Acquired - Home Depot

Starting point is 00:00:00 I'm sorry, I got tripped up. You used power tools, David Rosenthal. I built this whole door. I got the Blake door from Home Depot. I had to cut it down to size to fit a non-standard size door opening in my studio. I drilled the door handle. I put the doorknob on myself. It all worked great.

Starting point is 00:00:18 We got to get you to the pro desk. Yeah. And it's been part of every acquired episode since. All right. Let's do this. Welcome to the fall Who got the truth now Is it you?

Starting point is 00:00:35 Is it you? Is it you? Another store. Welcome to the fall 26th season of Acquired, the podcast about great companies and the stories and playbooks behind them. I'm Ben Gilbert.

Starting point is 00:00:51 I'm David Rosenthal. And we are your hosts. Home Depot is an astonishingly large company. Before I started this research, I thought of it as a big store at the middle of a bunch of shopping. centers, but not really like an important company to the world. But I was wrong. And the stats are large, David. It is the world's largest specialty retailer. The only retailers larger are

Starting point is 00:01:20 general, not in a specific vertical like home improvement. So think Walmart or Amazon or Costco, those are bigger. But the other vertical ones are not. In fact, Home Depot is the 45th most valuable publicly traded company in the world, period, with a $350 billion market cap. So that's more valuable than Netflix or Alibaba or Goldman Sachs or LVMH. Or Disney that we just covered? Yes. Which is wild because unlike all of those other companies, Home Depot is only in North America. Yes.

Starting point is 00:01:57 Home improvement is just a massive category way, way bigger than I realized. So here's a fun stat. Home Depot went public in 1981, one year after Apple computer. And astonishingly, if you put $1,000 into Home Depot and Apple and their IPOs and you held them all today, your investment in Home Depot would beat your investment in Apple. And if you reinvested the dividends that it paid out, it has compounded at nearly 25% per year for 45 years. I mean, imagine if your stock portfolio did that. Yeah, Home Depot is an all-timer. I kind of can't believe we haven't done this episode yet.

Starting point is 00:02:37 Right? That makes it the number one performing stock in the S&P 500 in total investment return from the day that it went public to today. So that $1,000 invested in the IPO would be worth about $17 million today. Not bad, not bad. Well, we're going to get into as we go, who holds that equity? because it's actually a critical part of the company strategy, or at least it was. Yeah. And listeners, if you're trying to contextualize, well, 45 years is a long time. You know, how does that 17 million stack up? Ben and David love their index funds. You know, we love Vanguard here. If you had bought the S&P 500 with that same thousand dollars, instead of $17 million today, you would have $170,000.

Starting point is 00:03:23 Wow. Today we will tell the story of how it happened. It is an unlikely story of two. guys who got unceremoniously fired from their old jobs with little savings and no retirement funds, who then had a revolutionary idea to build a home improvement store in giant warehouses, five times more square footage than any other hardware store at the time, which seemed risky at best, unthinkable maybe. And we'll try to answer the question, how and why did that idea become so large? I mean, of course it's bigger than Lowe's, but also IKEA, Trader Joe's.

Starting point is 00:03:58 It's bigger than nearly all dedicated grocery store chains, and today they employ an astonishing 470,000 people. That's more than any big tech company in the U.S., except for Amazon, more than any bank in the world, more than almost every car company, hotel chain, more employees than any restaurant chain also, including Starbucks. So listeners, this is the story of Home Depot. Ooh, let's go. So for all of you who have been asking for visuals to go with our episodes, you are in luck.

Starting point is 00:04:32 We are making our companion PDF a regular thing now. So you can click the link in the show notes or go to library.acquire.com to get access to all the charts and tables and illustrations from key concepts in this episode. You can join the email list at acquired.fm slash email. That's where we'll send out all the behind-the-scenes photos of research and past episode corrections and vote on future episode topics. that is Acquired.fm slash email. Join the Slack. Come discuss it with David and I at Acquired.com slash Slack. And before we dive in, we want to thank our brand new presenting partner, Sierra. Yes, Sierra helps the great companies of the world to build better customer experiences and drive stronger business outcomes with AI. And we are so excited to be working with them. That's Sierra S-I-E-R-A. So with that, this show is not investment advice. David and I may have investments in the company. that we discuss and this show is for informational and entertainment purposes only. David,

Starting point is 00:05:31 take us in. So the story of Home Depot is kind of like the acquired version of like an Avengers movie. There are these four business and retail superheroes that come together and, you know, save, well, they don't save the world, but they save customers a lot of money. They provide extreme value propositions to the American consumer. Yes, yes. So we start first with Home Depot's founding CEO, Bernie Marcus. Bernie comes from a poor family of Jewish immigrants in the rough neighborhoods of Newark, New Jersey in the 1930s during the Depression. Bernie was actually in a gang as a kid, which I discovered hilariously reading Bernie's book, kick up some dust, the foreword of which was written by his good friend, the rapper Pitbull. Like, amazingly, the two of them, like, bonded and became good friends later in Bernie's life.

Starting point is 00:06:24 Yeah, when you sent me that book cover, I had a serious double take at the foreword. So Bernie, despite his rough upbringing and gang experience on the streets of Newark, he's super smart. And he ends up being the first person in his family to go to college. He goes to Rutgers down the road from Newark there in New Jersey for college. And his dream is to go on to medical school and become a psychiatrist. That doesn't work out because his family doesn't have any money to send him to medical school. So instead, he becomes a pharmacist. That quickly leads him to becoming a concessionaire in a New York area discount store, concessionaire like a store within a store.

Starting point is 00:07:05 This begins Bernie's retail education, and from there he would go on to join the New York area discount chain two guys. Ultimately, this leads him a couple years later in his 30s to an executive role at the Dalyan Corporation, which was a retail conglue. Belomerate based in Los Angeles with a whole bunch of different stores. So we're now here in the 1960s. This is an exciting time for retail. All sorts of new concepts are popping up all over the country to replace the outdated general store model. There's shopping malls being built everywhere in the suburbs across America here in the post-war period. Sears is building big anchor tenant stores attached to these new shopping malls.

Starting point is 00:07:51 Kmart is rising. across the country as a discounter. Sam Walton and Walmart are starting to emerge down in the rural south and they're building a powerhouse. The landscape and retail is dynamic. The post-war 1960s, baby boom American suburbs are alive and well with their shopping. And Dalen was this holding company that operated almost like, I don't know, like a portfolio or an index fund on all these retail concepts. So they would go out and acquire small chains of all. All of these types of post-general store concepts serving the American suburbs. So, yeah, they had pharmacies, hardware stores, clothing, home furnishing, discounters, you name it.

Starting point is 00:08:34 And for the most part, all retail in America at this point, except for Sears, Kmart, some department stores, you really didn't have these big national retail giants the way that we do today. It was kind of these regional chains. Yep, yep. So Bernie's now a corporate executive at Dalyan. He has no equity in the company. He's just a employee, but it's a stable job. He's doing well. He's certainly moved up in the world from his upbringings.

Starting point is 00:08:59 And then he gets an opportunity. In 1972, Dalyne makes Bernie the CEO of its Handy Dan subsidiary, which is a chain of hardware stores that's also based there in Los Angeles. So again, he has no equity. He's the CEO, but he's just an employee. And also he comes at it from the real. retail side, not the hardware expertise side. This is kind of my favorite part of this whole story is of the people who would go on to found Home Depot, none of them are like general contractors

Starting point is 00:09:32 or grew up in the hammer manufacturing business. It's people who just knew retail. These are retail guys, exactly. Well, retail and finance guys, as we'll see. Yes. So once Bernie becomes CEO of Handy Dam, he quickly recruits another younger company man from within the Dalin Empire. a financial whiz named Arthur Blank to come over to L.A. and join him as his CFO at Handy Dan. And Bernie, you know, he knows himself, as we'll see. He is an incredible retailer, an incredible CEO, an incredible leader. But his weak spot is finance. Now, you might be wondering, wait a minute, if Handy Dan is a subsidiary of Dalyan, why does it have its own CEO, CFO management team, Because Handy Dan was also a standalone publicly traded company. And Dalyan didn't own all of it, right?

Starting point is 00:10:31 It just owned the majority of the shares. Yeah. So Dailen had bought all of it. But then there was this kind of crazy fad going on on Wall Street in the 70s here, which we're into now, where conglomerates would spin off these little 19% equity stubs of their various divisions and then float them publicly on the stock market, 19% being below 20% so that the parent company could still consolidate the division's financials on their books. I see.

Starting point is 00:11:04 So it actually looks like, oh, no, this is a division of ours. 19% of it just happens to be owned by someone else. Yep. Yep. And the idea was that this would unlock value since these conglomerates traded at a discount to the value that they'd otherwise have if all the businesses were independent. Actually, in reality, it didn't work at all. In practice, most of these publicly traded little divisional stubs traded at a further discount to the parent company's already discounted holding company valuation.

Starting point is 00:11:35 So why is Dailen doing all this financial engineering? You know, I thought we just said that times are great for retail. The American suburbs are booming, et cetera, et cetera. Well, they were in the 60s, but now here in the 70s, retail is. is struggling. So we've talked about this period on a whole bunch of other episodes on Acquired, Vanguard most recently, but the 70s were brutal in America. There's the oil crises that hit, there's stagflation. Federal interest rates go up into the teens. Like the teens, can you imagine? Yeah, they briefly even hit like 18, 19%. And well, we'll get to the high point in

Starting point is 00:12:14 1980 in a minute because it's right after Home Depot gets founded. But this is bad for America, the economy, etc. This is really, Really bad for suburban retail. Shopping just dries up. And Dalyan starts totally sucking wind, except for Handy Dan. Right. It's like this crown jewel within an otherwise withering empire, right? Right. And it's all thanks to Bernie and Arthur. Because when they take over, as you said, they're not coming from the hardware business.

Starting point is 00:12:46 These guys are seasoned retailers from other parts of, you know, the retail sector. Hardware, home improvement as a concept, wasn't really a term yet. The hardware store landscape at the time was this hatchwork of clubby, regional, not very sophisticated and not very good businesses. And they've got limited assortment. They don't stock that many things. The market's super fragmented. And importantly, you couldn't actually go to one place to get everything. You'd go to some store for lumber, then a different store to get tools, and then another store for plumbing, supplies, electrical products, lawn and garden was sort of its own entire thing. These are all little specialty stores. Yeah. And so like if you're a consumer, if you're a suburban

Starting point is 00:13:33 homeowner and you've got a project that you want to work on yourself over the weekends. Which actually wasn't very many people. That sort of do it yourself for wasn't really a thing yet. Totally. I mean, it's Home Depot that unlocks that category because before Home Depot, you couldn't trust that you could get all the stuff you needed to accomplish your project, to build a deck or retail your bathroom or whatever you wanted to do around your house. You would walk into these little hardware stores and good luck, you know. So the biggest operator in the industry at the time was a company out of North Carolina called Lowe's. You might have heard of it.

Starting point is 00:14:12 Yes. Lowe's back then, despite being the biggest player in the hardware sector, was not. not the lows that you think of today. It had evolved out of the general store concept. It was all these small store footprints that we're talking about, like a fifth or less of the size of what you know as lows today. They're mostly in strip malls. And the whole company, Lowe's, is only doing about $150 million in annual revenue total. And my understanding of the store concept then is it's basically a hardware store or sort of a small showroom, not, you know, concrete floors and giant ceilings attached to a lumber.

Starting point is 00:14:48 Lumberyard. Yeah. To get a lumberyard, a nice little showroom. That's kind of it. The craziest thing about Lowe's is it was founded in 1921. Yeah, as a general store. Yeah. Right.

Starting point is 00:14:58 By this point in history, it's already 50 years old before the Home Depot has even been founded. Yep. So Bernie and Arthur, when they come into Handy Dan and this whole hardware sector, this is like bringing a bazooka to a knife fight. These guys are much more competitive, much more sophisticated. than the whole rest of the industry. These guys are sharp operators. They've done concessions. They've done discounting.

Starting point is 00:15:24 They've done pharmacy. Yeah. They're students of retail. Yep. So despite this like super tough overall retail macro, Bernie and Arthur turn around Handy Dan and make it the best operator in the industry. But that still doesn't save Dalen, the parent company, because they're so weighed down by their other divisions that they file for bankruptcy in 1975.

Starting point is 00:15:48 and they bring in a noted turnaround artist as the CEO to turn it around. We'll come back to that in a minute. For the moment, though, let's flash back over to the East Coast to a completely different character. The New York investment banker Ken Langone. This is your third superhero. You've got Bernie Marcus, the retailer. You've got Arthur Blank, the sort of finance and operations genius. And now you've got Ken Langone in New York.

Starting point is 00:16:18 Yep. And Ken, I think a lot of listeners will probably know who Ken Langone is. He is basically the goat investment banker. He came up from nothing as an Italian kid on Long Island, talks his way onto Wall Street. And basically, while he's still a kid, he ends up winning the sole IPO manager position for Ross Perrault's company, EDS. People today remember Ross Perot was like, oh yeah, that guy who ran for president in the 90s. But he was kind of like, he was kind of like, Larry Ellison of his time. EDS was this giant company. Yeah, and I was trying to think about the best way to frame EDS, maybe like a palenteer. They were very involved in government contracts. I mean, Ross Perrault's history, we got to do a whole Ross Perot episode at some point. But from his time at IBM, he kind of saw people are buying all of these mainframes, but they have no idea how to use them. I actually have to start like a top salesman at IBM before starting the company. a deployment and service arm for enterprise computing and government computing. And that sort of led him down this whole crazy path of building. What was then an empire in EDS would be small by today's standards. But he was a technology enterprise business magnet at the time. Totally. And based in Plano, Texas.

Starting point is 00:17:35 EDS has this long history. They ultimately get acquired by Hewlett-Packard and become HP Enterprise Services. So, yeah, bent exactly what you're talking about, data centers, mainframes, etc. etc. So fast forward on Ken, he'd end up sitting on the boards of the New York Stock Exchange, General Electric, many other great American companies. And famously, Ken has this total loyalty to every customer and every entrepreneur that he works with. He never sells a share of almost every company he's ever been involved in. We're going to talk about the almost in just a minute. So, all right, back here, we're in the mid-1970s after the EDS IPO.

Starting point is 00:18:16 Ken has just taken public a Philadelphia-based hardware chain, you know, one of these other regional players, a company called Panorama. And like everyone else, they've fallen on hard times. So Ken goes down to Philadelphia to see the CEO. And Ken's like, all right, well, who can we look at in the industry that's actually good? Like, what does best look like in this industry? Because it should be a good business. I mean, we will spoil it now, David.

Starting point is 00:18:44 We spent some time with Ken prepping for this episode, and his comment was, God is good as it pertains to hardware and home improvement. It's the gift that keeps on giving. We've built tons and tons of houses in America, and they need just an endless supply of stuff. It's almost like a subscription of recurring revenue if you're in this business to keep working on a home as the weather and time acts on it. And market and, you know, whatever changes. The rule of thumb is that homeowners need to reinvest about 1% of the house's then market value into their home every year just in maintenance before you get into improvement. Right. But in post-war America, they were building more and more houses every year.

Starting point is 00:19:27 The old houses they built were getting old. It's a great business to be in or it should have been anyway. Should have been. Should have been. So Ken says to the CEO of this company and guy named Gary, he says, all right, Gary, who's the best operator here? the business. And Gary said, oh, easy. Handy Dan, out in California. Those guys are the best. And Ken's like, Handy Dan, what are you talking about? I know Wall Street. That company's going bankrupt. Gary says, no, no, no, no, no. Their parent, Daylin is going bankrupt, but Handy Dan is doing

Starting point is 00:19:56 great. So Ken says, okay, wait, wait, wait, hang on. Let me go get my Moody's manual, because this is how you checked company financials back in the day. He pulls out his Moody's manual, his little book, and he's going through. He finds Handy Dan. He looks at the financial. is holy crap you're right this is a great business but yeah it's trading for three dollars a share and if moody's is right this company is going to earn post-tax net income of a buck 50 a share this year so this company is trading it two years of post-tax earnings so ken's like something has to be wrong is there like an accounting problem is there some trick in the reporting or or a gimmick here that I don't understand.

Starting point is 00:20:41 I got to dig into this. So he says, Gary, let's get, let's get Handy Dan on the phone like right now. I got to talk to these guys. So Gary calls up Bernie, gets him on the phone. And Ken's like, Mr. Marcus, are your financial statements true? Bernie says, yeah, yeah, sure. Business is doing great. It's the craziest thing that Wall Street doesn't appreciate us.

Starting point is 00:21:03 Ken says, Mr. Marcus, would you mind if I come out and see you in person? Bernie says, yeah, sure, fine. Ken says, great. I'm booking my flight right now. I'll be there for lunch tomorrow. Bernie's in Los Angeles. Ken is currently in Philadelphia. This is classic Ken Langone. So the next day, he flies out. They sit down to lunch. Bernie brings his lawyer with him to make sure he doesn't tell this crazy guy from Wall Street anything he's not supposed to. Right. If you're the CEO of a publicly traded company and some person who is discussing the price of your stock with you calls you and says, I'm so interested in I'm going to fly across the country right away. It's like, okay, I really got to watch what I say to this guy.

Starting point is 00:21:41 Yeah, yeah. So they have lunch and quickly becomes apparent that Bernie is a gifted retail operator. Companies doing great. The financial statements are all correct. So Ken says to Bernie, do you have any equity in this company? Bernie says, no, just an employee. You know, this is a Dalyan subsidiary, even though we're publicly traded. Ken says, okay, I'm going to go back to New York.

Starting point is 00:22:07 tonight. And tomorrow, I'm going to start buying every single publicly traded share of your company that I can get my hands on. I suggest that you go call up your banker and mortgage your house and do the same because your stock is about to go way, way up. Now, Bernie, this is exposing his weakness here with finance. While he's brilliant and street smart, he's also kind of it like innocent about Wall Street and finance and investing and all this stuff. And negotiating. Yeah. In some ways, he overtrusts people to.

Starting point is 00:22:47 He's weirdly risk-averse in this area. So he says, oh, oh, I can't do that. That's, that's too risky. You know, I've got a family. Ken's like, Bernie, Mr. Marcus. The stock market is based on supply and demand. I have enough money. I'm going to buy every single share that exists of your company.

Starting point is 00:23:05 The price will go up. There's no risk. Bernie says, nope, nope, I can't do it. And interestingly, when I read this, I was thinking, is this insider trading? I don't think it would have been at the time since Ken is an outsider just telling Bernie that he's going to buy the stock. So the information is actually market information, not inside information originating from the company itself. And Bernie's lawyer is, of course, sitting there listening to make sure. Yep.

Starting point is 00:23:29 So Ken says, all right, all right. I told you. He flies back to New York. He does exactly what he said he was going to do. He buys every single publicly traded share of Handy Dan, except for one block. All right. So I look this up, David, in the book built from scratch, which is the awesome book that is kind of the canonical Home Depot story written by Bernie and Arthur.

Starting point is 00:23:58 And so here's how it goes. There was this little block of 50,000 shares, which was about 2% of the company owned by the Brooklyn-based congregation of the most holy redeemer. So Ken calls the priests like he called up every other shareholder. And when Ken asks the church's financial officer, who is also a priest, hey, will you sell your shares to me? The priest pauses and he says, Langone, is that an Italian name? And he goes, yes.

Starting point is 00:24:28 And he goes, and are you Catholic? And Ken goes, yes, I am. And the priest says, then under the pain of hell, tell me what I should do. And Ken, you know, smiles and laughs and says, well, on these terms, you should keep it. Don't sell. You should hang on to your shares. So Ken started buying at $3 a share.

