- Industry-leading incumbents are often disrupted by younger, smaller start-ups and fail to adapt to new competitive dynamics. As the leaders in the office supply segment, Staples offers an example of an incumbent that departed from its successful strategy and failed in its effort to shape a new coherent strategic vision.
- Eight lessons can be gleaned from the Staples saga.
Attempting to copy the successful launches of Toys “R” Us and The Home Depot, the big-box office-supply industry was launched in 1986, when both Staples and Office Depot opened their first superstores. In 1987, Office Club was started in California. In early 1988, Kmart acquired OfficeMax, a small Cleveland-based office-supply startup. Unlike hardware/home improvement, the office-supply industry had many startups, but the industry consolidated rapidly into three major players.
Although they followed similar store strategies—large warehouse formats with wide range and everyday low prices—the three companies had very different cultures. Staples was led by Tom Stemberg, who brought extensive retail experience from supermarkets. Coming from low-margin food retailing, Stemberg was very focused on driving low costs and volume, with much emphasis on systems, logistics, and supplier relationships. From the beginning, Staples was a highly centralized and structured company focused on organic growth.
In contrast, Office Depot was founded by three entrepreneurs who previously had been involved in a startup home-improvement business that was sold. Sadly, one of the founders, Pat Sher, died a year after Office Depot’s founding. Sher was succeeded by Dave Fuente, who had formerly run Sherwin-Williams, a leading paint and home-decorating franchise business. Fuente’s background leading a relatively independent franchise organization resulted in a more decentralized governance model for Office Depot. From the beginning, this decentralization also spurred Office Depot to seek growth opportunities through acquisitions and international markets, including buying out Office Club and entering Canada in 1991.
OfficeMax was one of a number of initiatives by Kmart to diversify away from discount department stores into category killers by acquiring startups in different sectors (Builders Square, Pace Warehouse Clubs, Borders Books, and Sports Authority were other examples). However, Kmart’s growing problems in its core business resulted in underinvestment in the specialty big-box retailers, and they quickly fell behind. In the early 1990s, investors pressured and eventually forced out the Kmart chief executive responsible for the specialty-superstore strategy and demanded the spinoff of the chains. OfficeMax was sold off through a share offering in 1994.
The first decade of operation had allowed Staples, Office Depot, and OfficeMax to grow rapidly within their home regions. By the mid-1990s, the office-supply industry was dominated by these three businesses, each with distinct geographic profiles—Staples in the Northeast and Mid-Atlantic; Office Depot in the Southeast, Southwest, and California; and OfficeMax in the Midwest. The three companies had each opened more than 500 stores by 1996, although Office Depot’s revenues of $6.1 billion were larger than Staples’ $4 billion and far above OfficeMax’s sales of $3.2 billion. However, it was becoming increasingly clear that the next stage of growth would require entering the others’ home markets.
1996 Merger Proposal
In light of these developments, in September 1996 Staples sought to acquire Office Depot in a stock swap valued at $3.4 billion. The deal was immediately challenged by the Federal Trade Commission on the grounds that it would harm competition and raise prices in stores. The subsequent trial represented a landmark extension of the reach of antitrust policy in defining the market not as the product category (office supplies) but as the retail segment (office-supply superstores). The June 1997 judicial decision to block the merger had dramatic consequences for the evolution of the industry, especially for Office Depot. When the proposed acquisition was announced, Office Depot slowed its expansion and lost key executives who did not expect to be part of a combined organization.
When the government decision caused the deal to be scrapped, Office Depot embarked on an aggressive “catch up” growth plan. This initiative included relaunching its store expansion program, the acquisition of Viking Office Products in the commercial market, and licensing deals for Office Depot partner operations in a diverse array of countries, including France, Japan, Israel, Mexico, Poland, and Thailand. All of these changes resulted in weak results, especially compared to Staples. As a consequence, Office Depot endured a series of senior management changes between 2000 and 2005, which further weakened the company.
OfficeMax, which had been spun off by Kmart in the early 1990s, continued to struggle through the 1990s. Believing that the government would approve the Staples-Office Depot merger, OfficeMax had hoped to obtain multiple premier store locations if the government required divestitures in overlapping markets. When the merger was scrapped, OfficeMax again faced two much larger and stronger competitors. In 2003, OfficeMax agreed to be acquired by Boise Cascade, a paper producer, which then spun off its forest products operations and retained the OfficeMax name. With the legacy paper business, OfficeMax had become focused on its commercial contract business, which accounted for 52 percent of the company’s $9 billion in revenues. Also undergoing a series of leadership changes, the company began to close stores and emphasize commercial operations.
