Earlier this week, Home Depot announced its Q2 earnings, beating Wall Street expectations on all the important metrics. How was the home improvement retailer rewarded? Shares dipped over 3% that same day.

At this point, not even a stellar earnings report can slow down the Amazon effect. Home Depot is currently riding a bubble and Amazon is poised to burst it, as it's been historically keen to do. The e-commerce platform did it before to Circuit City, leading to its bankruptcy 3 years after peak sales, and is doing it again in a number of verticals, like food and industrial supply.

Home Depot will prove to be no exception.

In order to emerge the victor, Amazon doesn't need to replicate all of Home Depot's product catalog to steal away huge chunks of its revenue. Amazon will only need to target the smaller inventory, the pack-and-ship stuff like batteries and bulbs, and offer it at lower prices.

As well, Amazon's deal with Sears to sell Kenmore appliances should send shivers down Home Depot executives' spines, as it's clear Amazon can move further upstream, spreading the disruption.

Alas, Amazon isn't the end of Home Depot's woes. Another reason for the lack of investor confidence is many believe that Home Depot's gross margins have plateaued. It's also suspected that Home Depot's stock has been buoyed for a while by a robust buyback program.

The sustainability of Home Depot's success has been called into question, causing this stock dip in the face of the company's strongest quarter ever. That's the power of the Amazon effect and the fallibility of linear retail growth - it can all be sent toppling.

An Amazon-Proof Vest?

Home Depot is a home improvement supplies retailer headquartered in Atlanta. Compared to Amazon, it does have a more robust product lineup and a growing focus on professional customers.

The retailer also offers a range of services, from water heater installation to bathroom remodeling, in which customers will be connected with trusted home improvement professionals to fulfill their needs.

Having been in this industry for decades, Home Depot developed a strong sense of brand loyalty with its customers, which has served it well. Unfortunately, that loyalty won't last long if Amazon can successfully duplicates the Home Depot's product and service offerings at a substantially lower price.

If Amazon wanted, it could replicate Home Depot's services, much like it did with Best Buy. In July, Amazon tanked Best Buy's shares over 7.5% (see below) on the news that it would launch its own Geek Squad competitor to help customers set up and fix gadgets, particularly the Alexa-enabled ones.

Amazon already has a division for selling professional services, where individuals can register to perform handyman services and more, akin to Handy and TaskRabbit. While not heavily marketed, a little bit of branding can easily bill it as a top source for home improvement sources and erode one of Home Depot's key defensive moats.

Amazon's size and scope enable it to scale virtually any new business unit it wants, so it wouldn't take much for Home Depot to completely lose this advantage.

Others cite Home Depot's ability to sell large products another competitive advantage over Amazon, but the aforementioned deal with Sears and Amazon's growing furniture delivery logistics will eventually render that moat moot.

Aside from the direct competition, Home Depot's margins wouldn't survive an indirect Amazon assault. If Amazon really targets the smaller products, like light bulbs, tools, and anything else on Home Depot's shelves, the big box retailer's margins will evaporate, forcing it to shrink to stay alive.

The Amazon threat is real and existential. Home Depot can't merely rest on its laurels - it needs to innovate fast.

Home Depot Needs to Fight Fire With Fire

Amazon shouldn't be the only headache for Home Depot. Housing starts are experiencing a sharp decline, which will send the whole market into a slump, which will necessarily decrease Home Depot's sales.

In the face of this slump and a falling stock, Home Depot's gains mean little. Amazon has never been better poised to cause painful disruption, so the home improvement chain needs to strategize and innovate to survive.

Of course, the only way to defend against or beat a marketplace is to build one of its own. Home Depot needs to create a network of hardware stores nationwide, everything from solo mom-and-pops to regional chains, and facilitate sales through this network.

As well, investing heavily in growing its base of service providers would serve the company well in staving off Amazon's own services offering. That's a low-cost source of revenue that also yields strong loyalty. Upgrading the offerings and making the process less frictional on both sides is key to bolstering that strategy.

Finally, Home Depot needs to evaluate a long-term reorganization. Ralph Whitworth will probably roll in his grave at this notion, but Home Depot should explore reuniting with HD Supply, which was a business-facing unit sold off a decade ago for over $10 billion.

HD Supply's been having a rough summer since its board sold off the Waterworks division, which had the best margins in the whole company. Since then, the stock has taken a beating, cratering around 25%, and the company's struggled to meet earnings expectations.

A newly restored Home Depot would be a big customer, allowing it to negotiate better prices from its suppliers and help margins. It already has the logistics network for moving large quantities of large products to stock its stores, so moving them to fill business orders wouldn't be too much of a strain.

Finally, it can serve any kind of customer that needs nails, bulbs, lumber, or any building material at scale, from weekend warriors and homeowners to massive construction firms and factories.

Serving as both a retailer and a distributor would give Home Depot more room to breathe in the wake of the Amazon effect and, ideally, more time to build its marketplace.

Published on: Aug 17, 2017
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