Starting point is 00:24:51 And by the time he was done, he bought almost 20% of the company. The last few shares that he bought were at around $9 with no float and no trading left. So it's essentially locked at that price. There's two plus a church shareholders of this business. And improbably, Ken going out and buying these shares leads to Bernie and Arthur getting fired and then founding the Home Depot. Which is in no way Ken's fault, but it is crazy that this is the first domino to tick over in that series of events. Right. This is how Ken Langone becomes a co-founder of the Home Depot is he gets his buddies Bernie and Arthur fired accidentally. Accidentally.

Starting point is 00:25:33 But before we tell that story, now is a great. time to thank our presenting partner, a company that we are big fans of Sierra. Yes. So on Acquired, we study the leaders of the greatest companies in history. And today, all of those folks are wrestling with basically the same question, what is my competitive advantage when everyone has access to the same intelligence? And what is the right way to turn AI into revenue for our company? Yep. And that's where Sierra comes in. First, your customer relationships are your competitive advantage. When you deploy Sierra's AI agents, those relationships get deeper with every customer interaction, generating insights that compound over time. Second,

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Starting point is 00:27:53 how you can build standout customer experiences that grow your business with AI, visit Sierra.a.ai slash acquired and just tell them that Ben and David sent you. Okay, David. So how does Ken hoovering up all the shares, even though he's sort of become buddies with Bernie and Arthur, how does that lead to their ousting from Handy Dan? Yes. So Ken is essentially like de facto board member now of Handy Dan. And he just loves everything that the guys are doing. He's super encouraging. He starts flying out to the West Coast and then around the country as Bernie and Arthur open new Handy Dan's. stores can basically becomes part of the crew, which is very different than the new Dayland CEO's approach to managing Bernie and Handy Dan. And quite bothersome. This guy who's the minority shareholder is sort of like closer with your management team than

Starting point is 00:28:51 you are. Right, that you consider one of your divisions in your company. Right. So on one of Ken's trips out to L.A., Bernie says, hey, you should probably go see our actual CEO at Dalyan, a guy named Sandy Sigeloff, and, you know, build a relationship with him. Now, Sigeloff, as we said, was brought in to turn around the company out of bankruptcy, and he's a bad dude. He's exactly who you would imagine is the bankruptcy value recovery artist here, shall we say. Yeah, didn't he give himself a nickname? Was it Ming the Merciless?

Starting point is 00:29:30 Yes, after the villain in the Flash Gordon comic series, and he called himself that because of how merciless he was to all the employees of these companies that he would slash and burn and get rid of. So Ken realizes right away that this Sigelof guy is bad news, but he's got this close to 19% equity position in Handy Dan. He's like, this guy can't walk all over me. All this leads to Ben, as you predicted, quite a lot of conflict between the two of these characters. And finally, Sigeloff says, all right, Ken, I want you out of here. I want you gone. What do I have to do to just buy back this 19% stake that you have? And Ken loves a good game here.

Starting point is 00:30:19 Okay, so Ken has no intention of selling here. Let's first say that. He is now in it with Bernie and Arthur. He thinks it's a great business. And loyalty is his whole MO. He never sells. Yes. So Sigeloff sends his lieutenant, Jeffrey Chaynan, to try to negotiate something.

Starting point is 00:30:37 So this is from the book built from scratch. Chaynan says, the stock is selling for about $8 a share. How about if we pay you $10? No way, Lengon says. The price is 12. Chaynan was shocked. Forget it. Langone left and went to the men's room.

Starting point is 00:30:54 Barely two minutes later, Chayin followed him in. Okay, he said, 12. Jeff, you don't understand. You offered to buy it for 10. I said no. I offered to sell it to you for 12. You said no. Now you are back wanting to buy it for 12?

Starting point is 00:31:09 That offers off the table. That is gone. We had an offer and a denial. No deal. Chaynen goes, what? Ken goes, I suggested a price of $12 in my office, right? Chan nodded. And you declined.

Starting point is 00:31:22 Well, that's it. I don't want to sell now. We're in the men's room now. Price is different. Chaden says, you must have some price. Okay, Ken says, $14. Chaited left in such a blind rage that he almost banged his head on the door. About a week later, Sigeloff called Langone.

Starting point is 00:31:37 Let's not mess around. He said, we will pay you 14. Ken goes, Sandy, you guys don't get it. I offered it to you for $14. Chaynen said, no, that offers off the table. I don't understand, Sigelof said. Ken goes, it's this simple. You had a chance.

Starting point is 00:31:52 You turned it down. I've reconsidered my position. I don't want to sell. Sigeloff hung up the phone, madder than hell. It's like, uh, is it in Empire Strikes Back of the... I am altering the deal. Pray I don't alter it any further is the Darth Vader line. So this continues for a while.

Starting point is 00:32:09 And then one day, Bernie calls Ken or Kenny as he's taken to calling him. Yes. He says, Kenny, just do me a favor. Just sell. Just sell to Sigel off. He's breathing down my neck. This situation's getting bad. It's making my life difficult.

Starting point is 00:32:25 Just sell. The business is doing great, so this is actually like my biggest headache. Yep. And Ken says, Bernie, what are you talking about? Don't you understand? Like, I am the only thing that is protecting you from Sigeloff. If I sell, he's going to turn around and fire your ass. He can't stand to see you being successful and getting credit for any success at Dalyan, you know, that's not him.

Starting point is 00:32:49 Bernie, though, again, he's like surprisingly trusting about this stuff. He says, no, no, no, no, no. Sandy needs me. I'm the only thing propping up the company. I'm a big boy. I can handle him. Please just sell. Make my life easier.

Starting point is 00:33:02 It's funny. I think it's actually this trusting nature of Bernie, even though he's got sort of a rough exterior that makes him a great leader. And then later on in Home Depot inspires such loyalty. He puts so much trust in other people, which steers him wrong sometimes. But it makes other people wholly trust him. Yep. So Ken says, all right, Bernie, I'll do it. But just know, it's your own death warrant that I'm signing.

Starting point is 00:33:30 And in early 1978, Ken sells to Sigel off. And this, I think, is basically the one time that he sells out of a company that he's invested in. But David, how much does he sell for? Well, even though he's going to sell, Ken is no pushover here. He sells for $25.50 a share that he started buying at three. Do you know over what period of time? I think it was only about two years, this whole saga. From $3.

Starting point is 00:33:59 His average entry price was probably, I don't know, $5,6. Yeah, $5.6, whatever. Up to $25.50 to sell. And the story is great where the Sigelof finally calls and says, all right, let's just do this on the phone. You name your price. I will buy it at that price. And Ken goes, 2550.

Starting point is 00:34:14 And he goes, why the odd number? And Ken goes, well, it's to look like we had some real hard bargaining here. So good. So good. So, January 1978, Sigeloff buys Ken's shares and now owns just about 100% of the company

Starting point is 00:34:31 except for the Catholic Church in Brooklyn. And then, just as predicted. Yep, just as predicted. Three months later, Sigeloff fires Bernie and Arthur and the audit manager at Handy Dan, a guy named Ron Brill.

Starting point is 00:34:50 The reason that Ron gets fired too is the pretense that Sigelof trumps up is an accusation that the three of them had violated national labor relations rules in negotiating with unions. Sigelhoff starts a labor relations investigation against his own company to trump up the excuse to fire them. That is how bad a dude this guy was. Yeah. And really what was happening here is Sigeloff, I think, couldn't do this while there was still a

Starting point is 00:35:21 large outside shareholder who would have disagreed with that decision. But now that he owns basically the whole company, he's like, great. I want to consolidate power. You guys are ready. I need to be the guy here. Yep. So famously in Home Depot lore, the next day after the firing, Bernie flies out to New York to come see Ken. Kenny. They sit down to breakfast together at Peacock Alley in the Waldorf Astoria Hotel. This is April 1978. Yep. And Bernie. Bernie is just losing it. He's freaking out. He's like, Kenny, this is terrible.

Starting point is 00:35:57 I'm 48 years old. I don't have any savings. I didn't have any equity. I can't support my family. Sandy's coming after me with this labor relations case. I don't know. I might go to jail. What am I going to do?

Starting point is 00:36:11 And Ken says, Bernie, relax. You just got kicked in the ass with a golden horseshoe. That's a verbatim quote, by the way. Because now we're going to go start that company that you told me about. So, listeners, we haven't revealed yet that in this fast and furious period, a few months before, they had had a conversation when Ken was flying around going all these store openings, when Bernie is opening a handy Dan in, I think it was Houston, Texas. Yep, Houston, Texas. And Bernie should have been all, you know, excited about this. This is the best version of the store yet.

Starting point is 00:36:48 And he's looking at Ken. And Ken's like, why are you melancholy right now? And Bernie says, because someone's going to put us out of business. I have in my head the idea of the perfect home improvement store, and this isn't it. And it's just a matter of time until someone does it. And it's going to destroy this store because it's just a structurally better business model, better idea, better thing for customers. So, you know, this is fine. And Ken's like, well, tell me.

Starting point is 00:37:18 And Bernie has started to learn a little bit. He's like, well, if I tell you, then you know. And right now only I know. So I'm actually, I'm going to hold on to it. And Ken's like, no, come on, dude, tell me. And so now Ken knows the idea, too. The reason that Bernie's so been out of shape about this is he'd just been down to visit one of his buddies, another retail guy down in San Diego, goes by the name of Saul.

Starting point is 00:37:48 price, that Saul price. Of Price Club and then what would eventually become Costco. Yep, yep, yep. And Bernie spills the beans to Ken and he says, well, I went to see Saul and he's got this new store concept that he's launching down there in San Diego. And I'm telling you, man, it's going to revolutionize the whole retail industry. It's just a matter of time before somebody brings Saul's concept to hardware, puts us out of business. to all sorts of other categories. We're all going the way of the dinosaur.

Starting point is 00:38:23 He's calling this thing Price Club. And the idea is warehouses. The warehouse is the store. Customers come in and shop the warehouse. So there's no backroom. All the square footage that we're paying money on on our lease is shoppable square footage. Yep. And even more than that, there's no distributors or wholesalers or anything. Price Club is the wholesaler. They're buying the goods directly from the manufacturers at wholesale pricing and then marketing it up just a little bit, selling it to consumers. This is blowing everybody else in San Diego out of the water. They're not even paying people to walk around and put the labels out. I mean, it's literally just people coming in to the

Starting point is 00:39:18 warehouse and buying stuff right off the palette, there's like no cost in this business. Yep. And there's no reason why it shouldn't work just as well in hardware. And someday soon, somebody's going to see Price Club. They're going to do this for hardware and we're going to be out of business. So cut back a couple months later here to breakfast at the Waldorf Astoria in New York. Ken's like, Bernie, you getting fired is the opportunity of a lifetime for both of us. you, me, Arthur, let's bring Ron along too.

Starting point is 00:39:49 We're going to go start that company. We got the golden horseshoe here. Yep. So Bernie's excited, but he says, well, there's one problem. What about the money? Arthur and I don't have any. And this isn't a handy Dan concept here. We're talking about a warehouse, but also a lot of stuff that we got to put in it.

Starting point is 00:40:08 And this isn't price club. We're not selling toilet paper and water bottles. We're selling expensive stuff. like power tools and lumber, we need a lot of capital to put into this thing. Yeah, Bernie and Arthur had gone away, done a little work, sketched out what the economics could be, and they realized even the best Handy Dan did about $3 million in annual revenue. I think these stores can do $7, $8,000, $9 million in revenue. And we're not just going to stock like 8,000 items.

Starting point is 00:40:36 We're going to stock 25,000 items. It's not a 10,000-foot store like Lowe's or Handy Dan. This is going to be like a 60,000 foot store. I mean, we need capital to make this happen. Yep. So Ken says, don't worry about the money. That's my job. I got it covered.

Starting point is 00:40:53 More on that in a sec. So Bernie's, he's in. He says, oh, okay. But someone I need to go talk to first. I need to go back down to San Diego and see Saul. Yep. Bernie goes back down to San Diego. He sits down.

Starting point is 00:41:08 He has dinner with Saul. He explains the whole situation, the firing from Handy, the labor relations suit from Sigeloff, et cetera, et cetera. Saul listens to all of it. And he says, Bernie, do you think you're talented? Bernie says, yes, I think I'm talented. I did a great job at Handy Dan. Saul says, do you think you have the ability to build something, to create something,

Starting point is 00:41:30 to do this on your own? Bernie says, yeah, yeah, I think this could be really successful. Saul says, then tell Sigelov to go F himself and just do this thing. And so is Saul's blessing, Bernie's in. And it's kind of important to keep Saul price in the loop because Bernie is trying to ascertain. Are you also going to meaningfully add home improvement to your concept here? Yes. I mean, it's an eerily similar thing.

Starting point is 00:41:58 They would diverge over time and we'll talk about all the differences. But the pitch is customers are going to love it because we're going to have the lowest prices. We're only going to make a 30% gross margin instead of what's industry standard in hardware retail at that time, 45%. it's going to be a little bit different than Price Club in that they actually think they're going to have the best selection. We're going to have tons and tons of skews. We're going to have tons of skews versus Price Club and Costco's famous low skew count. We're going to have the best selection. I mean, Bernie thinks that is essential to making this model work because it has to be a one-stop shop for any job that you want to get done.

Starting point is 00:42:32 You don't want to go to the outdoor lawn and garden store and over to the lumberyard and the tool store. Right. Yeah. being a warehouse unlocks putting all this stuff together under one roof for the first time. But it is different than the Price Club model of only having 4,000 items. They're going to have to have 25,000 skews in these warehouses and work with tons and tons of suppliers to make good on the promise that if you're doing something, it is the all in one place to shop for the job that you're getting done. And there is one other big difference, too.

Starting point is 00:43:09 people know how to buy toilet paper and how to use toilet paper. They know how to buy a big jar of nuts and eat a big jar of nuts. They don't know how to build a deck. Yep. They don't know how to install blinds. They don't know how to put in a floor. You need real expertise on the floor to make that happen. Yep.

Starting point is 00:43:30 So we already can kind of see there's two giant differences that I think Bernie is just trying to check on and say, you're not doing this, right? Because Price Club actually isn't set up to have an army of people with expertise and carry tons and tons of skews. Yeah, I think Bernie both really did need the pep talk from Saul and he also wanted to make sure. Yeah. Saul wasn't going to do this too. Yeah. All right. So back to the money. So who does Kenny know who has a lot of money and a lot of liquidity and is also just crazy enough to back a new retail concept?

Starting point is 00:44:07 here in the 70s with all this inflation and interest rates at 20%. And listeners, this is the part of the episode where we tell the story of how Ross Perrault almost owned the majority of Home Depot. Yeah, 70% of Home Depot because Ken flies everybody to Dallas, they meet with Ross, and they hammer out a deal for Perrault to put up the money for what would become Home Depot. $2 million. $2 million in return for 70% of $1,000. of the company. Except at the last minute, Bernie blows up the deal. He and Ross get into this big fight over management style and management philosophy.

Starting point is 00:44:47 And ultimately, the sticking point, you can't make this up. It's all inbuilt from scratch, is the car that Bernie drives. He drives an old Cadillac. Which was actually his Cadillac from Handy Dan that was his company car there, that somehow in the separation he managed to keep. but like old. This is not a expensive car. You know, fancy Cadillac.

Starting point is 00:45:11 This is an old fancy Cadillac. And Perrault says, hey, well, this is important to me. My guys, my guys here at EDS, they don't drive Cadillacs. They only drive Chevroletes. We're scrupulous here about our costs. Bernie's like, cost, what are you talking about? This is an old Cadillac. Right.

Starting point is 00:45:28 Practically, pragmatically, this is actually exactly in line with your ethos. Yep. And Ross's like, no, no, it's the principle of the thing. And it's a sticking point of two things. One, Bernie's like, no, we should be pragmatist. We shouldn't follow some dumb virtue signaling thing. But two, you're treating this like this is a division of your company, isn't it? Exactly.

Starting point is 00:45:49 You're treating me like an employee again. This is our company. You're the financier. This doesn't feel right. Yep. So he blows up the deal. And this might be the most expensive disagreement in a lot. all a business history. Let's see. I'll do the math here live on air. So 70% of a market cap of

Starting point is 00:46:14 350 billion. They did a ton of dilution along the way, but then counteract it with a ton of buybacks after that. It ends up being that the original seed investors in Home Depot today, if they held all the way through, would have had about 91% of their original percentage of the company. Yep. So Ross Perrault insisting on a Cadillac cost him $223 billion. Assuming he held. Assuming he would have held.

Starting point is 00:46:44 Right. Right. Which Ken did, by the way, still holds all his shares. Yeah, you didn't miss here, Ben, there, $230 billion. That's with a B. Dollars. Oh, man. So they're screwed, right?

Starting point is 00:46:59 I mean, there's not a lot of places to find the capital. This thing requires a ton of money to get off the ground. Yeah, for ordinary people, but they got Ken Langone here, the greatest investment banker of all time. So he says, no big deal. I get it. That was pretty heavy-handed a Ross. I'll just go round up a bunch of other investors instead, and we'll put a syndicate together. And, all right, let's rewrite the deal for this.

Starting point is 00:47:27 Rather than the investors getting 70%, let's give them 50% this time. And Arthur looks at him and he's like, wait, you mean we're going to get a better deal by walking away from Ross Perot to which Ken replies, Arthur, in the retail business, when you can't sell something, you mark it down. In my business, when we can't sell something, we mark it up. So great. Which is a little facetious. In my mind, what happened here is when you're negotiating with one counterparty that's coming in for all the capital. They have leverage. But Ken goes out and he finds 40 individual people. Yep, to put in $50,000 chunks.

Starting point is 00:48:11 Yeah. And so Ken basically writes the term sheet and then just going around all these people and saying, do you want to be in on these terms? It's kind of the, if you're a venture investor or you're a startup, it's the difference between you writing your own terms for the safe and writing in the number of the valuation and then just having people pile in on that number versus the lead investor coming in with a priced round, they get to dictate the number. and that number is usually not as friendly to you, yeah, as the number that you write on your own safe. Yep. It's still a great line, though. It's a great line. Totally sums up, Kenny. All right. So Ken gets the money and they all get back together in L.A. and they get to work.

Starting point is 00:48:48 And the way the cap table breaks down now is the investors own 50%. Ken gets 5% in exchange for, you know, putting this deal together, finding the capital. And I think he put in something like 100K of his own. Yep. He put in 100K. And then Arthur, Bernie, the rest of the management team would get 45%. And at this point, the founders of the Home Depot are set. It's Bernie, Arthur, and Ken.

Starting point is 00:49:14 For the moment. Yes. They are missing one superpower that you need in a Avengers of Retail team. Yes. Yes. Well, let's get to that. So Bernie and Arthur go back to L.A. and they get to work.

Starting point is 00:49:31 And the first question is, all right, where are we going to put the first store, the first warehouse? And as we talk about, warehouses are expensive. L.A. isn't great because real estate is super expensive. There are not a lot of empty warehouses lying around. And also, Handy Dan is still there. Handy Dan is still the best operator in the industry. Maybe not great if we start in our previous backyard here. We should go somewhere else in the country.

Starting point is 00:49:58 So they start scouting around, looking for other cities to go to. Before they can decide on a location, though, while they're still in L.A., they get wind that someone else has beat them to the punch, has been down to San Diego, seen Price Club, and has gone out and started Price Club for hardware for home improvement. And it's right there in L.A. It's a store called Homeco. and it's run by this wild man named Pat Farah. So Bernie and Arthur, they go to see the store, they walk in, and... It's the exact vision that Bernie had. Yep. It's 130,000 square foot warehouse.