The Staples Boom, 1997–2007
In contrast to its competitors, when the FTC review was launched, Staples continued to grow rapidly. The company opened 170 new stores in 1996 and 1997. Staples also launched the new “Heartland” store format, which renovated stores to make them brighter, softer, and easier to shop for growing categories like furniture and technology. Staples’ growth had accelerated: It took seven years to reach $1 billion in revenues, only two more to double to $2 billion, and then doubled again in one year to $4 billion in sales.
As the store network grew into a nationwide footprint, Staples began to shift its strategy—from EDLP/value to more emphasis on widest range, as signaled by its new slogan “Yeah, We’ve Got That.” Staples added new categories; expanded services, especially print and copy; and shifted emphasis from small business to the home, school, and home-office segment. Staples redesigned their stores and renewed investment in information technology and the supply chain to drive greater productivity. Staples itself was becoming a retail company with substantial brand equity.
Despite the tech crash in 2000 and the 2001 recession, Staples continued its growth. Sales in 2002 were $11.6 billion, and the network topped 1,300 stores. The launch of staples.com in 1998 had been slow to build momentum, but by 2002 the online channel was transforming the North American commercial delivery and contract segment.
Staples also saw its first leadership change in 2002, as Tom Stemberg stepped down and was replaced by Ron Sargent as chief executive. Sargent began to shift Staples’ strategy from rapid growth toward greater efficiency and profitability. Sargent’s plan had four pillars: serve the small-business customer, drive profitable sales, improve operating margins, and increase asset productivity. This reorientation led to fewer store openings and a shift toward renovations and refurbishments. Staples also began work on its next-generation store format, which reduced the standard size from 24,000 to 20,000 square feet. This downsizing was accompanied by a narrowing of the merchandise offer, reducing SKU count by 750 and raising prices on 450 key lines. The margin goals also led to a full launch of Staples private label lines, hoping to achieve 20 percent of sales within a few years. By 2007, Staples had shifted from an EDLP value retailer to a hi-low promotional business, reinforced by a loyalty program (Staples Rewards).
By the beginning of the U.S. economic recession in 2007–2008, Staples had extended its position as the leading office-supply retailer. In 2007, Staples’ sales of $19.4 billion were 25 percent higher than Office Depot’s $15.5 billion and more than double OfficeMax’s $9.1 billion. Staples also had much higher profitability and productivity. Staples’ 5.1% return on sales was twice that of Office Depot and OfficeMax. Staples’ network of 2,038 stores was pulling away from Office Depot’s 1,670 locations and OfficeMax’s 981 stores. Staples also had a very strong balance sheet, with only $342 million of long-term debt compared to $607 million for Office Depot and a staggering $1.8 billion for OfficeMax. As a consequence, Staples’ market capitalization of $15.3 billion was four times greater than that of Office Depot and 10 times greater than that of OfficeMax.
Reversal of Fortunes
Staples then embarked on a series of major strategic decisions that had dramatic negative consequences for the company. Staples had made minor forays into international markets with European, Chinese, and Indian operations. But faced with a softening U.S. economy in late 2007, senior management sought to expand Staples’ international presence as rapidly as possible. In February 2008, the company launched an unsolicited bid for Corporate Express, one of the world’s largest office-product wholesalers. Netherlands-based Corporate Express, with extensive European operations, had been under pressure from private-equity investors and hedge funds to put itself up for sale. Staples’ initial offer of 7.25 euros per share represented a 67 percent premium to Corporate Express’ prior share price. However, Corporate Express rejected the offer, saying it undervalued the company. Staples then raised its offer in two stages to 9.25 euros per share, representing an 85 percent premium and a deal value of 1.7 billion euros ($2.3 billion). Staples also agreed to assume $1.7 billion of Corporate Express debt. Including the debt financing of the deal, Staples’ total debt went from $350 million in 2007 to more than $4 billion by November 2008, with $2.94 billion of that amount due for payment or refinancing within a year. The debt also was very expensive, with interest rates as high as 9.75 percent. With the global financial crisis exploding in September 2008, Staples’ debt-financed deal came at the worst possible time.
The company attempted to put a positive spin on the acquisition, despite the high price and the accompanying leverage. Ron Sargent, chairman and chief executive of Staples, said at the time, “We're going to go from a company where retail is about 60 percent of our sales to a company where commercial delivery is about 60 percent of our sales. That is really transformational. . . . I think the paper clip wars are over, and it’s a win for both sides.”1
The Corporate Express acquisition transformed Staples into a company with three significant business units. North American Retail (which comprised 56 percent of sales in 2005) had grown to $9.4 billion in sales by 2009, but had just been passed by the North American Delivery business in revenues. Both North American units had operating profits of 8.3 percent of sales. In contrast, the Corporate Express deal almost doubled Staples’ international business to $5.3 billion in revenues, but with a paltry 2.3 percent operating margin.
