NEW YORK— Staples and Office Depot are going their separate ways, albeit one $250 million poorer and one $250 million richer, respectively, articulating at least somewhat divergent strategies in the face of an uncertain and rapidly evolving office products future.
To some extent, Amazon.com has driven the evolution. When Staples
and Office Depot announced their merger agreement a year and a half ago, on the heels of Office Depot’s acquisition of OfficeMax, Amazon was not a dedicated player in the business to business sector, but, today, it is aggressively building that business.
In the course of litigation resulting from a United States Federal Trade Commission action against the proposed Staples/Office Depot merger, Amazon became an issue and source of controversy. Indeed, the presiding District Court for the District of Columbia criticized the FTC’s discussions with Amazon about its plans for the commercial office products business and how the agency characterized those plans in the course of litigation.
Ultimately, it was the commercial end of the business that was the core FTC concern for the Staples/Office Depot merger. The agency determined that the proposed merger would involve a sufficient proportion of the commercial office products business to significantly reduce competition in the market.
Although the online retailer launched a dedicated business-to-business sales division last year, FTC argued that Amazon wasn’t about to become a major player in the commercial office products space. The Staples/Office Depot side argued that Amazon is and would be a formidable rival in a market that the agency already defined in an unrealistically narrow manner.
Amazon Business, the dedicated B2B operation, recently passed its first anniversary. By the end of fiscal 2015, the company stated, it had signed up 200,000 businesses as customers, with the portfolio ranging from small operators to Fortune 500 companies. By the end of this fiscal year’s first quarter, Amazon declared that it had 300,000 businesses participating in the B2B operation.
In the end, and despite any objections to how the agency pursued the case, the district court decided to grant an injunction placing the merger on hold. The ruling propelled Staples and Office Depot to end their merger effort, which triggered a $250 payment from Staples to Office Depot.
Staples Sets Growth Strategies
In the aftermath, the two retailers made public statements about how they would conduct themselves as independent operations.
The district court decision had a number of consequences for Staples. The $250 million fee mandated under terms of the merger agreement between the two retailers will push acquisition-related costs that will hit Staples in the current fiscal year to about $600 million, Christine Komola, Staples CFO, said in a first quarter conference call. Beyond cutting ties with its once and future rival, Staples also terminated an agreement to sell more than $550 million in large corporate contract business and related assets to Essendant, a deal set to mitigate regulator objections to the merger with Office Depot.
Of course, the court’s decision prompted Staples to reevaluate its future. As he announced the merger termination last month, Ron Sargent, Staples’ chairman and CEO, also proposed a new business plan, asserting, “We are positioning Staples for the future by reshaping our business, while increasing our focus on mid-market customers in North America and categories beyond office supplies.”
Staples also detailed a four-fold go-forward strategy. A central part of that strategy is serving the needs of mid-market business customers with 10 to 200 employees. To do so, Staples noted that the company would increase its offering of products and services beyond office supplies, and what the retailer considers office furniture. Other categories outside the core that Staples has targeted for growth include those that include home furnishings and housewares, including break room supplies and promotional merchandise.
In the conference call, Sargent said that Staples is “winning with customers of all sizes,” in those key segments.
At the same time, Staples will pursue market share gains in ink, toner and paper, its core home office categories. It will invest in lower prices to support that initiative and improve supply chain capabilities while adding more than 1,000 associates to its mid-market sales force. The company also indicated that it would seek acquisitions relevant to its mid-sized business focus.
In another strategic move intended to reinforce the intensification of North American activity, Staples set plans to explore strategic alternatives for its European operations. Staples already took the first steps toward reinvigorating North American operations by closing more than 300 stores in the region since 2011. Now, the company asserted, it would concentrate on boosting productivity and preserving profitability in its remaining North America retail stores by increasing customer conversion, enhancing the mix of services and reducing fixed costs. It also plans on shuttering at least 50 more underperforming North American stores this year.
To further its strategy on the financial side, Staples has initiated what it described as a new multi-year cost cutting plan that it expects will generate $300 million of annualized pre-tax cost savings by 2018’s end. The company will focus especially on reducing product costs, optimizing promotions, increasing the mix of Staples brand products and reducing operating expenses.
On the financial flip side, Staples committed to maintaining its dividend program and resuming repurchases of its common stock during the 2016 second quarter.
Office Depot Builds Business Model
Office Depot also has a plan for moving forward, one that builds on earlier efforts to focus on small business customers. However, success in the future will require Office Depot to reverse business trends that have plagued it recently.