Starting point is 00:50:40 Which is way bigger. It's not even Home Depot then. It's Home Depot today. Right. It's way bigger than those early home depots that would open that were like 60, 65,000 feet. Yep. It's got every hardware and home improvement item that you can imagine pile up high to the ceilings and price cheaper than consumers had ever seen it before.

Starting point is 00:51:01 In retail parlance, the strategy here is known as stack them high, watch them fly. I mean, it's a bonanza. The consumers walk in and they're like, oh, what? This is crazy. This is fun. It's like our Walmart episode where they were doing crazy stunts in the parking lot to attract people. It's a feeding frenzy. Yes.

Starting point is 00:51:20 So Bernie and Arthur call up Ken. They say, hey, I know this isn't the plan, but. We already found this thing fully baked right here in L.A. Fly out. Let's the three of us go talk to this guy, Pat, and see if we can just buy it from him. Buy the store. Buy Homeco. So Ken flies in, and I'm just going to read Bernie's description of what happens next here.

Starting point is 00:51:43 Pat, the Homeco, Bito, owner-operator here, was an hour late getting to his own store. When he finally showed up, the wild man with the huge Afro haircut, was wearing a powder blue velvet leisure suit that was one size too small for him. His ass stuck out the back of his pants. His shirt was unbuttoned halfway down his chest and he displayed a variety of gold

Starting point is 00:52:07 chains and a big old gold watch. Kenny shot Arthur a look that said, is this your idea of a joke? But Pat Farrah is one of the most creative people any of us had ever met. Pat is to retailing what Michelangelo was

Starting point is 00:52:23 to art. At least that's what Ken said. by the time the meeting ended. Or the way I've heard Ken describe this is Pat was crazier than a bed bug, but he was a genius. I mean, crazy, yes, but this is the missing piece of the puzzle. You've got Bernie the retailer, Arthur Finance and Operations, Ken finds the money and as sort of the spiritual glue holding this team together, but they don't yet have the genius merchandiser who is going around to suppliers, figuring out what the, best stuff you can get from them at the best terms, having a crazy nose for what consumers

Starting point is 00:53:01 want and making sure to find those items from the suppliers, cleverly figuring out how to display it and what the pricing and packaging looks like to whip consumers up into a buying frenzy. You've got to create heat in the store. Yes, yes. This is all of the universe of Pat. All Pat. And, oh, man, there's so many legends about Pat, including driving forklifts.

Starting point is 00:53:25 through walls, et cetera, et cetera, et cetera. Yeah, wasn't that like they wanted to tear down a wall, but they couldn't get a permit? And so Pat just drove a forklift into it. And when the inspector came out, he said, I don't know. Someone just is an accident. But we definitely got to take out this wall now. Yep. So despite the, you know, reservations about Pat's character, they sign an LOI letter of intent to buy Homeco from Pat.

Starting point is 00:53:51 with this new well-funded company that Bernie and Arthur and kind of started. They got $2 million. That's not nearly enough to do anything that they know. They're operating on a shoestring budget here, but I'll come back to that. Yes, yes. So they start digging in on due diligence on Homeco. And they discover that while Pat is a genius, all the revenue, all the sales, all the customer demand, it's all real. The store itself is actually insolvent.

Starting point is 00:54:20 because Pat has not been paying any of his suppliers. Pat needs an Arthur. Yes, yes, he does. He has just been ignoring the invoices that the suppliers were sending him, you know, 30, 60, 90 days later. I mean, that sounds malicious. I get the sense a lot of what he was doing was incompetence. Yes. Not.

Starting point is 00:54:41 No, he, yeah, yes. It wasn't that he was trying to steal the money. It was that he genuinely didn't know how to operate a business. He's like, I'd just go and go go get the stuff. And they bring in as a part of the due diligence on this auditors to look at, hey, are these financial statements correct? And the auditors determine, no, the margins at this store are not anywhere near what this owner thinks the margins are. And Bernie and crew have to break this news to Pat. And Pat's like distraught. He's like, what do you mean this thing's going to run out of

Starting point is 00:55:12 cash in the next few months? I'm doing great. And they're like, you're not doing great, man. Yep. But God bless them. And this is Bernie's trusting nature and optimism. They say, okay, we're not going to buy Homeco. You're going to go bankrupt. But we got to get you on the team. You are special. After you file for bankruptcy, we want you to come in and join us as our fourth full co-founder here. And you're going to handle merchandising. We're going to take care of finances and operations. You're not going to go anywhere near that. you are going to come in, you're going to stack them high, and we're all going to watch them fly. Yep. So I mentioned $2 million is not that much capital. They have to start getting really creative as they're thinking about the first store to make the business work on that.

Starting point is 00:56:03 So it kind of has two things it forces. One, they got to get the longest possible financing terms from suppliers. Yep. So, you know, once the goods arrive at the store, it's like a ticking clock to make sure that they can move these goods. So they don't want them arriving anywhere, you know, other than the day before opening day. Two, they have to try to turn their inventory as fast as possible so they can get as much cash in the door from customers to pay the suppliers when the bills came due. This is what Pat was not doing. So this resulted in about half of the Home Depot's inventory at any given time

Starting point is 00:56:38 actually being financed by the suppliers, which is still true today. Yep. Just based on payment terms, because they can sell about half the items before they'd have to owe those dollars to the manufacturers. Two, they realized they couldn't afford to extend payment terms to their customers. Now, they were already thinking this way, but what it did mean is they had to focus on retail customers, like consumers, who would just pay cash or, you know, credit cards when they're buying an item so that the Home Depot could get money right away versus businesses. Because the expectation with a business is I get credit at your store. They don't have the ability to offer credit at the store. So it's like, sure, if you're like a little pro contractor and you're expecting to pay in cash, we can deal with you, but we can't really deal with big businesses.

Starting point is 00:57:25 So they just have to be generally very scrappy in every area of their business to get kind of the most bang for their limited bucks, especially in the early days. Yep. Yep. And thus, the founding team, the Avengers of Retail is complete. They're all assembled. Bernie, Arthur, Ken, Pat. There's just a couple more things they need, you know, like a actual location and a name. But before we tell those stories, now is a great time to thank one of our favorite companies, WorkOS.

Starting point is 00:58:02 Yes. So listeners, there's this decision that every company faces once you find product market fit and you start scaling. What do you do next? But one big answer is move up market and find your first enterprise customers. Actually, it's funny, the way this fits into Home Depot is going after the first pros, not just these consumer customers. Yep. And today, the way you do that is WorkOS.

Starting point is 00:58:26 They make it easy to add all the things that enterprise customers require. Single sign-on, skim, permissions, audit logs, all with simple drop-in APIs. And this matters even more in the AI era, where products need deep access to sensitive data. to be impactful. But there's a new twist. It's not just your customers' employees who need to get into your app anymore. It's their agents. But-na-da-da-da. Which actually is a very Home Depot problem. About half of what Home Depot sells goes to a pro-contractor who is buying on behalf of a homeowner. It's someone else's money for someone else's kitchen that you're building and the scope of work that the pro

Starting point is 00:59:07 and their end customer agree to. Yep. Agents are like the pros. of software. They log in and take actions on behalf of the people who deploy them. Except the way most teams wire them up today is a shared API key or a borrowed human session, even worse. This is like handing your contractor a credit card and your house keys and just hoping a house comes out the other side. Or my new bathroom or... Yeah. Authentication used to just mean proving that you are you. Now it means proving that your agent is allowed to do this specific thing as you right now with limits. And that is what WorkOS has built the whole stack for. So their new system, WorkOS Airlock, doesn't just check which tools an agent can call. It checks

Starting point is 00:59:52 the user's original intent so that the agent that you sent into redo the kitchen doesn't decide to take out a load-bearing wall in the dining room. Which, you know, permissions tell you what an agent can do. WorkOS Airlock checks it was actually asked to do it. Turns out those are very different questions. Getting agent identity right is how you get in the door with enterprises now. It is why OpenAI cursor perplexity and friends of the show at Sierra and Anthropic, along with hundreds of other AI startups build on WorkOS. You can learn more at WorkOS.com and just tell them that Ben and David sent you. All right. So how is this company born in Atlanta? So far, we've been talking about California. So after the Homeco interlude and bringing Pat on the team, who by the way, we should say,

Starting point is 01:00:39 all those investors who lost money, Pat felt so bad that later on he would give them shares of his Home Depot stock equivalent to the value that they had lost in his first venture to make them whole. And, you know, if they held, that would be giant amounts of wealth for them in the long run. Yeah. So pretty quickly, they all decide on Atlanta, as you said Ben, for two reasons. So one, the demographics of the Southeast are good, promising. It's poised for lots of suburban expansion, even despite the tough climate of the 70s. But unlike California and the Northeast, which are already built up, good real estate locations are still pretty cheap and available there. Which leads us into the second reason they choose Atlanta, speaking of good real estate locations.

Starting point is 01:01:35 They end up getting a sweetheart deal from J.C. Penny, you know, like the big national department store chain. Yep. To sub lease a couple of their locations in Atlanta. J.C. Penny had started a Kmart copycat subsidiary. Is that what Treasure Island was? Yeah, I was trying to figure it out. Yeah, I think it was a Kmart copycat. Yep.

Starting point is 01:01:59 Ah. Yep. And it was in the southeast, and it was called Treasure Island. And they had great locations. I mean, J.C. Penny was like a big company, big national retailer, had a great real estate team. But the Treasure Island subsidiary wasn't working and it was failing. So they offer these crazy hardware startup guys four of the Treasure Island locations in the Atlanta suburbs. As a sub lease, right?

Starting point is 01:02:26 Yep, as a sub lease. Yep, at least to start. So Bernie, Arthur, and Pat, they all pack up their families. They move to Atlanta. but now they really need a name. They've got the locations that can open these stores. So they hire a marketing consultant who comes up with a great idea. Can't wait to present it to the team.

Starting point is 01:02:45 Bad Bernie's build-all. It's alliterative. Get it? Like, it's awesome. You're Bernie. You're bad Bernie. And we're going to have all this, you know, advertising that's going to be you behind bars in jail. Like, they put me in jail for these prices.

Starting point is 01:02:59 They're too good. Is that what the schick was? That was what the schick was going to be. I could not figure out why they would want to call it bad Bernie. Yeah. Oh, that is awful. It's like, he must be a crook because these prices are too low. Which, of course, is exactly what the loan officer wants to hear at the bank.

Starting point is 01:03:17 Yeah, exactly. I mean, speaking of being scrappy, they're just constantly going to lenders and trying to get capital so that they can buy inventory. But they're just trying to get loans so they can run the business. Yep. So obviously bad Bernie's build-all is not going to cut it. So Ken goes to the investor group that he put together to solicit ideas. And the wife of one of the investors suggests the Home Depot. And it sticks. Now, none of the guys ever wrote about this. So I don't know if this was part of the process or not. I don't know if it was. intentional or not, but what are the initials of Home Depot? And the stock ticker today.

Starting point is 01:04:09 And the stock ticker. Yeah. HD. Where did they get fired from by Sandy Stigeloff? Handy Dan. HD. Nice little homage. A tweak, shall you say. A little nod. Yeah, let's put it in a positive spin.

Starting point is 01:04:24 A little nod. Yes. Turns out, though, the consultant who came up with Bad Bernie's build-all wasn't a total waste. Because he's the one who suggests that they adopt the color orange as their company color. Because it would stand out. And because, Ben, like you're saying, they're trying to be so cheap. They could buy circus tent material like canvas for orange circus tents and use it as their signage and save money on that.

Starting point is 01:04:53 And that's how orange became the Home Depot color. Perfect. Which is totally brilliant. I mean, it's distinctive. The orange apron stand out. It's distinctive. It's great. Yep.

Starting point is 01:05:02 So that leads right into the opening of the first two Home Depot's in Atlanta on June 22, 1979. They open two stores, same day. And this all happened pretty fast. This is just over one year from when Bernie and Arthur and Ron get fired from Handy Dan. And it is obvious that it happened fast when you look at some of these pictures. listeners, we'll put some in the email. It's very clearly a big hardware store operating inside of a Kmart. I mean, it looks like that.

Starting point is 01:05:42 They describe the concept in all the books they've written and all these accounts of early Home Depot as this vast warehouse with tall ceilings and merchandise piled to the ceiling. But the early pictures are, I swear, Kmart's or even kind of JC Penney's. It's pretty low ceilings. The racks that things are on are like standard Kmart style racks. It's nothing like the Home Depot that you know of today. The floors are this sort of like linoleum type floors. And so, yeah, they're selling table saws and hammers and lumber out of discount.

Starting point is 01:06:24 Kmart knockoff. Kmart knockoff, right. Second use real estate. Yep, yep, yep. There's some pretty fun legends around all this, around the first store openings. The first of which is that they decide they're going to go big, blow a lot of the budget on a huge newspaper ad in the weekend paper that week to really drive. How you want to drive homeowners to your store. Well, weekend newspaper delivery highly correlated with homeownership.

Starting point is 01:06:55 which is why they did four stores, I mean two right now, but then quickly two more in one metro, because they wanted to, much like our Trader Joe's episode, amortize the cost of their advertising. Exactly. If you blitz one local geographies, radio, TV, newspapers, then you can kind of like justify the cost of all of that marketing expense if you have stores in different zip codes around the city that can all benefit from that same marketing. And this is actually the playbook that they would run for the next 45 years, is open in one city, saturate that city, become number one, and then move to the next city. Don't, like, sprinkle some stores here and there, no, go into a city with force. Yep, yep, yep, yep. So all this sounds good on paper, except there's a mix-up, and the newspaper ad doesn't run.

Starting point is 01:07:48 So they got, whoops. Nobody knows about these stores opening. Instead, Bernie and the store associates, like the retail workers on the floor in the stores, they go out into the parking lots of the two stores with a bunch of signs advertising that they're giving away free $1 bills to lure people into the stores. It's inauspicious beginning to Home Depot here. The other great legend around the first store openings is that the night. beforehand, the two store managers of the two locations get together. They've got a great idea. They're going to impress the founders.

Starting point is 01:08:29 They have a cleaning crew come in and polish up the linoleum floors as a surprise for everybody coming in in in the morning. That's all going to look great. And Pat Ferra comes in at like four in the morning the day of the opening. He sees the polished floors and he goes nuts. Oh, yeah. That was like a thing with this entire company for decades is that they all worked from like the wee hours of the morning and it was just like expected of the entire culture is if you're not sleeping you're here working and also it's fun like it's a party and we just work all the time and all of us do it yep so when pat sees these sparkling clean floors he loses it he calls bernie and arthur he gets him out of bed and the three of them come in and they start careening forklifts around the store floor to scuff up the linoleum so it looks like it was big

Starting point is 01:09:21 busy. Pat's like, we can't have this be clean. It looks like nobody's been in here. And it sends the wrong message. I think they sprinkled some sawdust, too. This is supposed to be a place where people who are actively working on projects come in the middle of their project, and they're like in work boots, and, you know, the store should feel like a place you're not afraid to mess up. We need it scuffed up like a Home Depot. Yep. Bernie's a quote about this that he would write is our stores, our action places. Yeah. And also, we're going to get to this later, but Part of the Home Depot's business model, and part of the big giant reason that it works is if you are mid-job, the Home Depot is the place that you use for real-time replenishment. So sometimes that means if you are swinging by every morning on the way to your job site, sometimes it means that if you're a pro, yep.

Starting point is 01:10:10 If you're trying to fix a deck and you realize, oh, crap, I've got the wrong nails, then you can go get the nails mid-project. But they wanted it to be a place where they could treat it like. the outsourced back office storeroom inventory that was reliable and you could count on and you could get in a just-in-time way whenever you were working on a project. Yep. Whether you're a pro or a homeowner. Yes. And it sure better feel like that.

Starting point is 01:10:36 Yep. Another classic story is their capital constraint. They don't have enough to actually buy all this merchandise and store a huge amount of inventory and stack it all the way to the ceilings. But they want to create the illusion that they, do for customers. And so a week before opening, they didn't have enough merch to fill the whole store. So Pat Ferrer calls the Delmar Cabinet Company and asks if they can borrow, not even buy, borrow 500 boxes of all different sizes. So the team stays up all night, folding them and

Starting point is 01:11:10 putting them on the racks around the stores. And apparently, I haven't seen this video, but they filmed themselves walking around the store because it looks so, in their words, fabulously legitimate that they had this big expansive inventory. And they did the same thing with paint stacks. Pat found 2,000 empty paint cans for each store. And they put special little labels so they would know not to investigate too significantly, but stacked them 10 feet high. Whenever I go to Home Depot now,

Starting point is 01:11:40 I'm going to have to start knocking on cans and boxes and make sure that they're actually cool. Capital constraint is no longer their issue. Yeah. So despite the, rocky launch of the first few stores. Within a couple months, they do get all these kinks ironed out. And the first stores start humming. By the end of the year, that first year there in 1979, they open the third store in Atlanta. And they do $7 million in total sales for just that like six month operating period of the first year. So like startup retailer, $7 million in,

Starting point is 01:12:19 sales across two and then at the very end of the year, bringing online a third store. This is right on with their aggressive financial projections that Ben, you were talking about, that they needed to make this work. And part of the appeal is they're blowing stuff out. I mean, a friend of the show, Arvin Navaratnam, who I'll bring up several times on this episode for his extensive research on the retail sector and especially Home Depot, he found that they were in the early days 10 to 25 percent below. the prices of their competitors.

Starting point is 01:12:52 And they did this through all the ways that you would expect, and we've talked about on the Costco episode, they're getting deliveries directly from the manufacturers on a palette into the store. So they can take relatively low margins, not Costco low, but 30% gross margins on these products. And they can offer these screaming deals. I mean, 10 to 25% below that of competing retailers, this should create crazy word of mouth.

Starting point is 01:13:19 You got to see the store. I just went. They have everything. I'm like discovering new projects to do. And it's all cheap. It's amazing. Yep. I mean, just like Costco.

Starting point is 01:13:29 No-brainer proposition to the buying public. And it's a different take on the classic retail triangle of price selection and convenience. You usually have low prices, large selection, and high convenience. And they definitely have low prices and large selection. It's in some ways not. high convenience because what's high convenience to me is I can walk literally two blocks from here to a hardware store. Granted, it's low skew count, but it's close.

Starting point is 01:13:58 This element, this twist on convenience is, yeah, you're going to have to drive kind of out into the sticks or here in Seattle, you know, down south of downtown, you know, in the neighborhood of Soto, but you can get everything. You only need to go to one store. It's one trip like we've been talking about. Yes. So the model starts to work quickly. And the flywheel here is getting spun up in Atlanta.

Starting point is 01:14:21 And then the next year in 1980, J.C. Penny calls him back again and says, hey, we're finally going to pull the plug totally on this Treasure Island thing. We got a bunch of locations that are now going to be empty down in Florida. Do you want them? And yeah, of course they want them. Right. The whole plan here is expand nationally. and this is great real estate. Like, we should jump on this.

Starting point is 01:14:50 Yep. There's just one problem, which is they are maxed out on capital. So in 1979, that first six-month period that the company was operating, they lost about a million dollars. So one out of the two million dollars of startup capital was blown in 1979. In 1980, this next year, they made a million dollars in profit. Like, this is incredible. This shows how well the model is working.

Starting point is 01:15:16 It's already profitable, and I think basically would be profitable for every year here on forward. I think they had one year where they had negative earnings, and then after that they've been a profitable company their entire life. Yep. Going like gangbusters. But that's not enough capital to take over all these leases in this great real estate down in Florida. So once again, Ken Langone says, no problem. I got this. We'll just go public.

