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Thinking Outside the Big Box


Two years ago, Staples (SPLS) Chairman Thomas G. Stemberg and then-President Ronald L. Sargent approached Microsoft Chairman William H. Gates III and CEO Steven A. Ballmer for some unusual career counseling. Stemberg, the visionary who founded Staples and built it into one of the most successful big-box retailers of the '90s, was itching to turn the CEO job over to longtime lieutenant Sargent and move on to other things in his life, much in the way Gates had passed the reins to Ballmer. The timing looked terrible, though. After years of blistering growth, Staples seemed to be hitting a wall -- sales had stalled, while profits and the stock were cratering. After a long meeting at Microsoft headquarters, Ballmer -- a classmate of Sargent's at Harvard University -- urged them to go ahead anyway. He predicted, "You'll be fine," Stemberg recalls.

Ballmer was right about Sargent. Since the baton was passed in February, 2002, the low-key, notoriously frugal CEO has seamlessly taken command and outpaced the rest of the industry, allowing the more flamboyant Stemberg, 54, to assume the role of "entrepreneur in residence." But now Sargent, 47, faces a much tougher transition. The market for the office superstores that drove Staples' meteoric rise is maturing, as everyone from Wal-Mart Stores (WMT) Inc. to the local drugstore peddles cheap office supplies. To fuel a second burst of growth, Sargent is thinking far outside the big box. His audacious aim: to nearly double Staples' sales to $20 billion within the next five or six years, while boosting net income more than 20% a year on average.

To get there, Sargent envisions tearing up Staples' old image as just a purveyor of paper clips and PCs at its 1,300 North American superstores. He sees huge opportunities in the highly fragmented field of delivering office supplies from warehouses directly to businesses. Ultimately, he believes the delivery business could equal sales of the better-known stores. That would be a radical departure, since it means Staples would do much more business than it does now with large corporations. He's also charging into Europe. And he's counting heavily on selling services, including copying, UPS shipping, and such new initiatives as mobile technicians who fix computers and install networks.

Some outsiders question whether Sargent can pull off such an ambitious transformation. For one thing, with the $450 billion North American and European market for office supplies growing only about two percentage points faster than the economy, Staples will have to get most of its growth by wresting it away from competitors. And it will have to push stores into markets such as Chicago and Houston, now dominated by OfficeMax (OMX) Inc. and Office Depot (ODP) Inc.

In Europe, Staples is playing catch-up to Office Depot, which in June acquired a French delivery business that doubled its European sales. And in the delivery business, Staples trails both Office Depot and Boise Cascade (BCC) Corp., a leader in serving large companies. On July 14, Boise Cascade announced a deal to buy OfficeMax for $1.15 billion, thus broadening its reach into small business. Cautions Geoff Wissman, vice-president at consultants Retail Forward Inc.: "The market is fairly saturated, and the competitive intensity has increased."

Still, Sargent has made a career of confounding critics. His first big challenge came in 1990, when Stemberg asked him to take on Staples' then-$20 million delivery business. "We were like the bad guys inside Staples," recalls Sargent, "because the feeling was that if customers got products delivered, they wouldn't shop our stores." Today the $3.4 billion delivery business has Staples' highest operating-profit margins. As CEO, Sargent's sharp eye for cutting costs has helped him boost profitability, despite a tough economy. Sargent may have pulled down a salary and bonus of $1.9 million last year, but the son of a mechanic hasn't lost his blue-collar touch. He still keeps key financial data inside a five-year-old file folder that has been heavily taped to hold it together, and he drives an 11-year-old Toyota Camry.

Upon taking over as CEO, Sargent cut back on selling PCs and other low-margin items. He put the brakes on store expansion -- Staples will open no more than 75 stores a year going forward, he says, down from 133 as recently as 2000. And he set up 45 task forces to find savings on everything from store leases to paper. The payoff? Operating-profit margins jumped to an industry-leading 5.9% of sales last year, from 4.5% in 2000. Net income surged to $446.1 million, from $265 million in 2001. And sales rose 8%, to $11.6 billion, last year, after barely budging in 2001. That has driven the stock to around $20, up from a low of $12 last fall.

Now the question is: Can Sargent work the same magic on the top line? Despite more than a decade of superstore growth, the business is still highly fragmented. In the delivery business, for instance, there are some 6,000 locally owned independent dealers, with average sales of just $3 million. Europe is even more ripe for consolidation.

But Staples faces daunting hurdles on the Continent. Far behind Office Depot in the delivery market, Staples last October bought the mail-order business of France's Guilbert for nearly $800 million. That boosted European delivery sales from $50 million to $450 million overnight. But partly because it still relies heavily on stores, Staples earned just $4 million on revenue of $1 billion in Europe last year, while Office Depot earned $212 million on sales of $1.6 billion. "They've struggled for the same reasons a lot of American retailers have had problems in Europe," including the high cost of land and restrictive rules in countries like Germany, says Office Depot CEO Bruce Nelson.

Investors seem willing to give Sargent the benefit of the doubt, as long as he's outperforming the competition. "They'll be a big beneficiary when the economy rebounds and small business expands," predicts Kevin Beatty, an analyst at MFS Investment Management, a major shareholder. Still, retailers have stumbled over far less ambitious expansion plans. Staples needs near-flawless execution if the handoff from Stemberg to Sargent is to go down in retailing circles as something akin to Gates-to-Ballmer. By William C. Symonds in Boston


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