“Our core business continues to decline, and it is clear that the status quo simply will not allow us to achieve our long-term sales growth,” said Roland Smith, Office Depot’s chairman and CEO, in an investor and analyst conference call.
Smith said that Office Depot has core strengths it can use to position itself, including a strong financial profile with a solid capital structure and no near-term debt maturities. The company has completed an extension of its asset-based credit facility for five years that reduces fees and borrowing costs, he pointed out. It also provides flexibility that will allow for incremental indebtedness, as necessary, and the funding of acquisitions, Smith said, affording $2 billion of available liquidity when coupled with $900 million of balance sheet cash.
“This position will be further improved with the receipt of the $250 million termination fee from Staples later this week,” he said.
Smith said Office Depot had recognized that, in a rapidly changing sector, the company must adjust its business model. Even before the merger agreement, Office Depot had been working on what the company dubbed its framework for growth. The framework rests on four pillars, Smith said, improving core business execution, developing Office Depot’s unique selling position, expanding into adjacent categories and service, and exploring new business opportunities.
Assets Office Depot can employ to build on its framework for growth include strong customer relationships and a 2,500 strong sales organization, Smith said, as well as a multichannel business model including 1,500 U.S. retail locations and an Internet operation that provides customers access to an expanded product assortment. He said the company also has a solid core of employees and executives despite the difficulties the company encountered in maintaining its leadership structure in the face of a potential acquisition.
Further, Office Depot’s national distribution system is highly efficient and capable of next day delivery to most of the U.S., Smith said.
Despite a protracted and ultimately thwarted merger process, he said the company hadn’t gotten off track as it and Staples struggled with the FTC. Office Depot determined not to begin an integration process with Staples given the uncertainty that the merger would proceed, but rather continued implementing its framework for growth, addressing strategic priorities such as the integration of OfficeMax operations into its own system.
Smith stated that the integration has delivered $600 million in synergies Office Depot enjoyed through 2015 and that the company plans to keep driving the effort and make it to $750 million in annual run-rate benefits by 2017’s end. As it completes the OfficeMax integration effort, he said, Office Depot would emerge as a more streamlined organization “better able to compete aggressively in the future.”
In the North American contract business, Office Depot is set on penetrating into and expanding sales in adjacent categories, Smith said. At the same time, the company is pushing to capture more share of wallet with existing customers by expanding assortment and broadening infrastructure. One consequence of that effort has been sales gains in the cleaning and break room segment, a business where the company sees a range of untapped opportunity.
Education is another realm that provides its own, varied opportunity, Smith said.
“Our K to 12 business had positive growth in both 2015 and the first quarter of 2016,” he said. “In fact, Office Depot today serves thousands of school districts and hundreds of thousands of educators with traditional office supplies and a growing portfolio of services and solutions.”
As an example of educational initiatives, Smith pointed to a partnership with IBM that marries cognitive computing and education materials in a package that provides schools with personalized learning solutions.
Office Depot has restructured its contract business to support its growth outside its core product categories and to provide resources to facilitate new business acquisition. At the same time, it is testing a program designed to boost its standing with small businesses by providing competitive pricing as well as e-commerce enhanced to improve customer experience.
Office Depot has continued shuttering stores under a plan that has resulted in 400 unit closings as of last month. Smith said business migration from the closed locations has exceeded the 30% target envisioned under the plan, and the result of the program has been a healthier store base. The store portfolio continues to undergo evaluation.
In the meantime, Smith said, Office Depot has continued enhancing store operations by initiating a buy online and pick up at store capacity, and it is developing a ship from store capability that will come online later this year, improving inventory utilization.
In addition, Smith said Office Depot’s store of the future, a 15,000 square foot format, has proven successful in an evaluation process. The easy-to-shop format takes a new approach to signage as a means of improving navigation and provides clean merchandising presentations with an emphasis on better merchandise in a good, better and best assortment. The larger intention behind the store of the future development is to differentiate Office Depot stores and serve shoppers who value quality, service and experience. Office Depot will expand its store of the future test to 20 stores by this year’s end, Smith said.
The company also has launched programs to enhance current store operations, including one dubbed “Store Experience” that shifts the orientation of employees from tasks to services, with the goal being enhanced sales conversion rates. In addition, Office Depot is driving promotion optimization as it relates to advertising and store-based efforts. Mark Cosby, Office Depot’s president, North America, said those initiatives in limited execution had already provided positive results. The company also began offering a ship to store option for contract customers in April.
On the international front, Office Depot also is evaluating the sale of its European business. In fact, the company has engaged Bain & Co. advisors as part of a company wide evaluation of its business going forward, one that may produce additional initiatives.