Starting point is 01:15:46 Now, this is a crazy idea in any market. The pitch here, to be clear, is we are going to take a four-store chain. They've now opened the fourth store in Atlanta public in 1981 here when interest rates are hitting their all-time peak of 20-plus percent. Can you imagine this pitch to Wall Street? You know what people don't like to do when interest rates are really high? buy speculative new IPOs, even though, in theory, valuations should actually be depressed when interest rates are high. So it's actually a great time to be investing because you can pick up equities and income generating assets for cheaper than in low interest rate times. Ben, are you suggesting that recessions are the best time to push your chips in?

Starting point is 01:16:38 Call me Warren Buffett over here, David. So, you know, once again, Ken is like, I got this. But by this point in time, he is no longer an active investment banker himself. He's just a principal investor now. So he can't lead the IPO himself. He calls up his buddies at Bear Stearns, and he strong arms them into taking on this crazy IPO. Bear agrees, and they set a target of raising $6 million. And I think Bear was not interested, but then Ken called some other investment banks who said, oh, we're interested, and then Bear got interested.

Starting point is 01:17:15 Yeah. As it always works. Ken knows how to get deals done. Yes. So of the $6 million target, the plan is that half of that is going to be for expansion capital to go down into Florida and take over these leases. And half of that money is going to go to the initial seed investors to cash them out at close to a 2X in, you know, call it a year and a half, two years here.

Starting point is 01:17:41 Great deal. Great deal. Great deal. right? Fortunately for those investors, the week before the IPO, Bear calls up Ken and they say, hey, we took this thing on as a favor to you, but in this environment, we can't get the full $6 million deal done. We're going to have to cut this thing in half. We can only sell $3 million. So Ken goes back to the existing investors and says, we're just going to let, our investment ride.

Starting point is 01:18:15 Rather than cashing out at a slightly less than a 2X, you have to stay invested. We need all $3 million that we were able to raise to go to the balance sheet so that we can do this expansion. Yep. Which, if you do the math, that $2 million from the initial Home Depot investor group bought 50% of the company in 1978, by not cashing out here at a 2X return, those investors, if they held to today, would have gotten well north of a 50,000 X return on their capital. Check my calculator, but I think it's better than the 2x.

Starting point is 01:18:57 Yep. So the IPO gets done. They end up raising a little bit more than three. They raise $4 million in total in the IPO at a $32 million initial market capitalization post offering. which this listeners is part of the reason why it's a better investment than Apple since IPO and, you know, since many other companies. Individa, et cetera. It went public at a tiny, tiny market cap. I mean, you could get in as a public shareholder at a $32 million valuation.

Starting point is 01:19:32 I mean, even if you inflation adjust that, that's $122 million today. Just think about that. A company went public at a total market cap. of $122 million. It had so much running room ahead of it. That is how you get that giant multiple sense IPO that the public had access to. Yep. But you needed to be, well, I was going to say crazy, but you needed to have vision to do this.

Starting point is 01:20:00 I mean, it's IPOing as a four-store hardware chain in Atlanta. This is not anthropic here where everybody knows them and they're giant. a household name, right? This is a four-store chain in Atlanta. Yeah. So after the IPO, they go to Florida, goes great. Next, they go to Texas by actually acquiring a copycat chain that had sprung up called Bowwater. That was a bad idea and cost the company a lot of time remaking those stores. But they turn it around. They're successful in Texas. Then they go to the West Coast. They go back to California. They beat Handy Dan. They go to the Northeast. than national rest of the country. The company is just like on a tear.

Starting point is 01:20:46 Yep. As of the IPO, they were tripling year over year in revenue. In 1984, they hit 31 stores. So that's Georgia plus Florida plus Texas. They're solidly a multi-regional chain here. Yep. And then quickly after that, in 1986, they hit a billion dollars in sales. With 60 stores.

Starting point is 01:21:07 They don't stop there. In 1989, they pass lows to be. become the largest home improvement retailer in America. Also, in 1989, Handy Dan goes out of business. They finally get their clock cleaned by the new HD. Meanwhile, Home Depot is now up to 118 stores nationally. Yep. So it's this interesting question here. We've talked about how they speed ran to a billion dollars in revenue and 100 plus stores. National market leader in less than 10 years. Right. Kind of ridiculous. The model, at least as we've explained it so far, clearly works at scale, but you should sort of have this question in your

Starting point is 01:21:47 head of, well, how did they do all that when they had $2 million and just a scrappy team? I mean, this was a shoot the moon strategy. It needed to grow fast in order to make it work. They needed to have a flood of customers on day one at the store in order to justify all the different inventory that they had. And they needed to have a flood of customers on day one at the store in order to justify all the different inventory that they had. And they needed to have suppliers give them great deals, even though they actually didn't have any proof points that they could sell in volume. So I don't know, how do you think about why they were able to sort of act like a scale company even when they weren't at scale yet? I think it was that they combined Pat Farah's aggressiveness that he

Starting point is 01:22:34 put together at Homecoe with Bernie and our three. There's operations and finance genius to just barely make it all work. And a lot of illusion along the way where they can sell the dream. And selling the dream is fine if the dream comes true. It's only bad if you promise people all this volume and then you can't get any volume. But, you know, as long as- Specifically selling the dream to their suppliers, to the manufacturers. Suppliers.

Starting point is 01:23:01 And to financiers to like max out the amount of debt that they would extend this company. All the debt capital they were raising. So there's a great quote in built from scratch that I think kind of addresses this point. Because this was a disconnect I had the whole time of, in theory, you shouldn't be able to start like this. And I think it addresses the uniqueness of the people. We had to be psychologists, lovers, romancers, and con artists to get our suppliers aboard. Our ability to paint a picture of how that would take place. The lowest prices, the widest selection, and great customer service was what convinced skeptical manufacturers to sell merchandise to us,

Starting point is 01:23:37 those early years. We didn't have the buying power of our established competitors. On paper, we couldn't compete with Handy City or Handy Dan, but we were good at selling futures. You need to do this for us now, we'd tell vendors, because down the road, we will have 50 stores. Eventually, we will be the biggest in the industry, so now is the time to get on board. And as in any long-term relationship, the key was getting to know the vendors and at the same time understanding what motivated them. Then we motivated them. We appealed to their greed, we appealed to their enthusiasm for new concepts, we appealed to their need to get their products exposed. It's like sheer force of will keeping all these plates spinning and convincing everyone in

Starting point is 01:24:17 your ecosystem that you're legit. It's why you needed the Avengers to do this. Right. And it's fine to sell the future as long as you make the future come true. American enterprise system here, the worst thing that happens if it doesn't work is you declare bankruptcy and like Pat Ferre, you go join the next thing. Yes. So I think this is actually the perfect place to really talk about what the model is.

Starting point is 01:24:43 And why here now we're in the late 1980s, there is capital available. It's the go-go-1980s. Why are copycats not emerging well-funded with a lot of capital to just come eat their lunch and do this too? Well, there were copycats. I mean, there were other large format hardware home improvements. stores. I mean, I've been to a builder's square, I think, when I was a kid. Yeah, yeah, yeah. So, yes, exactly. This did happen. A lot of capital rushed into the space trying to do this. Yeah, Builder Square. Home Club, Homequarters Warehouse, Mr. Howe Warehouse. These are

Starting point is 01:25:22 all copycats spun up in the 1980s. None of them are around today. Okay, so why? The answer is that as Home Depot scales, it's not just Costco for hardware. Costco, is a general merchandise retailer, like you said in the intro, Ben. And Home Depot is a specialty merchandise retailer. On the surface, these things look kind of similar, like a Home Depot store looks like a Costco store. But in specialty retailing, it's not enough just to have the classic holy trinity of price selection and convenience that Walmart and Costco and Amazon are all.

Starting point is 01:26:05 built on, you also need to serve the customer in ways that are wholly unique and specific to each specialty market. So if you think about like tire and auto shops, they need to offer fast quality installation of tires and auto parts, right? Or beauty, right? Like beauty needs to offer in-store sampling and makeovers or even like Apple and Best Buy. They need to offer the genius bar and the Geek Squad to help with troubleshooting, specifically expertise that serves the customer. Nobody's serving the customer in a Costco except at the checkout aisle. It's like you go grab your toilet paper. Right.

Starting point is 01:26:46 The whole point is that we don't actually need to have that many people in the store serving you. Right, right. That's how we can pay our associates so much. That creates so much goodness in the model. Yep, yep. Home Depot basically invented what serving the customer looks like. in home improvement. Before Home Depot, there basically was no customer servicing in hardware. It was like you walked into a hardware store and good luck. If you knew where things were, good. You know,

Starting point is 01:27:14 if not. And we're generalizing here. I'm sure there were amazing associates at amazing hardware stores all over the place. But there wasn't this idea that I went to a Home Depot last week as I was prepping for this. And this was after I had, you know, read some books and I had seen all the stuff about Home Depot's unique culture and their obsession with serving the customer above all else. And we drop everything in order to serve a customer. And there's even stories about people at headquarters who will pick up the phone in the middle of a meeting and interrupt corporate work because they actually need to take a call from someone who is on the floor with a customer to address a customer-specific concern. I mean, the culture is this sort of service and customer-obsessed

Starting point is 01:27:55 orientation. Ben, I noticed you said headquarters there. I don't think Home Depot has a a headquarters. That is correct. They have a store support center because headquarters merely exists to support the stores. Yes. Yes. Atlanta for Home Depot, the corporate address is the store support center, not the headquarters company. But that's powerful to name it that and sort of instill that in the culture. Totally. Totally. So I promise you, I wasn't like secret shopping and trying to prod for these questions, but I was making a copy of a key while I was there. And I asked the associate how his day was going and this was like the eighth associate that walked by and it was chalk full of staff and this guy the words out of his mouth where it's going well I have like eight things on my to do list today

Starting point is 01:28:38 I've gotten a none of them because customer always comes first and I've had so many interesting customer problems come up today I mean it is this like very real customer service oriented mentality yep and I would say that's the culture still to this day with some bumps around the road that we'll get to as we go but what I mean though when I say that Home Depot invented what servicing the customer means in this segment, was that before Home Depot, nobody would teach the customers how to accomplish their projects. Like, if you were just a DIY homeowner, you had no way of obtaining knowledge about how to build a deck or how to retile a bathroom. Like maybe you could go to a bookstore and buy a how to book, maybe if you found one for what you were looking for.

Starting point is 01:29:26 No, you're hiring a contractor, who knows how. Right, exactly. But people want to work on their own homes. This is the unique thing that Home Depot figures out as they scale. They actually need to bundle education with the products that they're selling their customers. And rather than going out and hiring separate teachers that are going to run clinics in Home Depot, they just recruit employees from the trades who are professional tradesmen contractors to come. be their retail staff in the stores.

Starting point is 01:30:01 And then they create a culture of, hey, anytime a customer comes in and asks you how to do something, stop what you're doing. You know how to do this stuff and explain it to them. Show them. Get some products out. Show them how to build what they want to build. Which is crazy, right? If you have a reasonably high paying job as a contractor, switching gears and taking a retail job is typically not on people's bingo card. Good point.

Starting point is 01:30:25 You would think on the surface that this is crazy. and this is what all the copycats miss. They just hire regular retail employees like Walmart does or Costco does or Target does or what have you. Actually, though, if you're a tradesperson, there's a pretty good chance that a Home Depot job might be appealing to you. So back here in, I don't know, call it 1985, 1990, imagine you're a plumber, you're an electrician, maybe you're a carpenter. sure, you can make more money in your trade than you can working at Home Depot. But being a contractor is not easy, like even if you're successful. One, it's not steady.

Starting point is 01:31:10 Cash flow is lumpy and unpredictable. Two, it requires a lot of driving. And then three, it's manual labor. Like, what are you going to do if you get old? What are you going to do if you get hurt? What are you going to do if you can't work? Do you have a retirement plan? Well, if you're in a union job at like a big, you know, commercial constructor, sure.

Starting point is 01:31:34 But if you're working residential, you're probably not in a union. You probably don't have a retirement plan. You probably don't have a fallback of savings. Okay. Now Home Depot comes to town and they're recruiting. It's a stable job with regular hours, with other people like you. You don't need to drive around. you don't need to manage clients.

Starting point is 01:31:57 Yep. You need to stock the shelves, but it's not hard labor. It's pretty attractive. And there's all sorts of benefits to the Home Depot long term of doing this. The most obvious of which is if a former tradesperson works in your store and they meet with a customer trying to do a pretty simple project, hey, I need to paint the walls of my living room. You do that and you have a pro help you pick out all the right stuff you need and get the right amount of paint. You suddenly feel empowered. And you're like, you know what?

Starting point is 01:32:22 I'm going to try drywall next time. And your basket size at Home Depot over the years and the scale of your projects goes up and up and up if you have good education and good service. So today, all this that we're talking about sounds like, sure, nice. I can go talk to the associates at Home Depot and they used to work in the trades and they can help me with my projects. You got to imagine back in the 80s and 90s before the Internet and before YouTube, this was the only way that you were going to be able. to even attempt to learn how to do this as a homeowner. Yep. And so unless you copied Home Depot's labor employment model,

Starting point is 01:33:02 you weren't actually going to be able to make the model work like they did. And it's not just the employment model. There's a lot of other elements that kind of have an escape velocity component. Yep. So we talked about who's in the stores. Then there's what's in the store. At its core, it's the warehouse concept. You're eliminating middlemen. You're not paying distributors.

Starting point is 01:33:20 You're shipping directly to the stores. you're passing savings onto customers, lower margins than elsewhere in the industry. This leads to you having the lowest prices. This is a well-understood warehouse model at this point. But they have something working against them, which is super high skew count and lots of associates doing all this service. So they sort of have to figure out how to succeed despite sort of two big strikes short-term against the business model. Those are great- economics of the model. Long term, right, but it is horrible operationally having lots of skews. It's

Starting point is 01:33:55 hard to turn them over quickly. You have a bigger payroll at each store than you would in a price club-like model. So what are all the elements that make up for it and make it worth those investments? You have to encourage a buying frenzy. That is a huge part of making this work. When you have so many skews, you have to have reasons for people to buy. all of them. And if you have low gross margin percentages, that can be okay as long as people are buying lots of items and coming back and buying them often. Because it's not the gross margins percentages that put food on the table. It's the gross margin dollars that put food on the table. So you're just trying to sell enough volume and turn everything over fast enough that

Starting point is 01:34:43 those gross margin dollars add up and justify holding all of that inventory. in a Home Depot. So it's the crazy stunts. It's the heat in the store. It's the one-stop shopness. So you buy a bunch of things. It's starting to work with pro-contractors as customers because they're going to buy huge amounts of things every week. They're going to be repeat buyers. Again, the whole goal here is we actually don't generate that much margin percentage. We have lots of skews and we have lots of inventory of each of those skews. So how do we get as much volume as possible? So if you succeed in that, and you're doing your job and you have stuff flying off the shelves, that means you can place ever larger orders with suppliers, and that means you can ask for ever lower prices

Starting point is 01:35:29 on your bulk orders. So you either can harvest that extra margin for yourself, or what the Home Depot did, at least for a very long time, is pass that along to the customer, make the whole thing spin faster of, oh, my God, they have even lower prices. So to summarize all this, friend of the show, Arvin Navarotnam at Worldly Partners, has studied this company at length, and I'm just going to quote from his 100-page study that we'll link to in the show notes. The big box warehouse format itself was the most visible innovation at the time in 79, but the more enduring advantage was the operating system beneath it. Home Depot built a high-volume model and shared the benefits of scale with customers, generated greater traffic, strengthened supplier relationships, supported a broader assortment, and reinvented. invested the resulting productivity into stores, associates, logistics, technology, and price,

Starting point is 01:36:19 creating a self-reinforcing flywheel that became increasingly difficult to replicate as the company scaled. And there's one more element, too, that turbocharges the whole thing, which is the company's stock price. And the fact that employees all the way down to and including the retail associates on the floors, the good jobs for the former tradespeople, are getting equity in the company. So you're probably listening like, wait, what, how does the company's stock price make this model work better? A big portion of the associate onboarding and training was about the stock and the stock price

Starting point is 01:37:02 and what equity is and building the connection between the stock price and your work on the floor. And it's all possible because the company went public so. early. Right. There was so much upside remaining. Yes. So for these early associate employees of the company, they build this real link and culture among the labor force of, hey, I serve my customers well on the floor of the store. I help them complete their projects. They come back. They buy more. My store sales grow. The company's revenue goes up. And the company was small enough back in the early days that this made an impact on the company's revenue. The stock. then goes up and then I get rich, like really rich. There are thousands and thousands of early

Starting point is 01:37:52 Home Depot associates who became multi-millionaires because of this. When we were talking to Ken in research for this, he put it this way to us. When you tap into people's basic instincts, good things happen. Yeah. I mean, if you come from a Silicon Valley tech startup, this is second nature to you. But this really wasn't done in retail. This is really the first time that a scaled company, sort of at mass employment, has retail employees who are participating in this, like, giant wealth generation machine. And because it was compounding at 25% per year, I mean, it's the best thing they could have put their money in. The way it worked was if you were a salaried employee, which started at assistant store manager, you got stock options. If you were an

Starting point is 01:38:39 hourly employee, you couldn't be granted stock options, but you got this stock purchasing program, which in the early days they set up as you can buy stock at a 15% discount to the current trading price and we'll give you a no risk guarantee. So if the price ever goes down below what you bought it for, we will fill the gap for you. And then they did all this education to the associates and say, hey, you really need to do this. And the whole thing works because they were able to position it to Wall Street as a growth stock. If you don't have a financier who's doing that or you don't have the business results to justify it, then this cool party trick doesn't do anything for you because the people aren't in the break room getting rich. Yes. And it all comes back

Starting point is 01:39:23 to the specialty retailer model versus general merchandise. Let's say your Costco or Walmart, you set up the same thing. No associate on the floor is going to be that good customer service that a customer is going to come in and buy $10,000 worth of toilet paper. Hardware and home improvement is different. So there are these legends within the company. The one that gets told often is the faucet washer that leads to a kitchen remodel. So legend is customer comes into the store with a faucet that he's brought in from his kitchen sink. He says, hey, my faucet is leaking.

Starting point is 01:40:06 I think I need a new faucet. I know it's probably going to be a couple hundred dollars. And the store associate, who has plumbing experience, looks at the faucet and says, oh, no, no, no, you don't need a new faucet. Like, we can fix this. Let's go get a new washer. That's all you need. We'll get a new washer.

Starting point is 01:40:21 It's 25 cents. Install it. And, you know, you're going to be good to go. They do. The customer's so happy. He goes home. He tells his wife and family. Next thing, you know, a couple of weeks later, he's back.

Starting point is 01:40:33 And he says, you know, we've been thinking about a kitchen remodel. we're going to do it with you guys here at Home Depot, and it's $100,000 sale. Because of hardware and home improvement in this category, this stuff happens and customer service directly drives it. Yep, yep, that's a great point. The continuation of that story is that someone makes a comment like, boy, your boss is going to probably fire you. You could have sold a $200 faucet and you only made $0.25 on the washer.

Starting point is 01:41:02 You're probably going to get fired for losing that sale. Bernie Marcus hears about this, and he's like, calls the... the guy and says, I think we should promote you. Thank you. That's the exact right customer service mentality. We're going to give you another equity grant right now. Right. So listeners, a fun aside, one fellow listener and friend of the show is Frank Blake, who famously

Starting point is 01:41:22 was the Home Depot CEO going into and navigating the company through the Great Recession, 2007 through 2014. And he gave us this great quote when we were talking to him for research. He said, the best sign of cultural health is, walking into the break room and seeing the associates watching the stock price. We want that. We encourage that here. Yeah.

