Supply Hardware can help reverse its relatively disappointing performance in recent years. From fiscal 2010-2012, Lowe’s net sales climbed only 3.5% while its chief rival, The Home Depot Inc, grew its net sales by more than 9.9% during the same period. As the housing market in the US continues to recover after its recessionary collapse, consumers are once again looking to invest in their homes. In this environment, Lowe’s realises that it is vital to remain competitive with its larger rival in order to fully capitalise on the recovery of the US housing market.
There’s Gold in those Hills!
As the US housing market collapsed during the recession, Western states felt the strongest effects. High unemployment rates and plummeting home prices caused a severe contraction in consumer spending on home improvement products in the region. In fact, from 2007-2012, sales in the home improvement and gardening stores channel plummeted 28.4% in California relative to a US decline of only 16.8%. However, these markets have rebounded strongly in recent months. Data from the Federal Housing Finance Agency show that house price indexes in Pacific states have risen 10.97 and 14.78 points, respectively, in the fourth quarter of 2012 and the first quarter of 2013. This is much faster than the US average of 5.43 and 6.72 points during this same period. The West, therefore, has emerged from the depths of the recession to lead the renaissance of the US housing market.
Unfortunately for Lowe’s, this Western housing resurgence is occurring in a geography of relative weakness for the company. In California, for instance, The Home Depot operates more than twice as many outlets as Lowe’s. In fact, while The Home Depot operates more outlets in the West than any other region on a per capita basis, the West remains Lowe’s weakest region by the same metric (see graph). As a result, the reinvigorated housing markets in Western states have helped buoy sales at The Home Depot to a much greater extent than at Lowe’s.
Home Depot and Lowe’s: Per Capita Outlets by Region, 2012
Source: Euromonitor International; Company Reports
To help it better compete in the West, therefore, Lowe’s sees a significant opportunity with Orchard Supply Hardware. The company’s 89 outlets in California stand to nearly double Lowe’s total store footprint in the state. In addition, this acquisition allows Lowe’s to diversity the format of its store base by adding a chain of smaller-sized outlets. Orchard Supply Hardware’s smaller outlets have been able to successfully penetrate some of California’s most densely-populated urban areas. Also – as many retailers have begun to downsize in the face of strong competition from internet retailers like Amazon.com – this collection of smaller outlets could help Lowe’s as eCommerce grows in the US.
Squeezing the Middle
Within the US Home Improvement and Gardening stores channel, Orchard Supply is positioned between larger home centers like The Home Depot and Lowe’s (which average around 10,000 sq m per outlet) and small independent hardware stores like Ace Hardware Corp and True Value Hardware Corp (which average around 900 sq m per outlet). Lowe’s challenge, therefore, is to help Orchard Supply stand out in an increasingly crowded retail environment that is squeezing competitors in the middle.
Orchard Supply will struggle to compete with giants like Home Depot or Lowe’s in terms of product selection. These big box retailers boast a vast selection of branded and private label home improvement offerings at competitive prices. In April 2013, for instance, Menards Inc opened two new stores with more than 18,500 sq m of shopping space as the scope of these mega-stores continues to grow. Orchard Supply will also struggle to compete with other big box retailers like hypermarkets, mass merchandisers, or warehouse clubs which can typically offer home improvement products at the lowest prices.
At the same time, smaller outlets like Ace and True Value have grown by offering expert advice and a high level of customer service. While they can’t necessarily offer the prices or product selection of a home centre or a hypermarket, consumers value the hometown feel of these small shops and appreciate the personalized service they receive from the knowledgeable owners of these outlets.
In recent years, the recession has had a squeezing effect on middle-of-the-road retailers like Orchard Supply. The downturn forced many consumers to become acutely price-conscious, which served to benefit big box stores that can offer the most competitive prices on home improvement products. At the same time, higher-income consumers that avoided the worst of the recession continue to value the small local hardware stores that specialise in technical expertise and customer service. As a result, while Home Depot, Lowe’s, Ace, and True Value have all seen steady sales growth since 2009, net sales for Orchard Supply tumbled more than 5% from 2009 to 2012. In addition, Orchard Supply posted a net loss of $14.5 million in fiscal 2011 and $118.4 million in fiscal 2012. This performance forced the company to file for Chapter 11 bankruptcy while it announced its deal with Lowe’s.
Realising the Opportunity
Lowe’s acquisition of Orchard Supply Hardware offers the company a significant opportunity. If Lowe’s can turn Orchard Supply around, it could dramatically strengthen its relatively weak presence in a rapidly-growing home improvement market in Western states. However, economic trends continue to squeeze middle market retailers like Orchard Supply that must compete against both big box retailers and small hardware shops. The challenge for Lowe’s, therefore, is to retool Orchard Supply’s marketing strategy in order to find a niche within the rapidly-growing market in Pacific states.