Office Depot's Savvy Overseas Strategy


By Amy Tsao Sometime in the late 1990s, pens, staplers, and desk sets stopped being the brisk sellers they were during the boom times. When investors figured this out, they sent the stocks of office-products retailers like Office Depot (ODP) and Staples (SPLS) sharply lower. Valuations tumbled as PCs and high-tech consumer electronics also became less viable revenue sources for the office-product giants.

Then recession came. Shrinking demand for Post-It Notes and Hi-Liters reflected the gloomy economic mood. All of these things put an end to stratospheric new-store expansions.

Now office-supply retailers are scrambling to figure out where their future growth might come from. The sector's No. 1 player, Office Depot, thinks it has an answer: It's focusing on getting its fastest growth overseas. That's a solid strategy, some analysts say.

"WHAT'S NEXT?" Still, Office Depot and its rivals have their work cut out for them. Generally speaking, superstore specialty retailers "in home improvement, consumer electronics, housewares, and office supplies are all heading into a new era of lower growth amid market saturation. They have to say: 'What's next?'" says Colin McGranahan, analyst at Bernstein Research.

The good news is that the office-product retailers, including distant third OfficeMax (OMX), are getting their operations leaner through cost-cutting even as they build their business-services side. Then with help from an anticipated economic recovery later in 2002, these companies should see a rebound in earnings compared to last year. That should help lift their stocks, which have already gained ground this year on improved earnings guidance from the major players.

Staples and Office Depot are both trading around $18 a share. And both stocks are higher year-to-date, although Office Depot shares have been stronger after the company reported respectable 2001 results in February. But each office superstore has its own strategy for beating the odds. "Office Depot and Staples have different strengths," says Dan Binder, analyst with Buckingham Research Group.

SPOTTY RECORDS. With some 1,100 stores in the U.S. alone, Binder says Staples will keep focusing on its retail presence in the U.S., in contrast to Office Depot's push for international markets. Delray Beach (Fla.)-based Office Depot, which has 859 stores in the U.S. and Canada, is the bigger company by a tiny margin. It had $11.2 billion in sales in fiscal 2001, while Staples is expected to post just under $11 billion.

Although U.S. retailers in general have at best a spotty record abroad, Office Depot seems to have figured out a smart approach that helps it offset the lackluster growth at home. Its operations overseas are based primarily on catalog and Internet sales, which have helped keep costs lower.

For fiscal 2001, this segment contributed 27% of Office Depot's total operating profits. International is the smallest of the company's three main business groups, which include North American retail and business services, but should be its fastest-growing division going forward. Bruce Nelson, Office Depot's chief executive, says the international division, which accounts for 14% of the company's total sales, should become a much bigger part of the business.

BIGGER ABROAD? The international strategy started to take shape in 1998, when Office Depot merged with Torrance (Calif.)-based office-products catalog company Viking Office Products in a more than $2 billion deal. The most attractive part of Viking, which then had sales of around $1.3 billion, was its international presence. At the time of the purchase, Viking had operations in the U.S., Europe, and Australia, and had been a player in Europe since 1990.

"I wouldn't be surprised if in the not-too-distant future, five or six years from now, we had more revenues from outside the U.S. than within," says Nelson, who has been in the business for more than 20 years. He arrived at Office Depot from Viking as a result of the merger and initially headed international operations. Nelson says he began to push for more resources. "We began to fund much more expansion than the company was willing to do before." In July, 2000, he got the CEO job and has kept international a focal point.

Despite weak economic conditions abroad, Office Depot's fiscal 2001 sales overseas totaled $1.55 billion, compared with $1.47 billion in 2000. And that was up from $1.35 billion in fiscal 1999, the first full year to which Viking contributed to Office Depot's results. Nelson predicts that the business abroad can grow at an annual rate in the mid- to high-teens range for the rest of 2002 and beyond. Office Depot is starting mail-order and Internet-based operations in Switzerland and Spain this year, and it will add more retail stores in France and Japan. After 2002, Nelson says he has his eye on Costa Rica, Guatemala, and eventually China.

THE LOCAL WAY. The Viking purchase is looking pretty wise these days. Office Depot now has 39 wholly owned stores in France and Japan, and it has delivery-based operations in 16 countries and joint venture or licensing deals for 104 retail stores in five countries outside of North America. The latter operations don't have the high cost structure that stores do, Bernstein's McGranahan says.

CEO Nelson has a lot riding on markets outside of the U.S., and a conscious effort to acclimate to local ways of doing business seems to be paying off. "We let what needs to be local be local. Hiring, marketing, customer service, manufacturers, culture is all done country by country," Nelson says. He notes that most individual heads abroad are from that particular country. And call centers for different markets are staffed with native speakers.

"It's about recognition that other cultures don't necessarily think the way we do in America," he says. And instead of forcing the Office Depot brand on customers, Nelson has stuck with the Viking name in many of its foreign markets.

COSTLIER MODEL. Of course, Office Depot isn't the only U.S. office-products company abroad. Staples has a total of 1,400 stores worldwide, of which 300 are in Canada and Europe. For the nine months ending Nov. 3, 2001, Staples says its European operations had sales of $560.6 million and broke even. But Bernstein's McGranahan notes that Staples' model abroad is much more expensive to run because it's centered mainly around stores. Meanwhile, No. 3 OfficeMax has been slower to embrace international growth, although it has joint ventures for stores in Mexico and Brazil.

Office Depot's international success also translates into added risk. Nelson notes that launching operations in a new country can run up millions in losses before profits materialize. And currency risk is an ever-present factor. As long as the dollar stays strong, businesses in countries with weaker currencies will show less profit growth. For example, Office Depot's international sales in 2001 grew 11%, but the increase after accounting for currency exchange was just 6%.

As office superstores enter a leaner phase, Office Depot, like its competitors, will do as much as it can to keep itself fresh in customers' eyes. A U.S. economic recovery, while no sure thing, clearly would help these companies. Still, over the long run, Office Depot's international division might just give the company an edge over the competition. Tsao covers financial markets for BusinessWeek Online in New York


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