Starting point is 01:41:44 It's like the opposite of prevailing Silicon Valley wisdom. We're like, oh, you know what? Your employees checking the stock price at Home Depot, at least for many decades, it was, no, we very much want our employees checking the stock price and thinking about how their day is going to impact that. So the last thing that I think is fascinating about this model is the original hunch of why the business would work despite all the tradeoffs was correct. In 1980, Home Depot's worked twice as large as lows, and they carried three times as many products, which if you

Starting point is 01:42:18 know us and our Costco zealotry, that sounds like a lot of danger. These are all downsides, right? But what ended up happening is they had four times as many transactions as those smaller lows stores. So there really was this benefit where when you made a lot of those. You those investments in more square footage, more inventory, more skews, the return on that investment actually increased at scale. As you added more things, the word of mouth, the one-stop shopping, the feeling of the buying frenzy, it more than paid for all that additional allocation that you were making in inventory and square footage. And, you know, that was a Bernie hunch before they actually opened the first store. But he was right. That is the, that is the,

Starting point is 01:43:06 kind of key insight behind the whole thing is that actually there are returns to your investment that increase once you get out beyond a certain skew count and out beyond a certain square footage. Yep. And again, was super unique to home improvement. Because there's no cap on the amount that a customer can spend, you will get super whale transactions happening of $100,000 kitchens, home remodels, et cetera, et cetera. Yep. So this is basically the core. model that takes Home Depot to the $350 billion market cap company today, except it's not exactly a straight line. Yes.

Starting point is 01:43:49 There is a fall from Grace coming, listeners, before we get to the Home Depot of today. But first, now is a great time to thank our friends at Anthropic, the makers of Claude. So, David, Anthropic published a number over the summer. that I have not been able to stop thinking about since I saw it for the first time. They looked at 1.2 million clod co-work sessions over the course of three weeks across a ton of companies, like 600,000 organizations. Software development, which I thought would be a huge part of it, was less than 9% of those sessions. I assumed it'd be way higher. I know.

Starting point is 01:44:27 The biggest category by a mile was business process and operations, which was about a third of all co-work usage. then content and writing was the next highest. So, you know, if your mental model is still AI writes code, like, this is very different in the data. Yeah, and it's a perfect lens for the company that we're covering today with Home Depot. Home Depot has thousands of employees, and very few of them are ever going to open a command line interface. Their job might be merchandising or supply chain or figuring out what their stores should

Starting point is 01:44:59 be putting on the shelves. And so there's a lot of use cases there for AI, even though almost none of them, are writing code. Yep. These are all types of cases that require analysis in documents and spreadsheets all day long. And that is exactly what Claude Co-Work is built for on your desktop, working in your actual folders, not just a chat window. And that's the important part for you, listeners. As is so often the case, you are waiting on engineering resources to free up in your company to build some tool. No longer. With Co-Work, Claude can build you the tools that you need to do your job better. And in fact, that is even the case for us here at Acquired HQ. Absolutely. We have a bunch of

Starting point is 01:45:41 proprietary tools that live in web dashboards that Claude has just built for us that handle tons of our process and automation. So if you want to be like us and build tools using Claude co-work to make your organization work better, you can go to Claude.aI.A.A.R.A.R. And just tell them that Ben and David sent you. So back to Home Depot, not exactly. being a straight line from here. So at first, things are going great, as we talked about. What's the models in place? The whole company is humming. By 1996, Home Depot is doing $20 billion in sales annually and expanding rapidly. They're averaging a new store opening every four days. They have over 600, approaching 700 stores. They have 32 international. Yep. That year,

Starting point is 01:46:33 is a big year for the company because the Olympics come to Atlanta, to their hometown, and they see it as the perfect moment to really put their foot on the gas on national advertising, becoming a big brand. So they become a major Olympic sponsor, like right up there with Visa and Coca-Cola, Nike. Now JP Morgan. Yep, that's right. And Ben, as you alluded to this era is when they really start serving the pro-contractor market as well as the D.I.E. DIY Weekend Warrior. They offer business credit accounts. They're finally on solid enough financial footing that they can do that. They start carrying more pro-line tools like DeWalt or Milwaukee Tools. This actually only boosts the DIY weekend Warrior market because it turns out there's some segment of consumer homeowners who also want pro-level tools and hardware and supplies. People with high willingness to pay for the best or if they want to have a tool for 20 years. Sure.

Starting point is 01:47:36 I want what the pros use. Absolutely. They also hire dedicated salespeople to handle pros. They stand up a pro desk in a lot of their stores. They offer, this is a big change for them, pro pricing. Yep. So they start offering bulk deals if you are coming to the pro desk. I think importantly, though, that bulk pricing is available to DIY customers.

Starting point is 01:48:01 too. You just have to buy in a certain amount. Right. They also start offering for the first time job site delivery, since not everyone wants to come into the store for everything, especially if you're building a shed, like the one you're recording in right now, David. You know, you don't want to have to go to the store and load up a car with all of that or rent a truck. It'd be nice to just have it delivered to the job site. Yep. And pros would go on to be this just giant driver of the business, whereas, and this is a 2015 stat, so we're flashing forward, but, but I think it's still a relevant data point. The average Home Depot DIY customer interacts with the company about five times a year, spends about $330.

Starting point is 01:48:44 The average professional customer would interact 66 times a year with an annual spend of $6,000. Yep, sounds right. And of course, there are pros that spend hundreds of thousands of dollars a year. Yep. So on the back of all this train of success, great stuff, Bernie says, all right, time to declare victory. He retires as CEO, hands the title over to Arthur in 1997. So almost 20 years. Yep, almost 20 years in.

Starting point is 01:49:22 And he goes out on top. And that's when some cracks start to emerge in the Home Depot. foundation because there actually were a bunch of problems that this very rapid growth had massed. So first, that same year in 1997, the company agreed to one of the largest corporate gender discrimination lawsuit settlements in history up to that point. Bernie and Arthur dispute the claims in Bill from Scratch in the memoir that they wrote. But even just the fact that the company ended up in this position shows that corporate management wasn't exactly tip-top, shall we say, in this era. And the lawsuit also kind of reflects the stores. I mean,

Starting point is 01:50:10 Home Depot's up to this point were like a man's place, you know. It was guys buying hardware from other guys. Which lows would gone to exploit cultivating women as customers. Absolutely, which we're going to get to in just a second. And so, yeah, this whole dynamic ends up coming back to bite Home Depot pretty quickly. There's also all of Bernie and Arthur's accounts in their book of the early days of the like partying hard in stores and like drinking after hours. And obviously they cleaned all that up over time. Yeah, it was there for sure. Yep.

Starting point is 01:50:43 Yep. So, okay, that's problem number one. Problem number two, we didn't talk about this as much in the model because it didn't survive the early days. but part of the philosophy of Home Depot as it was getting built was radical decentralization. And it's awesome because the stores get to use their local knowledge of the market to make sure that they're buying all the right stuff, the right quantities, that they're super in touch with the customer. And that leads to, I think Bernie estimated 15 to 20 percent higher sales per store because the regions were making their own decisions. Yep, yep. But as Home Depot scales, the benefits of doing that really start to get outweighed by what you're leaving on the table in terms of scale economies with purchasing power if you were to centralize your merchandising organization. Right. So there's chaotic operations. There's lack of being able to use technology and systems because it's so fragmented everywhere. There's a zillion decision makers and a zillion negotiators with all these different vendors. And the thing you're talking about.

Starting point is 01:51:50 talking about, David, you can't get the best prices from your suppliers. From your suppliers, if you've got 57 different regional or even store-level buyers negotiating with them. Which wasn't an issue at any other store because Home Depot invented the concept of the national hardware store chain. Right. There wasn't even an opportunity to do national buying for hardware before Home Depot because nobody was buying nationally.

Starting point is 01:52:14 Like, sure, absolutely there were still regional differences in what like Arizona needed versus is what Alaska needed. But like a table saw is a table saw. You don't need different table saws for different parts of the country. Yeah. So that's two. And then three, the market is changing. As we get into the end of the 1990s and into the early 2000s, the U.S. housing market is rapidly inflating.

Starting point is 01:52:40 This is everything that would lead to the financial crisis and the subprime crisis. Yeah. You're putting down no cash and managing to get a house because they're, willing to lend against invisible earnings. Yes, yes. So obviously, that contained a lot of bad things for the American economy and for home improvement retailers to come. But during the run-up...

Starting point is 01:53:03 Right, they're building houses at an unmatched clip. Yep. And it reopens the market for Lowe's to come back as a real competitor. So while the housing market is inflating here in the late 90s and early 2000s, Lowe's completely changes their strategy. Yeah, in 1990, they got wise to what was happening to all of their regional competitors and the smaller format stores. And they basically studied Home Depot and said that is the correct way to do this. So I think it was 1990.

Starting point is 01:53:33 They opened their first warehouse store. And they did a complete about face. Obviously, when you go to a Lowe's today, it's a very, very similar concept. But this is like a real innovator's dilemma, impressive thing that they did to shed their old operations and formats and close. those and open only Home Depot style stores starting in the early 90s. Yep. And here as the market is changing, you're getting younger buyers of homes, you're getting more women buyers of homes. What they want and need from home improvement is actually starting to shift a little bit from what Home Depot is offering. Didn't Lowe's come in with a slogan,

Starting point is 01:54:10 improving home improvement? Exactly, exactly. Tracking the slogans in this industry will tell you everything that is going on strategically. Yeah, improving home improvement is aimed directly at Home Depot and directly at appealing to younger, more casual, often more women buyers. These are buyers that aren't necessarily doing home remodels. They're doing home makeovers or home refinishings. They're like weekend sprucers versus weekend warriors. So, you know, they're buying more kitchen and bath products, furnishings.

Starting point is 01:54:45 They're not buying lumber and plumbing pipes and stuff like that. So Lowe's starts to shift. They actually used to appeal more to pros. And then in this era, they really start shifting more to the end consumer, the DIY casual consumer and having a more pleasant shopping experience than Home Depot's sort of rugged appealing to pros environment. Yep. And what does it also coincide with? The Internet. So all of a sudden, for the first time, there's a way to get educated as a consumer, as a DIYer, about how to complete these projects without needing to go to these tough, burly former pros that are staffing the Home Depot.

Starting point is 01:55:29 Now it would be a while still before YouTube was founded. This is, you know, the late 90s, not the 20 teens. But you start to get people sharing information on forums and things like that. Yeah. All of this in aggregate. though, opens up the market for a real competitor for the first time. Yeah. So once Arthur takes over Home Depot, he runs the company for a couple of years, but these issues start piling up.

Starting point is 01:55:53 And he's also getting tired just like Bernie when Bernie retired. And the company's just getting bigger and bigger. By 2000, it's over $40 billion in revenue. They have over 1,000 stores and over 200,000 employees. And so one day, at a board meeting, Ken asks Arthur, about succession. Like, hey, man, you seem like you're kind of getting tired too. If you need to step down tomorrow, is there anybody here at the company that could take your place? Right. When Bernie stepped down, we had you, but who's after you? And so Arthur goes away, thanks about. He comes back.

Starting point is 01:56:27 And he's like, oh, man, Ken, you're right. Actually, the answer is no. Pat certainly can't take my place. And you can, you know, we love you, but you're not an operator. You can't be CEO of this company. And yeah, I guess we haven't really cultivated an executive bench here in the company of someone who could take over a CEO. It is worth saying they very impressively figured out a management track for store managers. 75% of store managers at Home Depot don't have a college degree because they have figured out how to promote from within. And so you can come to Home Depot as an 18-year-old retail employee and become a store manager. And that works super well. But what they didn't cultivate, at least in this era, was who's going to succeed these founders?

Starting point is 01:57:15 So the board and Arthur together decide, hey, we got to bring in an external search firm and bring some more management talent into the company. And the plan is that they're going to go recruit a president and COO. Basically, somebody to replace Arthur's old job as number two now that Arthur is CEO. and this new person will be next in line to take the helm of the company when Arthur's ready to retire. And Arthur actually chairs the search committee himself. And the first target is Jamie Diamond. It's amazing. Who has just gotten fired by Sandy Weil at Citigroup.

Starting point is 01:57:53 Yes. And Jamie loved the Home Depot founders, as he told us on stage at our Radio City show last year. But the other thing that he said right after that was, you know, I've never actually been to a Home Depot before considering this opportunity. And I think he went in once because a friend told him like, oh, you need to go upstate and go to that Home Depot. And it just didn't. He was like, what am I doing here? I'm like pretending to be a home improvement. Yeah.

Starting point is 01:58:18 But this does burn a bunch of time. The whole process of meeting Jamie, wooing him, recruiting him. And they really do vibe. Jamie will say to this day that he loved everything about Home Depot, the culture, the philosophy as a company. He talks about the store support center thing all the time. When we were preparing for Radio City, I watched 50 Jamie Diamond interviews, and he references how awesome it is that their HQ is called Store Support Center, and that's a cultural indicator. Yep. So the company burns about six months on the Jamie process.

Starting point is 01:58:52 At the end of it, they've still got nobody, and the board is starting to get a little frustrated here. Now, it just so happened that Ken, in addition to now being the lead director of the Home Depot board, was also on the board of General Electric. And at the time, GE was going through its own very public succession drama of who was going to succeed Jack Welch. The most storied CEO in America at the time. Yeah, history has kind of forgotten this now because GE, frankly, has fallen apart. But like literally got broken into three pieces. So that's not a controversial statement.

Starting point is 01:59:35 Yes, yes. it actually. And before that, incinerated more market cap than any other company before it in history. Or at least until some of the Nvidia drawdowns, right? Yeah. These days, like these drops that happen at big tech companies is, you know, dwarfs everything in comparison. But at the time, that was the story is post-Jack Welch, GE, just completely destroying shareholder value. Yep.

Starting point is 02:00:02 But here we are in 1998, 1999. 2000. I mean, Fortune magazine crowned Jack Welch, the manager of the century in its millennium issue at the end of 1999. That's how vaunted GE was. Yep. And it was all driven by a culture of operational excellence as embodied in GE's famous Six Sigma approach to defect-free output. Sounds great. Yeah. Sounds great, right? Well, we'll see.

Starting point is 02:00:37 So back to Home Depot. So here's Ken and the Home Depot board thinking, man, we sure could use some of that operational, excellent stuff around here. I think that would really be good for the company. And if you're going to go cherry pick the best corporate leadership that you could possibly get, the GE bench is probably the place to go hunting. You couldn't get Jamie Diamond. We don't have it here. Let's start at the top. GE is the consensus best place to look in America for.

Starting point is 02:01:05 management. Which is crazy looking at the three choices to succeed Jack Welch and how disastrous it was for all three of them in the three places they went. Yes. So in November of 2000, Jack Welch announces that Jeffrey M.L. will be his successor to take over as GE's next CEO. And Ben, as you were alluding to, the other two candidates for the GE job were James McNerney, who quickly leaves to become the CEO of 3M. You may know his name because he would then leave 3M to go and become the CEO of Boeing. Yeah. We all know how that turned out.

Starting point is 02:01:47 And then the other candidate, Bob Nardelli, who Ken, Langone, again, being on the GE board here, knows well and loves, loves Bob. So immediately, after the succession news comes out at GE, Ken calls up Nardelli and pulls out the same line that he used on Bernie 20 years earlier. You've just been hitting the ass with a golden horseshoe. Guess where you get to go work now? Yes, what we are going to do together now that you didn't get the GE CEO job. I'm going to bring you into Home Depot.

Starting point is 02:02:28 So the board immediately pivots and offers Nardelli the president and C-O-O-O job and says, you'll come in, you'll be here for a little while, Arthur's going to retire, you will be his appointed successor. And so to incentivize Nardelli to take this job, they say we'll make you whole on your GE stock options. We're going to give you a $150 million equity package. to come join Home Depot. Bob says, okay, great.

Starting point is 02:03:01 I clearly can't stay here at GE. I'm in. And then at the last minute, after they've already agreed on a deal for Nardelli to come in and be president and COO under Arthur, Nardelli calls the recruiter and has the recruiter tell the Home Depot board that he's changed his mind.

Starting point is 02:03:21 He's only going to come on board if he becomes CEO right away. He's not going to wait. This leads to a awkward, shall we say, Home Depot board meeting, where the board presents this new development to Arthur. He says, okay, I'm okay with it. Bob can have the CEO job. But deep down, he's not really okay with it. And part of it, I think, was Arthur not being ready to let go.

Starting point is 02:03:52 The other part of it, I think, was a genuine spiky. sense that, hey, what is this last minute bait and switch from Nardelli? Is this a red flag here? Well, Arthur would later say, A, this is faster timing than I was thinking for me to leave. But B, Arthur would later say in an interview, I thought he was the wrong choice by a lot, even though I'm the one who initiated an external search. Yep. To your point, though, I think the, yeah, yeah, I'm okay with it is a little bit of like a test to the board of what I would like is you to come back to me and Actually, we love you so much. Who is this guy?

Starting point is 02:04:28 No, get him out of here. We think you should stay CEO. Yep. Yep. Well, that's not what the board says. They take him at his word. They take him at his word. This leads to a big fight, like a big fight between Arthur and Bernie and Ken.

Starting point is 02:04:45 As chronicled in Ken's book, I love capitalism, because Bernie's still on the board at this point. And I think pretty severely damages their relationships going forward. Regardless, the board does bring Bob in as CEO. Arthur resigns as CEO but stays on the board for just a couple months. And within six months, he fully steps away and is gone from the company. We'll come back to Arthur all the way at the end. He's got his own golden horseshoe. Spoiler alert, he would, I think, become the highest net worth of any of these folks.

Starting point is 02:05:25 So Nardelli comes in as the new Home Depot CEO. And to the outside world, this looks like a huge win. I mean, they got essentially the most eligible corporate bachelor in America. One of the two runners up to the GE job. And as you're imagining, that's probably not a great dynamic you want to enter into for a new relationship, be it romantic or in a boardroom. I wanted that job, but I got this one. so I'm going to try to make this job like the one that I wanted. Yeah, yeah.

Starting point is 02:05:59 Now, to be fair, the first couple years of Nardelli's tenure are great. Maybe even the first three or four. Yeah. Yeah, yeah. Ken Langone still says to this day that for the first four years, everything Nardelli touched turned to gold. It turns out that a lot of the issues that had been popping up in the company that we talked about a minute ago could be fixed with great operational excellence, and there was a lot of low-hanging fruit around.

Starting point is 02:06:29 Yeah, when he came in in 2000, there had been four consecutive quarters of slowing comparable store sales growth. There's clearly some serious underlying issue there. The older stores, they were getting really run down. And yeah, this is where Lowe's was coming back and beating Home Depot. The extreme decentralization made things very chaotic. Nardelli referred to the company in an interview as having been in startup mode for 20 years. clearly what Nardelli missed is how important being entrepreneurial was to the company's success. He was about to embark on a mission of operational excellence, but you can operationally excellence yourself out of being entrepreneurial.

Starting point is 02:07:10 If you take away all of people's ability to take ideas and act on them and have fun and all that stuff like you, that could kill the company. Yeah, yeah. The other things he did was just this, if you look across every system, purchasing, replenishment, merchandising, all operating functions, he would centralize. He took nine separate buying offices and folded them into one. So they were suddenly getting better prices from their suppliers. He invested in a bunch of new technology systems. I mean, the answer here isn't decentralized or centralized. You have to have the balance where you centralize where there's actually a benefit of getting all the data in one place or doing a bulk negotiation or doing analysis

Starting point is 02:07:51 on one data set in a system of record, but you definitely don't want to centralize it when you can push decision-making closest to the customer where people can see like all the idiosyncrasies of any given situation. Yep. Yeah, here's the way I would characterize it. There was a bunch of hollow-hanging fruit.