The 2008–2011 period proved to be tough going. Because of the U.S. recession, North American revenues essentially were flat, with Staples’ slight revenue growth coming mainly by taking share from Office Depot and OfficeMax. Staples’ international businesses lost almost a half billion dollars in revenues and saw a reversal from profits to significant losses. Staples also slowed store openings and shifted its strategy from reinvesting in the business to distributing operating cash flow to shareholders through dividends and share repurchases. Prior to the recession, Staples’ capital expenditures had averaged $500–$600 million annually. From 2008 to 2011, capital investments of just under $1.5 billion were only a half of the $2.9 billion spent on dividends and buybacks.
By 2012, despite a recovering economy, Staples was continuing to struggle. Revenues declined from $24.7 billion to $24.4 billion, the first full-year decline in company history. Operating profit dropped from $1.6 billion in 2011 to $500 million in 2012. Staples also suffered its first-ever net loss as a public company of $211 million—a reversal of $1.2 billion from the year before. The restructuring included more than $1 billion of impairments and write-offs of goodwill. The company further reduced capital expenditures but boosted its dividends and spent $767 million on dividends and repurchases. Despite these distributions, Staples’ stock price continued to fall. From 2008 to 2013, Staples stock declined 37 percent, compared to a 21 percent increase in the overall market and a 97 percent increase in the Standard & Poor’s retail index.
In the wake of this performance, Staples announced an aggressive cost-cutting program, aimed at saving $250 million annually and further reducing store count by 15 percent across the United States and Europe. The company also announced a dramatic shift in its merchandise strategy away from office supplies toward general merchandise, under the tag line “Every product your business needs to succeed.” The cover of Staples’ 2012 annual report showed an array of products, including hammers, stethoscopes, drills, vaporizers, and kitchen blenders. Both the online business and the stores dramatically reduced both width and depth of their traditional office-supply categories, spurring declines in customer-satisfaction scores without offsetting new business.
By 2014, Staples’ attempt to reinvent the company with a general merchandising strategy was failing. More than 300 stores were closed, and revenues had fallen by $2 billion since 2012. Return on sales was only 0.6%. Gross margins had fallen from 27.1 percent to 25.8 percent, with declining average selling prices as well. Performance worsened across the entire business: traffic was down 1 percent, basket size down 4 percent, overall sales down 2.7 percent, and same-store sales down 4 percent. Another 169 stores were closed, and an additional $469 million worth of impairments was taken. The shift in merchandise strategy was not matched by investment in the business—dividends and repurchases were 50 percent greater than capital expenditures. Staples had clearly decided that its future was no longer in stores, and no longer in office supplies.
However, Staples’ “reinvention” was completely turned upside down with the announcement in February 2015 that the company proposed to buy Office Depot for $6.3 billion, a 44 percent premium to Office Depot’s prior closing price, and a 65 percent premium over the average price in the prior quarter. (Acquisition premiums typically average 20 to 30 percent.)
It is near-impossible to understand why Staples was interested in acquiring Office Depot. Both Office Depot and OfficeMax struggled during the financial crisis and recession, losing share to Staples and undergoing repeated restructurings and management changes. Office Depot had gone from $15.5 billion in revenues and almost $400 million in profits in 2007 to 2013 sales of $10.6 billion and barely breaking even. OfficeMax had a similar experience, with sales falling from $9.1 billion to $6.9 billion and profits falling from $207 million to $70 million in profits. Office Depot’s stock price had fallen from $39 per share in 2007 to $3 per share in 2013; OfficeMax fell from $55 per share to $7 per share over the same period.
Weak performance was exacerbated by weak balance sheets. Office Depot had $350 million worth of convertible preferred stock with an 8.5 percent yield held by BC Partners, a private-equity hedge fund; OfficeMax had over $1 billion in long-term debt. Starboard Value, another hedge fund, had taken a stake in Office Depot and then sought to merge with OfficeMax in a merger of equals. Each OfficeMax shareholder received 2.69 shares of Office Depot stock, about a 50 percent premium to prior trading. The deal was completed with the hope of creating a combined company of 2,200 stores, with revenues of $17 billion. But merger integration proved to be a challenge, with cost savings being swamped by restructuring costs and the closing of 400 stores. Conflicts arose over who would be the CEO, where combined headquarters would be located, and what the name of the combined company would be (the name they settled on was Office Depot Office Max!). A year after the deal, combined revenues were down to $16.1 billion with a net loss of $312 million. An additional 300 stores were slated for closure.
