By Carter Harrison
With the acquisition by Staples now firmly off the agenda, Office Depot must now plot its own course for the years ahead. Unfortunately, as these latest results demonstrate, that course has a very clear direction: downward. To be fair, the disruption and distraction of the failed deal with Staples will likely have taken the wind out of Office Depot’s sales and diminished growth further and faster than might otherwise have been the case. However, in our view, the impact has only affected the magnitude of decline and has not changed the direction of travel.
That Office Depot is in decline is not particularly surprising given the unfavorable market trends buffeting the sector — including the rise of online, the growth of non-specialist players, and the deflationary pressures in terms of pricing. All of these things have conspired to reduce growth, especially on the retail side of the business. Against this backdrop the consolidation of Office Depot and Staples to remove excess capacity made sense; that this deal will now not go ahead will ultimately damage both businesses, not least in terms of profitability.
Fortunately, Office Depot does have some room for maneuver largely thanks to opportunities still available from its previous merger with Office Max. This activity was largely a defensive one designed to allow the company to compete more effectively by reducing store numbers and boosting the profitability of remaining outlets. In essence, the thinking is the same as that behind the Staples merger, albeit on a slightly smaller scale.
Office Depot cannot keep shrinking its way to profitability. [Expansion of] a smaller 15,000-sq.-ft. store that focuses as much on services as on products … provides an opportunity to offset some of the declines in its core stationery market.
The results early on in this process were encouraging and resulted in Office Depot pushing comparable sales into positive territory and eking up underlying profitability thanks to the savings associated with the closure of 400 outlets. However, over recent quarters this benefit has waned as the consolidation program has lost focus. As such, we welcome today’s announcement that the company will look to close a further 300 stores over the next three years. This is the correct response to a market that is still overcapacity.
Closures are only part of the answer, however. Longer term, Office Depot cannot keep shrinking its way to profitability. As such, the decision to expand the future format program is to be welcomed. This initiative involves a smaller 15,000-sq.-ft. store that focuses as much on services as on products. Initial results have been encouraging, with sales productivity above that of the rest of the chain. In our view, this template provides Office Depot with an opportunity to offset some of the declines in its core stationery market.
Out of Office Depot and Staples, we believe that the former is much better positioned to weather the challenges ahead following the failure of the merger. Performance will remain sluggish, but unlike its rival, Office Depot has a clear and focused plan of action.
Carter Harrison is a retail analyst at research firm Conlumino.