Starting point is 02:08:13 Operationally, Nardelli was excellent at implementing all the changes that needed to be made on that front. at Home Depot, but he was all about Six Sigma, all about operational excellence. I mean, he was the GE guy through and through. And operating the Home Depot was not the same thing as manufacturing turbines at GE. Right. So if you go back to the whole thesis of Home Depot here and this idea of being a specialty retailer with great service, meaning you need to service your customers,

Starting point is 02:08:50 It's not to say that GE doesn't service their customers, but it's a very different dynamic. At GE, line-level employees are completely replaceable. Right, by design. This is the whole point of Six Sigma Blackbell. We are going to drive out costs and inefficiencies ruthlessly within the organization. It's the system. It's not the people. That's the opposite of the 25-cent kitchen sink washer sale.

Starting point is 02:09:20 leading to a $100,000 kitchen remodel on the sales floor at Home Depot. You just can't measure that in a Six Sigma spreadsheet management process kind of way. It reminds me of why Jeff Bezos doesn't like to have his meetings have a hard end time because he likes to be able to wander, to invent and wander. And if you're going to invent, you need to wander. It's like if the job of the Home Depot store is to have an associate wander with a customer who's trying to figure out how to solve some problem or dream up some project, that is really hard to optimize because it's kind of an unbounded problem. Yep.

Starting point is 02:09:58 So what does Nardelli do? He replaces huge swaths of the associate on the floor retail workforce in Home Depot with part-time general retail labor. So doing away with the whole philosophy that made Home Depot of we have knowledgeable people who are going to make that 25 cent washer sale and fix a customer's kitchen sink and have that lead to something bigger down the line, all that's going to go, we're going to bring in 16-year-olds on part-time jobs to just ring them up at the cash register. And not only that, there's just going to be less of them, period. according to Arvin's research, associates per store dropped from 200 to 170 over the course of 2000 to 2006. Yep.

Starting point is 02:10:52 The 15% reduction in headcount just like, all right, we've fewer people to help you solve your problems now. Yep. So those are the associates on the floor. Now the store managers. Before Nardelli, all the store managers were promoted up, Ben, as you said, from store associates. And they were focused on their stores,

Starting point is 02:11:09 the customers doing what was right, et cetera. Nardelli changes the criteria for store managers now preferring candidates with college degrees. So now there's no promotion path because no one's starting on the floor with a college degree. Every single person that you're hiring into those associate jobs doesn't have one. So what you're just telling them is like you're locked in this forever job with no path now. And think back to the old workforce, all these tradespeople who are highly educated, highly knowledgeable, they have trades degrees if they have degrees at all. They don't have college degrees.

Starting point is 02:11:41 That has nothing to do with either knowing about hardware and home improvement or being a great retailer. Yeah. I mean, at weekend the culture, zooming out, there's a great case to be made that the only sustainable competitive advantage this company had were their scale economies and their culture. This entrepreneurial, we can figure it out thing. This is heavily destructive to that in a way that you may never be able to fully rescue and get back. So a couple years into Nardelli's tenure, customer satisfaction among Home Depot shoppers falls to the lowest level of any major U.S. retailer. So all the major U.S. retailers, you know, there's annual surveys of customer satisfaction

Starting point is 02:12:26 at everything from Best Buy to Costco to Walmart to Home Depot to Lowe's. Home Depot goes from near the top to dead last. But David, they doubled their revenue and their profits, and they grew from 1,100 stores to 2,000 stores in five years. What do you mean there are problems? All the charts are up into the right. Yeah, yeah. So that then leads into the issue of Nardelli's compensation. So on top of the huge equity grant that he got when he joined Home Depot from GE, Nardelli also gets paid.

Starting point is 02:13:06 roughly $200 million by the board over the six years of his tenure running Home Depot. And the board would always give him bigger bonuses and pay him more than they were contractually obligated to because Nardelli would always make the argument to them, hey, I'm crushing my numbers. Revenues up, profits are up, I'm beating plan. Everything is great. He would refuse, however, when the board would ask to tie any of his compensation to the company's stock price. Which I will say is in some ways fair. I know it's misaligned with shareholders, but it is in some ways fair because it is incentivizing you on the things you can control because a stock price is just what the outside world thinks of you, not actually what you are doing. It always has struck me

Starting point is 02:13:53 a little bit weird that you're comped on what other people think of the company. Ben, it's like you're Reading from Nardelli's script right here. So Business Week would report on this because this was uncommon for major CEOs at the time and through to today. And Nardelli would always say, hey, this is the one measure of company performance that I can't control. So I'm not going to agree to my comp to be tied to it. The problem in Home Depot is that this is fundamentally going against a key part that we talked about a minute ago of the company's model. No stock go up. No machine work.

Starting point is 02:14:31 Exactly. And so for all the associates on the store floor now, those of them who are left with equity, their promise has always been, I do good work, I see the results, the stock price goes up, I get rich. Now here's this big week former GE guy coming in as CEO and saying, yeah, I'm going to get rich regardless of whether the stock price goes up. And the stock price stops going up. Yeah, why did the stock price stay flat during this time? Well, here's what's going on. Even though he doubles revenue and profits, he actually mostly does it by doubling store count. Ben, as you had said, same store sales comps had already trended flat before Nardelli joins. They actually stay flat for his tenure.

Starting point is 02:15:23 So Wall Street keeps bringing this up as a major red flag in comparing Home Depot to Lowe's, which is growing. same store comps as they're taking this new segment of the market, the weekend spruces here. And it gets even worse. During Nardelli's tenure, he authorizes $20 billion in share buybacks and dividends. That doesn't even move the stock price. Which you should read as all the institutional investors have all these discounted cash flow models. And they don't believe that the sum of all the future profits that this business will generate discounted to the present is. growing. They think the value of this business is staying flat. Yeah. Well, they think it's shrinking

Starting point is 02:16:05 because Home Depot is also in the market buying up stock. And that's not moving the price up. So. Right. But the high level point is despite revenue and profits and being up due to new store openings, we do not think the future of this company is brighter. Yep. Yep. And meanwhile, during this same period. Again, this is as the U.S. housing bubble is reaching its peak inflation, low stock price is up 200%. They're winning the housing bubble. The other thing we haven't talked about is he tried to bolt a lot onto this company. He was growing by acquisition and expanding into adjacencies and launching new business lines to create these new adjacencies versus just kind of investing in the core business.

Starting point is 02:16:56 Yep, yep. Which like when you come from a conglomerate like GE, that's what you do. That's what you do. And on top of all of this, some of what made Home Depot unique starts to fade. They took gross margin up, which results, of course, in more profits, but prices that aren't blow away. They're closer to market competitive. And actually, if you look at their gross margin profile, it's remained elevated ever since. So it's not a huge difference.

Starting point is 02:17:27 The gross margins are still lower than typical retail and certainly lower than that 45% that we talked about way back when. But they went from this like 28, 29, 30 range to like pretty squarely 33% gross margins, which is not as low as Walmart, let alone Costco's razor thin margins. So they kind of moved away from that Costco model, if you will. The scale economy's shared idea. They sort of realized, you know, we can actually keep a little bit more of the profits. Yep. Which also coming back to Wall Street's disappointment with Nardelli and the company despite the growth of revenue and profits makes sense, right? Like he's trying to pull out all the tools in the tool bag to get Wall Street back on his side here.

Starting point is 02:18:14 You're right. It's just incentive misalignment. If you're comped on the stock price, you don't care about the business's current performance. you just want investors to believe the story that you are storing up long-term value inside the company. So you keep prices really low, you keep volume really high, you keep customers really obsessed. If your comp is tied to today's numbers, you don't store value inside the company. You try to pump today's numbers. Exactly.

Starting point is 02:18:40 It's a paradoxical misalignment of incentives. Fascinating. Yep. So you actually, coming all the way back around, you do want to incentivize management on stock price because that is the way that we are storing up value in this business for the far future. Yep. So all of this brewing negativity and certainly Wall Street dissatisfaction with Nardelli comes to a head at Home Depot's 2006 annual shareholder meeting. Jonah Sarah, great financial journalist, wrote for the New York Times.

Starting point is 02:19:21 I'm just going to read here, quote, Mr. Nardelli has become this year's version of Mr. Overpaid CEO. In the five years since he was recruited from General Electric, Home Depot's stock has fallen 12%, while shares of its chief competitor lows have risen 173%. You've heard of pay for performance. This is pay for pulse. Oof. But these facts barely begin to get at the richer story that is the Home Depot scandal. So I hopped on a train and headed to Wilmington, Delaware, where the Home Depot shareholder meeting was being held this year. I arrive.

Starting point is 02:20:04 I can hear protesters chanting, hey, Bob, why are you chicken while the stock price takes a licking? Mr. Nardelli finally takes the podium. He's accompanied by no one else. suddenly we all understand what's going on. The board isn't coming to the annual meeting. In all my years as a business reporter, I have never seen that before. As a corporate governance expert at the University of Delaware

Starting point is 02:20:32 will tell me the next morning, quote, your one obligation as a director is to show up at the annual meeting. The fact that the directors didn't show up is disgusting. Nardelli begins the meeting. When the first person gets up to speak, the questioner gets mad. I think it is absolutely outrageous that the board is not here. The board is too chicken to face the shareholders.

Starting point is 02:20:58 As he speaks, the timer hits zero and his microphone is cut off. After the meeting, the words on people's mouths are appalling, disgraceful, and arrogant. I would add one more, contemptuous. I'm sure there are plenty of boards and chief executives who have contempt for their shareholders, but most of them are at least smart enough to keep it to themselves. So what happened? Did the board not want to show up and say they were aligned with Bob? Did Bob say, please don't come because I don't want you speaking against me? It has never come out.

Starting point is 02:21:33 I think that Nardelli was just fed up with the narrative around him. and all the discussions of his pay and the flat stock price. And he just wanted to say a giant FU to the shareholder community of Home Depot, many of which included current and former Home Depot employees. Wow. It's bad. I mean, bad on the board too, though. Yeah, bad on the board, bad on everybody.

Starting point is 02:22:07 So the fallout from this event is extreme. Home Depot basically becomes the new symbol of everything that is wrong with corporate America. And in particular, Nardelli's pay package is being held up as the number one example of corporate greed, corporate executives making too much. Yep. In the weeks and months after this meeting, the company and Nardelli and the board issue a series of explanations and apologies in escalating obsequiously. doesn't do anything to change the narrative. Finally, on January 2nd, 2007, Ken Langone calls a special board meeting in Dallas and the board fires Nardelli at this meeting. He gets an $18 million cash severance payable immediately and gets a quote-unquote retirement package

Starting point is 02:23:05 valued at $210 million. This is on top of the. initial make-you-whole grant plus the pay along the way? Yes, yes it is. Ultimately, in Ken Langone's book, he does say that Nardelli only ended up getting a fraction of that amount. But it doesn't matter. The headlines are brutal.

Starting point is 02:23:29 When the news gets announced the associates on the store floors in Home Depot, there's reports and videos of them celebrating and high-fiving and basically. having a party. Was not exactly a man of the people. No, no, not exactly a man of the people. After this, Nardelli quickly gets another job. He becomes the CEO of Chrysler to guide that great American car company through the financial crisis. And continue its path as an independent American automaker succeeding and coming through it,

Starting point is 02:24:07 much like Ford did as an independent company and GM did as an independent company. Oh, wait. Ends up getting known by the Italians. Yes. Yeah, you can go listen to our Ferrari episode to learn how that all turned out. How Fiat Chrysler was born. Yep. So once again, Home Depot and the board are left without an obvious successor.

Starting point is 02:24:31 Who do they turn to to go, well, I would say up from here, anywhere from here would be up from here. they decide that they're going to pin their hopes on another GE guy, one of Nardelli's lieutenants that he'd brought over from GE to run M&A and corporate development for Home Depot. A new role, as you were saying, Ben, as they added all this stuff to the company. Someone who Ken loved, but Bertie was nowhere near convinced was the right choice. Yeah, yeah. A former lawyer by the name of Frank, Blake. Bernie, and also I would assume Arthur, although I don't think Arthur was on speaking terms with the board at this point in time, are hissed.

Starting point is 02:25:19 Bernie's actual quote to Ken when Ken calls him and tells him who the next CEO of Home Depot is going to be is, I can't believe you brought in another goddamn GE guy to run my company. But it would turn out that not only was Frank Blake Nothing like Bob Nardelli, he was exactly what Home Depot needed. But before we tell that story. Yes. Now is a great time, listeners, to thank one of our favorite partners. Sentry, that's S-E-N-T-R-Y, like someone standing guard.

Starting point is 02:25:56 Which is what they do for developers. Century helps teams debug everything from errors, to latency issues, basically any software problem, and fix them before users get mad. It's considered, quote, unquote, not bad by millions of software developers. And David, I have yet another interesting parallel for you to this episode on Home Depot. Home Depot is not just in the business of selling, you know, lumber. They wouldn't be a $350 billion company if that's all there was to it. They were in the business of turning regular people into builders.

Starting point is 02:26:29 Aha, I see what you're doing here. Yes, Bernie and Arthur staffed those first stores with actual plumbers and electricians and carpenters, people whose job was to stand in the aisle and teach you how to do the thing yourself. They didn't just sell you the tools. They gave you the confidence to pick them up. Which is exactly the moment that software is in right now. The number of people who can build something real has been completely blown open. I mean, engineers, sure, but also designers shipping their own products,

Starting point is 02:26:57 founders who have never worked at a tech company before, people who describe what they want and watch it get built by AI. Yep. Everyone's a builder of software now, so the hard part isn't building anymore. It's the part afterwards. Something breaks in production and you have to figure out what actually went wrong. That's what Century does for builders of every kind, from a solo founder's side project to the engineering teams at Anthropic, Versel, Cursor, Linear, and GitHub. And when something does go wrong, Century shows you exactly what broke, which release it started in and where it is in the code. Then it hands that whole picture to whatever you build with, Claude code or cursor or Sentry's own agent, Sear, which finds the root cause and opens a PR

Starting point is 02:27:38 for humans to review. Sentry is where software gets fixed with over 200,000 organizations running on it. So you can check out sentry.com.com.com. All right, David, the saving of Home Depot. Man, things got pretty low there, didn't they, for a little while? Yes. Fortunately, there's a comeback story here, too. So the thing that is the context of all of this, we're going to talk about all the personnel stuff and the culture change. In 2006, the housing bubble burst. Yep.

Starting point is 02:28:11 I mean, we know of the great financial crisis in 2008, which is after this leadership transition, which was January of 2007. But if you go back to 2006, that is where you can see it in Home Depot's financials. Spending on home improvement supplies fell off a cliff 2006 into 2007. And the actual ceasing of building new homes for all of these unqualified buyers took like 18, 24 months to wind its way all the way through the financial system and to blow everything up. But for Home Depot, their revenue would fall starting in 2007. It bottomed in 2010. And it actually did not get back to 2007 levels until 2014. So that's a seven-year span.

Starting point is 02:29:00 And it's the same story with net income where they were below their previous high watermark on revenue and profits. Yep. And I think this maybe explains a little bit of the board's behavior. once again, we don't have a bench here that we know well and are confident in to come run the company. Shoot, I think we got to stick with this guy as long as we can. Yeah. Most if not all of the other executive ranks at Home Depot were all Nardelli guys at this point in time. So if they were to get rid of Bob, the bench is only staffed with more Bobbs.

Starting point is 02:29:42 Or so they thought. Or so they thought. To give some credit to Bob, even though his tactics were not the right tactics on this company for their core competency, their culture, their mission, any of that stuff, the wind had for decades been at Home Depot's back. Yep. You know, this amazing boom in housing. And suddenly, you no longer have that. It's just hard to manage and create growth in an environment like that. Yep.

Starting point is 02:30:08 So coming out of the board meeting on January 2nd, 2007. when Nardelli gets fired. Frank Blake, the Dark Horse candidate, becomes CEO. So yeah, Ben. Who is Frank? So Frank was a lawyer by training who'd worked in D.C. In the federal government as a public servant. Who'd been a Supreme Court clerk, had gone to GE and risen up to become the head of M&A,

Starting point is 02:30:35 came over with Bob Nardelli, and held a senior role at Home Depot, but he didn't own a P&L. Like his job didn't look anything like what a CEO's job would look like. Right. He didn't have an operational role at the company. He wasn't in touch with the store associates. He wasn't on the store floors. But the answer to why he's the right choices, he was in touch with the culture, with what made Home Depot special, with its original founding principles, all that. One of the ways in which he was, he talked about this on Invest Like the Best in Patrick's podcast interview with him.

Starting point is 02:31:10 his son worked at Home Depot. Yeah, that's right. And so he got the unvarnished take, not the corporate ivory tower sort of filtering of information. He got the dinner table conversation of what's it like in the stores. Yep. And obviously it wasn't just that one thing, but that's the mentality that he brought to this job of how do we exist as a store support center, not as a headquarters. Yep. So when Frank takes over as CEO, at that same board meeting,

Starting point is 02:31:40 on January 2nd. Like the first thing that he says to the board, the first ask that he makes is I want to place a call to Bernie. By this point in time, Bernie had retired fully from the board and certainly was just disgusted

Starting point is 02:31:56 with the whole state of the company, as evidenced by his, another goddamn GE guy quote. So Frank gets him on the phone, even knowing that Bernie is hostile to him and convinces Bernie that, he wants to come meet him and spend some time with him. That leads to Frank and Ken going to Florida to meet with Bernie where he now lives, getting breakfast with him the next weekend. And then

Starting point is 02:32:23 Bernie and Frank go out and they do a storewalk together. But it's not a storewalk of Home Depot. The first place they visit together is Costco. Because to Bernie, Home Depot stores no longer embody the values and qualities of a great retailer that he wants to teach, you know, the young Jedi here. So that's the first thing that Frank does is mend the Bernie relationship. And really learn directly from him, what do you think the culture is? Because the whole time he's been here, he's been under Bob. Frank wasn't here under Bernie. And so it's like, hey, I'm going to try to reinvent, reinvigorate whatever was special about the culture.

Starting point is 02:33:06 Help me understand what that is. Yep. And one of the things that he breaks. up is this sort of fabled, uh, inverted pyramid at Home Depot where, you know, you've got imagine a pyramid, except it's upside down. And at the bottom is the CEO. And that the CEO is just this tiny little triangle. And at the top, the big thick level is customers. And then underneath customers is associates. And the belief is like, look, the people who can actually affect the experience of the customers on their projects is the associates. And everyone under them just

Starting point is 02:33:37 exists to serve them. And Frank sort of grabs this and brings this to the company as kind of a management tool of, hey, we need to start paying attention to this again. Yep. So after calling Bernie, the second thing that Frank says to the board upon becoming CEO is, hey, we got to get this whole issue of the Home Depot CEO's compensation out of the newspapers. We got to make it not a thing anymore. So obviously my compensation needs to be much lower than what Bob's was. And I want to align myself with you guys, the company and the shareholders. So I want 90% of whatever number we collectively decide is my compensation, the right number for the CEO of Home Depot. I want 90% of that to be in stock options. So that I'm aligned with the company.

Starting point is 02:34:33 the shareholders, the employees, I'm going to bring it all back to the equity strategy that the company had forever. Okay, that's a way to make a statement. Yep. And if the company does well, you do really well. Yep. And the company would do well under Frank. So the next thing is he completely stops new store expansion for Home Depot. It says, all right, if we're going to return this company to growth, we got to do it with same store sales.

Starting point is 02:35:03 So this is crazy. In 2008, they had grown to 2,300 stores. And today, 18 years later, they are at just 2,400 stores. Yep. Here's how it went from 2008. Right away, they closed about 30 of them. They took a billion dollar write off on all of the pipeline that they had been developing, so all this new store development, they said, nope, we're not going to open any of those. We're just going to focus on store productivity. Then for the next 11 years, other than like four or five stores a year here and there, they did not open any new stores. They were flat for over a decade. As they are simultaneously returning to growth. So remarkably, while they weren't opening new stores, they grew revenue from 70 billion to 130 billion and net income from 4 billion to 11 billion, all by focusing on the return they could get from their existing stores. So sales per store go from around 30 million to about 65 million over that 11 years per store. Yeah, crazy. I mean, they just cranked on store productivity.