Given this bleak performance and outlook, it hard to understand why Staples wanted to acquire Office Depot, let alone why they offered such a huge buyout premium. Even Ron Sargent, Staples’ CEO, seemed confused in his letter to shareholders in the 2014 annual report, writing (italics added):
The progress on our strategic reinvention is a result of the strength, experience, and persistence of Staples’ management team and board of directors. We’re responding to the changing needs of customers, aggressively reducing expenses, and competing with a much wider set of competitors in categories beyond office supplies.While we’re right on track with our reinvention, we also remain committed to carefully considering other strategic options. In early 2015, we announced the acquisition of Office Depot. We believe that the acquisition will create significant value for our shareholders and our customers. It will better position us to accelerate our reinvention and more effectively compete with a wide range of competitors in a range of categories beyond office supplies.2
The situation became even more confused when the U.S. Federal Trade Commission sought to block the deal on the grounds that the two companies had a dominant share of the commercial contract business for office supplies. After many delays and extensions, the case moved to trial in late 2015. The markets became increasingly pessimistic that the proposed deal would be completed; Office Depot began to trade well below the bid price. Moreover, the core businesses continued to erode. In early 2016, Staples reported that 2015 revenues were down $1.4 billion from 2014, while Office Depot reported revenues of $14.5 billion, down $1.6 billion from a year earlier.
Faced with faltering businesses and a premium-priced deal, Staples then stunned the investment community when it chose not to present any defense of the proposed merger to the court, saying the government’s case was woefully lacking and a defense was unnecessary. On May 10, 2016, the judge then upheld the government blocking of the deal, noting his surprise at Staples’ unwillingness to provide any justification.
Cynical commentators believed that Staples was trying to get out of the deal, but in any case, it proved extremely costly. After the court decision, Staples stock fell 19 percent and Office Depot stock 37 percent. The combined market capitalization of Staples and Office Depot by mid-2016 was half of that of Staples alone in 2007. Staples had to pay Office Depot a $250 million breakup fee and announced it would proceed with more cost cuts and the sale of its European operations. Three weeks later, Ron Sargent resigned after 26 years with the company and 15 as CEO. Clearly in search of a new strategy, Staples’ board announced it would begin an open and external search for a new leader. In August 2016, Roland Smith announced his retirement as CEO of Office Depot Office Max, with a search for an external candidate as well. By August 2016, the two US office supply giants were looking for new leaders and new strategies.
- Staples’ strategic position began to erode when it moved away from an EDLP value strategy toward one reliant on widest range and convenient locations. New competitors, both digital (Amazon) and brick and mortar (Walmart), eventually were able to claim price leadership—which became critical in the recessionary economy.
- When your historical competition is weakening, you can overestimate the strength of your own competitive position. As the recession worsened, Staples’ results were bolstered by the problems at Office Depot and OfficeMax.
- Like the department stores, Staples tried to serve different segments of the market with a “one size fits all” strategy. This created opportunities for specialist competitors or broadline competitors with differentiated strategies (Amazon Business/Amazon Prime/Amazon).
- Staples gave up on stores, despite having over 2,000 locations. The lack of investment and the reductions in merchandise width and depth discouraged customers and employees. The hi-low pricing with rebates through the loyalty program made it hard to figure out price/value. Customer service worsened, reinforcing this downward spiral.
- Staples’ 2012 shift toward general merchandise worsened its competitive position—the U.S. market did not need or want another general merchant trying to offer convenience. This was especially true given Staples’ hi-low pricing and constant promotions.
- Staples’ decision to acquire Office Depot was a complete reversal of the actions the company had taken in the prior three years. While the prior strategy might be questioned, the sudden reversal suggests that senior management was not invested in either the old or the new plan.
- If you don’t have a strategy, someone will give you one. In recent years, private-equity groups have increasingly stepped in to force strategic decisions that too often are focused on short-term financial gain. In the office-supply industry, Starboard Value played a key role by taking investments in both Office Depot and Staples, and then agitating for deals. In some cases (like the Office Depot-OfficeMax merger), negotiations between private-equity groups can drive dealmaking.
- Acquisitions often become the default strategy. Yet acquisition strategy remains one of the least developed skills in retailing. In the office-supply industry, deals were repeatedly done at extreme premiums and worsened by a reliance on debt financing. This is especially problematic when the merging companies are experiencing weakening performance and are seeking consolidation.
- Staples 2014 annual report and 10-K, available at http://investor.staples.com/phoenix.zhtml?c=96244&p=irol-reportsannual