Starting point is 02:36:16 Yep. And we're going to get to e-commerce in a minute, which was a big part of that. Of course, it's funny. That was my next thing, too. I was like, that is the missing piece of this puzzle. But I think there's an interesting, like, cultural thing here. They'd always grown ever since founding by growing stores. It was this like safety net that we can, we will always show growth because we are always growing stores, which means, A, you don't really optimize the stores you have.

Starting point is 02:36:41 You don't try to ring the very most you can out of them because you have a different way to provide growth. And B, if you believe opening stores is intrinsically virtuous, then you just open more stores whether it was a good idea or not. So there's lots of stores they open that like probably shouldn't have been open and they either needed to close or focus on getting their. productivity up to where it should be. Right. Like Starbucks has run into this several times in their life as a company. Yes. Opening more stores is not inherently virtuous onto itself. Yep. So the other big thing that Frank does right away is spin off and sell some of the other businesses that Nardelli had been acquiring. Yeah. They built this business called Home Depot Supply, which is sort of an amalgamation of several things they bought 2000 to 2006. This is mainly a distributor,

Starting point is 02:37:36 this business they built, Home Depot Supply, that served home builders, infrastructure contractors, municipalities, maintenance professionals, like big commercial customers. And the goal was this broader ambition than just their existing pro-desk. They wanted to serve properties across their whole life cycle and whatever needs pop up across the life. cycle, not just this like single job, single contractor, order stuff, we'll give it to you. It's a super different business model than their traditionally very focused model where everything kind of runs through the store. And they had to develop all these new competencies, which, you know, are good, but also detract from your focus. So wholesale distribution, offering commercial

Starting point is 02:38:21 credit, specialized sales forces, large scale delivery to job sites for these giant commercial projects, it did grow to 13% of Home Depot's revenue by 2006, so it was starting to become a big business for them. But when Frank came in, his assessment was, this is such a different thing, and we're such a mess right now. And the macro is starting to look a little shady. Shady. Yeah, I don't think Frank would take credit that he knew that it would affect the whole financial system, but at least it was impacting home building and home supplies. So in 2007, they sold HD supply to a private equity consortium for about $8.3 billion and kind of focused attention back on its core retail business. But it wasn't just the attention that they focused back on the core

Starting point is 02:39:10 retail business. Frank under the extreme nudging from Ken realized the core of this business is awesome. Yeah. The adjacencies around this business might be great, but I don't know. The core is We're starting to do some of the right things. We're starting to turn this around. Wouldn't it be great if we owned more of the core business? So what they do with the $8.3 billion, and this is ballsy, they put it all into buybacks. Yep. They just bet on themselves. They said, I think the best ROI thing we can do is buy Home Depot stock with this $8 billion. So right away, they bought back 14% of the total. I think the best ROI thing we can do is buy Home Depot stock with this $8 billion. So right away, they bought back 14% of the total. outstanding shares in the first year, and Frank would go on to buy back 30% of all outstanding shares over the course of his tenure. He dramatically shrunk the size of the shareholder base. Those buybacks were done mostly at $30 to $50 a share. I mean, today, Home Depot is $340 a share. Yeah, this is, Balsey is putting it mildly. Buying back 30% of your company's company's share base, starting in the summer of 2007.

Starting point is 02:40:31 Well, you're in the housing industry. While you're in the housing industry, as the housing bubble is popping real time, continuing this buyback program through the financial crisis, this is all Ken Langone right here. To the extent that Ken sinned at Home Depot during the Nardelli era, he is atoning for his sins here. And we'll put this chart in the email. The graph of the total number of outstanding shares is almost this, like, perfect uphill, downhill that's centered right around the year 2001, where when the company was in its growth phase, it was doing all these new equity offerings, creating more and more and more shares all the way up through about 2001. Then they'd slowly started buying them back during the Nardelli era.

Starting point is 02:41:21 And then Frank, and, again, Ken just go nuts and say, no, no, no. This company at the core is awesome. We want to own as much of it as we possibly can. It's flattened out in recent years because they've done some more recent giant acquisitions and they had COVID and good reasons to flatten them out. But the number of outstanding shares today is almost all the way back down to where it was at IPO. I know. This is just incredible. And in big part, thanks to this, through the financial crisis, Home Depot stock performs great.

Starting point is 02:41:53 This is like so counterintuitive. You would think that the financial crisis would be terrible for Home Depot stock. But from 2008 to 2012, Home Depot stock is up 132 percent. And then it continues after that. 2013. It's up 33 percent including dividends. 27 percent, 2014, 26 percent in 2015. Compounding is back, baby.

Starting point is 02:42:20 Why? Is it just Wall Street suddenly believing a narrative? that Frank walks on water or what's, what intrinsically is happening that is driving the value of this company? Well, this gets into the next end, and frankly probably the biggest thing that Frank Blake did for Home Depot, which is how they grew the company despite not growing store account. And that's e-commerce.

Starting point is 02:42:48 And this is absolutely awesome because, as we've alluded to throughout the episode, the internet actually represented a pretty big disruptive threat for Home Depot. Not from Amazon. We'll get to Amazon in a minute. But actually from YouTube. Like you're unbundling the core value prop of the knowledge in the stores has gone, you know, first to the internet in a little bit during the beginning of the Nardelli era.

Starting point is 02:43:18 But once YouTube comes along in 2006, 2007, this is a... a big time threat to the company. It doesn't matter where you get your goods anymore if you get your knowledge for free on YouTube. That's interesting. It sounds great in the abstract. I wonder if you're actually a, you know, Home Depot store manager, how much this actually impacts you. I'm sure people come in being like, I learned this on YouTube and then you got to be like, okay, but you think you know everything right now, but let me save you some trouble. I suspect there's a lot of that going on. But I think over time, YouTube gets pretty good at surfacing the best videos for Home Project, DIY.

Starting point is 02:44:02 I think that's probably right. Yep, yep. So a big part of the way that Home Depot reinvents itself here in this era to maintain its relevance for customers is e-commerce. So Frank invests a lot of capital into building distribution centers, which is interesting because they're not growing stores. Right, right. In 2009, they opened 12 big distribution centers that they call rapid deployment centers. This is a huge shift from the original model where manufacturers would ship directly to the store. This is centralizing the supply chain. Yes.

Starting point is 02:44:43 This is saying, look, we want everything shipped to these 12 DCs. and we will quickly chop them up and get them to stores, but also it now enables us to have these centralized places to ship from, since it's kind of a mess if you're shipping your entire e-commerce storefront. Out of the stores. Out of the stores. Yeah, you can't really do that. Except, one caveat to this, they do also do that.

Starting point is 02:45:05 So I had two e-commerce Home Depot experiences in the last week. One, I bought on Home Depot.com and arrived two days later the way you would expect, the same way you buy from Amazon. I'm sure that shipped from a distribution center. The other was something that I could get sooner within two hours because they had it at the store. And it wasn't pickup. They had someone drive it out to me later that night from the Soto store in Seattle. It's about 20 minutes away from my house.

Starting point is 02:45:35 But within a couple hours, it was delivered at my house since it was fulfilled from store. So they have the flexibility to do both ship from store and ship from distribution center. Yeah. So, yeah, e-commerce is actually this incredible opportunity for Home Depot, right at the same time that Amazon is crushing the rest of the retail landscape and disrupting everything. When you think about it, though, if you think about Home Depot's core best-selling products, things like lumber or drywall or plumbing supplies, roofing, siding, insulation, just imagine that attempting to go through the Amazon logistics pipeline, right? Like you probably have a- They can build a whole specialized system for it.

Starting point is 02:46:24 Totally. Amazon is not equipped to do this. I mean, can you imagine putting 200 cubic feet of lumber that weighs 6,000 pounds on an Amazon delivery van? One of those little rithians. No, that is the amount of lumber you would need for a deck job. Yeah. So Home Depot is actually pretty uniquely positioned to build this out and own e-commerce for home improvement and hardware. At the very least, just because it's wholly different, that an Amazon or a Walmart actually doesn't bring that much to bear to compete in delivery-based e-commerce for goods like this.

Starting point is 02:47:01 And it gets even better. It turns out that in e-commerce for hardware, there's actually a whole separate. servicing the customer element that Home Depot can lean into, which is when you're working on a project, it's really, really important that you get all the stuff you need all at once. And when you run out of something, you get a refill of it as soon as possible. Because if you run out of nails, the whole job stops. Yeah. You know, and so if you're a pro, obviously this is an issue. But especially if you're a consumer, this is an issue because you only have a limited amount of time on the weekends to, you know, build your deck or retile your bathroom, et cetera. And so if it's Sunday morning and all of a sudden you're out of grout for your tiling job, are you really going to want to wait until two days later to get grout delivered? By which point in time, it's the week you're at work. You can't finish your bathroom. You got to wait until the next weekend. Like, hell no, you're going to do anything you can to get that grout as soon as

Starting point is 02:48:08 possible. So this gets to the thing that I really didn't think about until diving into this research. Most of the time when you say e-commerce, people equate it with delivery. These are a bundled thing in the world. I want to order from my phone or my computer and I want to have it delivered to my house in a short period of time. At Home Depot, a giant chunk of the e-commerce is actually store pickup. Yep. Because if I'm out of grout. I need it. Right. now. I don't want to wait. Like, I can get my car right now. I just want to know that it's going to be ready when I get there and I want to have the easiest possible checkout experience. So, oh my God, I'm out of grout. Uh, crap, I'm ordering on my phone and then I'm pulling out

Starting point is 02:48:52 of the driveway and going down to Home Depot. Even if they were going to do their fastest delivery to me, it's probably going to take at least half hour, an hour, two hours longer than me just saying, you know what, this is the time I have. I'm driving right to the store right now. Yep. Exactly. So in March of 2009, the company changes its slogan from its long-time slogan that many Americans probably remember of, you can do it, we can help. Which we didn't talk about earlier, by the way, but it's so perfect to encapsulate the value proposition of the original Home Depot model. You can do it. We can help. Their marketing consultants got much better over time.

Starting point is 02:49:29 Yeah, much, much better. So they scrap that and they change it to more saving, more doing. How many entendres is that? And it reflects this change in strategy, right? Like it's more saving. So like, hey, we get it. You know, we're not differentiated anymore by the education that we bundle that we can help. We're going to re-dedicate ourselves to the saving value proposition, you know, the Costco elements of our strategy.

Starting point is 02:50:01 But then also the more doing, this is what we're talking about. shoot, I ran out of grout. It's Sunday afternoon. I need to get this bathroom done before the end of the night. We're doing. Yep. Pop online. Go on your phone.

Starting point is 02:50:15 We're going to get it to you. Yep. So the net of all that is building towards what Home Depot's strategy is today, which is 90% of all homes in America can get anything they need for any project. So over a million skews delivered to their, home or job site or a nearby store within two to 24 hours. And what they need to pull that off is just an incredible amount of density. So, David, I texted you this.

Starting point is 02:50:47 I said, I can't believe it. California alone has 250 home depots. Washington State has 48. And what you say there are, by comparison, there are two IKEA's in Washington State? There's two IKEA's. But, you know, if you want to have that value proposition, 90% of homes, can get anything they need for a project, a million skews with two to 24 hours, that requires two things. One, being really close to lots and lots of stores, which was their initial market

Starting point is 02:51:14 strategy to kind of go really dense before going to the next city. And two, to have an just ridiculous distribution center footprint to facilitate the e-commerce component. So I did as much research as I could to figure out what does their distribution center network look like today? Because it's evolved a lot since that 2009, and they've really figured out how to have all these different specialty ones. They have seven import distribution centers to bring things in from outside the country, and this is all just within the U.S. They have 18 rapid deployment centers, which take goods from manufacturers, cut them up, get the merchandise into stores.

Starting point is 02:51:55 Then there's special stocking and bulking distribution centers, which are meant to store inventory rather than cut it up and get it into stores. There are 17 flatbed distribution centers, which are all about fulfilling those massive orders to pros. So if you need huge quantities of things onto flatbread trucks, they also have 160 market delivery operations centers, which are cross-doc facilities for other large items like patio furniture that they don't want to route through stores. David, to your point of really benefiting from a specialized supply chain, this is an insane footprint to have. for e-commerce they have 20 dedicated direct fulfillment centers that are just for that that they started in 2014. Those stock way more skews than you would ever see in a store. That's where all their online only stuff comes from.

Starting point is 02:52:47 And that explains why one of my goods that I ordered last week took, it was a battery for a camping lantern that I bought, took like two and a half days to get to me. Whereas the other thing that shipped right from the store got to me in just a few hours because the lantern battery was an online only skew. And then, not to mention, we'll talk about this later, but they do reacquire HD supply and they make some other acquisitions. HD supply on its own has 130 dedicated distribution facilities. So it's just this crazy footprint to accomplish that mission you talked about. Crazy footprint and specialized footprint that looks super different than Amazon's. So this kind of becomes the story of the stock and the company. And the company.

Starting point is 02:53:31 after the financial crisis of, oh, hey, it's retail apocalypse out there and Amazon's eating everybody's lunch, except Home Depot's, because this is a highly specialized, again, specialty retail, logistics and fulfillment chain, and Home Depot's built it out. With very, very high dollar items that you buy through it. And actually, they make a decent margin. I mean, it's 33% gross margins. This is not Costco. So you multiply. decent margins, buy large dollar items, buy lots of them, buy every house in America, the number gets really large. Yep. So Frank Blake retires in 2014. And unlike any of the previous chapters of the company, he's actually built a management bench. And the people who would stay in the company and succeed him are matched in their impressiveness only by the people who were in that same group who are leading other companies now. Right. So the same. So the same thing. And the same thing, CEO of UPS.

Starting point is 02:54:33 Yep, Carol Tomay. She was the CFO of Home Depot for a long time. And the CEO of Floor and Decor. Yep, Tom Taylor, legend. So when Frank retires, he hands the reins over to Craig Maneer. He runs the company for another eight years, and then he retires in 2022 and hands the reins over to Ted Decker, both of them, come up through the company, you know, practically lifers at Home Depot. And yeah, speaking of 2022,

Starting point is 02:55:01 All of this strategy and all of these people look like absolute geniuses when COVID hits. Isn't it insane? They just, they stopped building the physical stores a decade before. They invested billions and billions of dollars building out many dozens of fulfillment centers. It's where all of their effort went. Yep. In the category of improving your home. Yep.

Starting point is 02:55:27 And then suddenly we're all stuck at home wanting to order things to improve our home. embark on home projects without necessarily going into stores in 2020. And they've got all this capacity built out and invested in. Or be able to go into stores to get what we need, but do it in a way that you minimize human interactions there. And guess what? Home Depot has already built out all that infrastructure to order online or on your phone and pick up in stores.

Starting point is 02:55:55 Yep. It was like the most incredible unintended. preparation of all time. Yeah. So during COVID, Home Depot's revenue growth goes nuts. It goes from 110 billion in revenue to about 160 billion of revenue. In just three years. Yeah.

Starting point is 02:56:15 They had a little, obviously, some hangover after that. So it would decline and then take a couple of years to come back. But still, America wanted to shop there, and boy, did they have the capacity built out for it. And then in 2024, we all wanted to spend money on something besides our homes. Yes. Exactly. Exactly, exactly. Yeah, Ben, you mentioned the HD supply round trip in there.

Starting point is 02:56:38 They spun off the company, sold it to private equity as the housing bubble is bursting right before the financial crisis. And it was mostly the distribution company that they sold off, which is a fine business, but not a great business. Yep. Used all that capital to buy back the stock. And then 13 years later, bought the company back for the same price that it sold it for, right? They actually just bought part of it back, the most valuable piece of it, for $8 billion, but there's been lots of inflation since that.

Starting point is 02:57:13 It's not really fair to call it the same price. They definitely bought the best part of it for less than they sold it for. But yeah, the purpose of doing this, like leave capital allocation aside for a second, they wanted to better serve that maintenance repair and operation customer, and you kind of need to do it with specialized distribution. outside of the retail stores for larger and more complex planned purchases rather than what the Home Depot retail store really is, which is filling in the gaps real time or one-off for a project.

Starting point is 02:57:41 Yep. The next thing they do is they buy SRS in 2024. This is a giant deal, an $18 and a quarter billion dollar acquisition, the largest deal in the company's history. They actually pause stock buybacks here. In order to do this. Yeah. really got to use the capital to swallow that.

Starting point is 02:58:00 SRS is a specialty trade distributor that serves professional roofers, landscapers, pool contractors, and other trades. You can kind of think of it as expanding into an adjacency, growing its total addressable market. The thesis is similar to HD supply, but it's less focused on maintenance and more focused on net new exterior building projects. So these are bulk orders, planned ahead of time, delivered to job, with a dedicated delivery fleet of vehicles, again, a whole another set of distribution centers and vehicles that they now own that are specialized for their business, mostly facilitated

Starting point is 02:58:38 outside the walls of their traditional stores. This continues to grow, and they've already made another multi-billion dollar acquisition within SRS to do interiors, so drywall, ceilings, things like that, in addition to SRS's traditional focus on exteriors. So it's like a parallel business that's sort of. serves even bigger pros doing different types of jobs where they can fulfill the whole thing outside of stores. And then those same pros probably come into Home Depot retail to do the real-time stuff

Starting point is 02:59:10 while they are doing a job in progress. Yep. So it's interesting. Like that Bobner Deli growing via expansion into adjacencies wasn't wrong. It was just the wrong time to do it and the wrong way to do it. Yep. Yep. Yep.

Starting point is 02:59:25 And now that the company has shifted its strategy to e-commerce, which is so much more distribution and logistics and fulfillment heavy, it makes more sense to expand into these adjacencies as logistics become the core competency of the business. Yeah. And now that the core business is healthy again. I mean, now that you have stores that are actually working at their highest level of productivity possible with some work done on the culture. Yeah. Yeah. So, all right, take us to today. Yes.

Starting point is 02:59:56 So the business today, it's $165 billion a year revenue business. Not a super fast growing company grows at 2.5 to 4.5% per year. A little over half the revenue is pro-contractors, and half is that sort of consumer DIY retail customer. Moving on to profits, the gross margin is a little above 33%. Operating margin is 12.5%. Net income last year was 14 billion. So of the $165 billion they make, they get to keep about $14 billion of it, which, if you do the math, is about an 8.5% net income margin. They have 2,400 stores today, opening about 15 new ones each year.

Starting point is 03:00:39 They own 90% of their real estate. They only lease about 10% of the stores since once capital stopped being an issue for them and they started being free cash flow generative, they realize that actually a competitive advantage for, us is lock up the best real estate and hold it forever and don't get held hostage in a real estate negotiation when a lease comes up. Early on, they obviously couldn't do that. And they intentionally did stuff like the JCPenney deal to lease secondhand retail stores so that they could quickly stand up new stores. But over time, it just became better to own the real estate.

Starting point is 03:01:15 This has actually been why international has been tough or one of the reasons why. a lot of the best real estate in Europe is taken. But like a lot of the best real estate in Georgia in the 80s was perfectly available. And they sort of grew up with the U.S. I mean, it's weird to say because the U.S. was already 200 years old, but they grew up with the suburbs of the U.S. becoming extremely populous. They have moved to Canada, Mexico. You know, they're branching out in North America, but completely failed.

Starting point is 03:01:51 in China. They totally miscalibrated home improvement is not really a thing. A DIYer is not virtuous in China. Sort of like, why can't you have someone fix that for you? And the wealthy people live in cities. Right, right, right. So 86% of stores are here domestically in the United States. If you go over to the classic retail metrics and look at inventory turnover, it is higher than lows, but it's nothing crazy. They turn their inventory about four and a half times per year compared to lows turning 3.3. Just for reference, Costco turns their inventory 13 times per year. Right.

Starting point is 03:02:27 So again, like very different category here. Costco sells the items on its shelf faster than it needs to pay suppliers for them. Yep. Home Depot doesn't have that. They have what we mentioned earlier where at any event time about half of their inventory is financed by the suppliers who they haven't paid yet. Yep. One big thing we should say here is totally unbelievable that the Home Depot can turn their inventory four and a half times per year, given that the goods that they carry are super high dollar specialty, and they have 35,000 skews against Costco's 4,000. Yep. In store and then a million skews online.

Starting point is 03:03:06 Right. The inventory turn, given the nature of their business, is kind of unbelievable. Yep. At any given time, Home Depot has about $11 million of inventory tied up in a store. and Lowe's is about the same. The funny thing about whenever you look at any chart of Home Depot and Lowe's is, used to be super different, now about the same. They've really converged toward each other over time. One thing we didn't talk about is private label.

Starting point is 03:03:30 They started this slowly back in 1985, and it grew to become a really big part of their strategy to have house brands and brands that are exclusive to Home Depot. You may not realize this, but bare paint, B-HR, only, available at Home Depot. Hampton Bay, lighting and ceiling fans. That was a Pat Farras special, I think.

Starting point is 03:03:52 Yep. Glacier Bay, fixtures. Ryobi, which is a very hot brand recently, especially lawn care, anything with lithium ion batteries. Rigid power tools. Anvil HDX, Everbuilt, Ecosmart lighting, husky tools.

Starting point is 03:04:11 There's actually a lot of brands that I did not realize were exclusive to Home Depot. they don't actually disclose now, but industry estimates are 15 to 25% of their sales are house brands. House brands. Yeah. Again, nothing compared to the one-third of Costco sales that are Kirkland signature. But still, I mean, that's a giant amount.

Starting point is 03:04:35 I think house brands are getting more interesting, too, especially with electric tools. If you look at Ryobi, batteries create brand loads. Right, right. So I'm actually in the other camp. I don't have Ryobi stuff. I have ego. But I bought an ego lawnmower, which gave me an ego battery. So over the years, I now have an ego.

Starting point is 03:04:59 You develop switching costs. Weedwacker. I have an ego hedge trimmer. I have an ego leaf blower, which kind of, I think, puts me out of the Home Depot ecosystem for all that stuff. So imagine the thousands and thousands of dollars Home Depot could have gotten on me if I had first bought a Ryobi. lawnmower. Yeah. Talking about e-commerce, after all that discussion, it's still only about 15% of their sales

Starting point is 03:05:22 are online. Yep. There's so much running room that they have there. So much running room. They have 472,000 employees, and their market cap today is $350 billion. And my favorite fact to sum up the state of the company and the business today is the CEO of Lowe's. is a former Home Depot executive groomed under Frank Blake. Really?

Starting point is 03:05:51 Yep. Today, the Home Depot executive CEO lineage tree runs across the street to Lowe's. Marvin Ellison was head of stores under Frank Blake and then went to take over JCPenney as the CEO of JCPenney. And then in 2018 became the CEO of Lowe's. such a deep bench that you created your competitor's CEO. Yep. I think Frank would be proud. Yes.

Starting point is 03:06:20 So, yeah, the Home Depot story to put a bow on at least the original Avengers plus Frank. So Bernie Marcus passed away in 2024 at age 95 after a long, incredible life, including becoming friends with Pitbull in his later years. Pat Farah is alive and retired in his 80s, keeps a low profile. Arthur Blank, who we said we would come back to. Today is 83. And as some of you know, is the owner of the Atlanta Falcons NFL franchise and several other sports franchises. And Arthur has been one of the most influential NFL owners of the last 20 years. He serves on basically all the critical NFL league committees.

Starting point is 03:07:15 He's been a big part of everything we talked about on the NFL episode and all the strategy decisions that have made the NFL the dominant force in American sports and really American media today. For as much affiliation as he has with the Home Depot, I think he actually has more with the Falcons and the NFL now. No question he is much better known for the NFL. Whenever you see an interview with him, it's Falcons owner, not Home Depot co-founder. Yep, yep. And we said he got the third golden horseshoe. So when he bought the Falcons in 2002... Just one year after fully leaving Home Depot.

Starting point is 03:07:54 Yep. He paid the then crazy price of $545 million for the franchise. The Falcons today, by the latest... you know, public valuations that are bandied about out there are worth $7 billion. There's no way. They're worth way more than that. That vastly discounts the actual value of the falcons. The Seahawks just traded for nine and a half. Yep. Seahawks just agreed to a sale at $9.6 billion. And since then, the Lakers at 12 and a half. Even just comparing the Falcons to the Seahawks, Atlanta is about a 30% bigger market than Seattle, the whole metro area. And

Starting point is 03:08:37 Much more importantly, Atlanta has a much better stadium deal with Mercedes-Benz Stadium than the Seahawks do with Lumen Field. So I think the Falcons are worth a minimum of $10 billion and arguably more than that, which I think combined with his other assets and his remaining Home Depot stake makes Arthur the wealthiest of all of the co-founders of the Home Depot. Listeners, one update here from the acquired editing bay after recording. The Falcons just agreed to sell a minority stake at a $10.6 billion valuation. So, yes, we were on to something. David, you nailed it. Now back to the show. Continuing on Frank Blake, who of course Bernie Marcus so violently reacted to as another goddamn GE guy

Starting point is 03:09:28 when he got the news that he was taking over the company. Today runs Bernie Marcus's foundation. Amazing. Which is about a $4 billion spend-down foundation. And Ken Langone, the goat, is about to turn 91 years old, has never sold a share of Home Depot. His stake in the company is worth about $6 billion today. I went and looked back at this, that little 5% he got at founding, compounded 25% for nearly half a century. But you all know this.

Starting point is 03:10:05 The hard part is actually not about the stock picking. The hard part is in the holding. Yes. So in 1985, and this is a great Arvind stat, I mean, long-time listeners know, worldly partners, their whole thing is figure out what it takes to build a business that can 100X as a public company and then figure out how to have the stomach to stay with those companies through the downturns because there are always massive drawdowns in these giant 100x companies.

Starting point is 03:10:35 I mean, you look at Nvidia, like you just have to weather through them and know enough about the business to believe that it's going to make it through. So in 1985, the stock was down 66% and Ken didn't sell. Then in 2002, down 70% and he didn't sell a share. Then in 2008, the whole Nardelli situation, the housing bubble, and then again down 70%. He didn't sell. In fact, if you bought the shares at their peak in 99, your investment would have been underwater for a full 12 years until the stock recovered in 2012, but Ken still never sold. Yep. Hey, he's a loyal guy.

Starting point is 03:11:20 The value is in the holding. Yep. Yep. And amazingly, Home Depot may not be Ken's largest position. Because in 1977, before even getting involved with Home Depot, Ken sold a medical device company to Eli Lilly for stock and got at the time 2.5% of Eli Lilly's equity. And of course, I believe Ken has also never sold a share of Eli Lilly. But that is a story for 2027 on Acquired. Yes, it is.

Starting point is 03:12:03 All right. Analysis. Let's do it. So we did a lot of analysis along the way. I have one major topic that I want to discuss with you. That I think it's the perfect episode to... Yeah, you foreshadowed this with me, but you didn't tell me what it is. To do it on it.

Starting point is 03:12:17 I'm itching here. Okay, so we talk about this all the time. I can't actually remember if we've talked about it on Acquired, but I feel like we talk about it endlessly on our phone calls. The thing that made you special often holds you back at scale. And I'm going to throw out a few. few examples that I actually highlighted when I was first reading the built from scratch book, we wanted to see the big stuff loaded in the front of the parking lot so everyone could see it. No, they definitely have loading docks now in the back of the stores.

Starting point is 03:12:45 They talk about how merchandise is not fronted. There's not someone walking around, turning things, making sure they're facing out. I walked around the store last week. Most items I saw definitely facing out to be the most presentable and appealing to the customer. There is no backdoor or discount for contractors. We were priced right for everyone, not just a select group. They definitely have a pro-pricing desk now. They even talked this big game about in the book how they did everyday low prices, just like Walmart did, to not appear duplicitous to customers and not have people time their purchases.

Starting point is 03:13:18 Well, I got an email three days ago. It said, Daily Deals with a big dollar sign through the S. Free delivery, online only, well supplies last, 84 offers for you up to 30% off. Select Home Essentials, shop now. I was going to say, I'm pretty sure I've been to some Home Depot Memorial Day sales. Definitely. You won't see aisle numbers in our stores. Why?

Starting point is 03:13:43 Because if we had aisle numbers, when a customer asked where they can find something, it would be very easy for our associates to say, Isle 8? If there's no numbers, the employee has to say, let's take a walk and we'll find it together. I was in Home Depot a week ago. There were definitely aisle numbers, for sure. Same with decentralized decision making or having manufacturers ship direct to stores. These all changed. So what is the lesson here?

Starting point is 03:14:09 I think there's two ways to look at it. And I'm curious how you think about this. Way number one, companies in general just get less special over time as they scale. It's like entropy. The world wants you to look more like every other company when you get big and to stay special like Costco, Rolex, Hermez, Van Gogh. guard, these are like companies that fight gravity. It's like ridiculously hard to clutch to the thing that made you so special and not look like everyone else. But the other way to look at it is it's actually completely the correct thing to do in most instances. All the special things that you

Starting point is 03:14:46 did when you were little to get attention and be different. In most cases, that actually holds you back when you're big. And it's easy to think, well, we have to keep doing things that way because it's what let us succeed in the first place. But you probably have completely different reasons of why you succeed now than you did compared to when you were small. Yep. And also, usually the market changes, right? Like, case in point in this story, early Home Depot would never have fulfillment centers

Starting point is 03:15:12 and distribution centers. Home Depot today would be toast without them. Totally. I think the second bullet point is actually the correct one, that it is the rare case where clutching your pearls and holding on to this founding insight is the way to succeed at scale. I think a lot of the time your scale is the reason you can be successful at scale

Starting point is 03:15:37 and you have to make decisions that make sense for a giant scaled company. And like, Hermes hand stitching their Birkenbags, even at the scale that they are today, is like a one in a million example where it's actually the right thing to hold on to some founding, tactic that still works today. Yep. The founding values are important, but the founding tactics are probably not.

Starting point is 03:16:05 Yep. I totally agree. Well, speaking of embracing your scale and your scale economies, I think this is the perfect transition to powers for Home Depot. Yes. So, listeners, this is the part where we do the seven powers framework from Hamilton Helmer's book of the same title, where we try to figure out what does a company have that enables it to get persistent differential returns or to be more profitable than their nearest

Starting point is 03:16:33 competitor on a sustainable basis. And those seven are scale economies, network economies, counter positioning, switching costs, branding, cornered resource, and process power. Well, the first thing you'd have to believe is that Home Depot is sustainably more profitable than lows. They are, but it's not by as much as you would think. Yep. Home Depot is marginally more profitable than lows. there's been a very dramatic convergence over time. Yep. The biggest one to me is scale economies, I suspect it is because they can just negotiate for the very lowest prices with their suppliers, get the best manufacturers to do their house brands, that sort of thing given their, what are they, 3X the scale of Lowe's?

Starting point is 03:17:17 Yep, about 3X. So that's the biggest thing now. Early on, I think it was definitely counter positioning. Definitely. Lowes doesn't get enough credit for the pivot in 1990. Because think about all the things working against a traditional hardware store. You've got a smaller footprint. Yep.

Starting point is 03:17:36 You have to change your entire real estate strategy. Basically all your real estate is useless. Yep. You probably have to lower your gross margins. Yep. But you're not doing enough volume to justify the lower gross margins. So you really can't lower them unless you can like pull some of those magic beans that Home Depot had and go convince people. that the ride is going to be so long and fruitful together

Starting point is 03:17:57 that even though you're not large yet, they should give you great deals. Yep, yep. It's unbelievable that any of those stores manage to adopt the Home Depot strategy. Yep. Oh, and they probably use distributors. So you have to blow up all of your existing supplier relationships to go direct to manufacturers.

Starting point is 03:18:14 Yep, yep, yep. Today there's some switching costs with the house brands, but I'd say the switching costs are probably more for pros who have just integrated Home Depot into their workflow. Yep. I think there's significant switching costs for pros. Yeah. For that reason. And probably branding for pros.

Starting point is 03:18:32 And I think the hardcore weekend warrior segment also prefers Home Depot, but that's for the same reason that the pros do. Yeah, I think so too. I think there is still counter positioning today. It's just very different. It's counter positioning versus Amazon with their logistics and fulfillment network. Yep. Amazon is building out more specialty fulfillment and logistics, but it's going to be really hard for Amazon to build and match the scale of what Home Depot has in hardware. Yep, I agree. But yeah, I think that's it. I think that's it too.

Starting point is 03:19:11 A lot of scale economies. Which makes sense for a retailer. Yes. Yeah. Yes. All right. Quintessence on this one. Listeners, David and I chatted before.

Starting point is 03:19:23 and we decided for this episode, the quintessence, the main takeaway, we want to try and answer the question, why did this work so uniquely well? Home Depot is the only specialty retailer in the world that is in the same universe as Costco and Walmart and Amazon retail. So how did it get that way? David, it won't surprise you that I have a several part answer slash equation to answer this question. Equation. All right. You've certainly piqued my interest. Because it's basically several things multiplied together. Does it include scale economies shared? Well, see what you think. So the magical thing at the core of all of this is forget home improvement.

Starting point is 03:20:08 If you can get consumers excited about shopping in a warehouse with no frills, there is an insane number of downstream benefits that comes from that. And we talked about them all episode, particularly as it relates to saving costs. of not having to have a separate backroom and showroom. Normally, that is a huge if, but home improvement is the perfect category. I mean, you are delighted to go buy hammers and lumber in a warehouse. So not issue. That's factor number one. Two, giant market.

Starting point is 03:20:37 Today, the home improvement industry in the U.S. is $300 billion. For reference, like a comparable market, U.S. furniture, $180 billion. So even other large retail categories aren't playing in this large of market. market. Three, they captured a huge part of the market. Used to be super fragmented, but today, Home Depot is 51% of the market. Lowe's is 29% of the market. The next highest is Minards with less than 5% of the market. By 2026, Home Depot and Lowe's together represent 80% of the market for home improvement stores. Yeah, that's wild. The scale economies in this business, which were not apparent when it was a small fragmented thing, have actually

Starting point is 03:21:20 led to win or take most. Yep. And in fact, the narrative around Home Depot and the market that I think management itself would tell for many years is, hey, we're still a small part of the market. That's, yeah, not true anymore. It depends how you define the market. But yeah, if you define it as home improvement stores, they are 51%. And it makes sense that they should be able to command the cheapest prices from the manufacturers. And as long as they're good about passing that on to you, that should reflect

Starting point is 03:21:50 in market share. Yep. Okay, so that's three. Four, aging housing stock in the United States. I wanted to save this all the way for the end. Arvin did some amazing research on this one that the stat is perfect. The median age of the housing stock remained broadly stable at about 23 years old from 1940 all the way to 1980.

Starting point is 03:22:18 Post-war construction, you kept adding new homes to the overall stock. The American Suburban Build Out. So the median age of a home stayed young since you were injecting so many new single-family homes. As of 1980, right when Home Depot was starting, that ended. The median age of a home by 1990 went up to a little bit higher, 25 years. Then by 2000, it was a 30-year-old home. Then by 2010, it was a 33-year-old home. Today, the age of the median home in the United States is 42 years old.

Starting point is 03:22:54 This company was founded and IPOed into a market of houses that were only getting older and needed evermore repairs. And as the very proud owner of a 115-year-old house here in San Francisco, let me tell you, we have been very busy for the last few years maintaining our house. This is one of the largest tailwinds we've ever studied in a business. and in a very predictable one too. I mean, one thing I know for sure, if the age of the median home in the United States right now is old in five years, it's also going to be old. Yep, it's going to be older.

Starting point is 03:23:28 So here's a market. So this is a different way to slice the market, but another crazy stat. In 1975, U.S. consumers spent $28 billion on residential improvements in repairs. That was right before the company was founded $28 billion. Five years later, that $28 billion grew to $47 billion. Today, that number is $600 billion that U.S. consumers spend on home improvements and repairs. It's funny. We haven't really talked about this whole episode, but like so many of the other great companies we cover on Acquired, Home Depot is also a story of impeccable market timing. Five, they massively grew slash invented the do-it-yourself concept. And six, the pro market ended up having way.

Starting point is 03:24:15 more running room ahead of it than anyone thought. And Home Depot smartly crafted these very flexible offerings and parallel ways that you could buy from them, have different business models, have different distribution models. So if I had to answer the question, why did it get so freaking big? It's the literal multiplied product of giant market, captured a huge part of that market with scale economies, aging housing stock, invented the DIY concept, at least at scale, and then sort of also consumed the pro market along with the consumer market. Yep, yep. I love it. I think maybe the only thing I would add to that beautiful equation is it's also the product of the U.S.'s economic and property rights policy.

Starting point is 03:25:10 decisions over the last 100 or so years that have created this market for U.S. housing where a huge portion of the households in America own their own homes. Single family, freestanding structure homes. Yeah. And that was a necessary precondition for the home improvement industry to get so large. If you either had... And the U.S. finances it. And the fact that we...

Starting point is 03:25:39 And the U.S. finances it. Yeah, yeah. These 30-year mortgages are the most insane financial instrument ever. So we let people own homes, even though no one has anywhere near the capital to own these homes. And the strong tax incentives to have mortgages to own homes, et cetera, et cetera. If you either had not as high ownership rates in the U.S. Or like China, if you had a just fundamentally different kind of housing stock that people own. because actually the Chinese housing market is larger than the U.S. housing market,

Starting point is 03:26:12 but it's a terrible market for home improvement and Home Depot. Yep, good point. Yep. That's what I got. It's a good ad. All right, that's our quintessence, ladies and gentlemen. This was a fun one. A lot of characters along the way.

Starting point is 03:26:24 A lot of characters. Carvouts. What's you got? Carvouts. All right, listeners, this is where we recommend things that have nothing to do with the episode that we've just been enjoying recently. one for me is silo season three. I think I've probably made a carve out of silo season one and two in the past.

Starting point is 03:26:44 I think so. I might have done the books. The books are great. I think you did the books. I've never read the books. And the books have dramatic spoilers for the show. So please don't tell me anything about the books. It's really good.

Starting point is 03:26:55 The acting has always been great. The directing has always been great. The story has always been great. Apple TV makes good stuff. Yeah. I just can never wait till Friday night. and not for all the normal reasons to wait for Friday night. It's because that's when the new silo drops.

Starting point is 03:27:09 So I can't recommend it enough. Great, great sci-fi. Throwback to appointment viewing. Yes. My second one is also a season three of a TV show, Tires. Oh, yeah. This is with Shane Gillis, right? Yes.

Starting point is 03:27:23 Oh, my God. It's so funny. I try to watch it at night after we put my son to bed, and I'm just, like, laughing so hard. I'm always afraid I'm going to wake him. It's just so, so good. I'm so glad they did a season three because Shane got very famous after they did season one and two. And I was like, oh, this is this low budget thing that he did with his friends is done.

Starting point is 03:27:44 But it's back. The whole cast is back. And it's better than ever. So I highly recommend it. Nice. Nice. And my third one is the ratio eight coffee maker. It is a all glass, ceramic, and metal coffee maker.

Starting point is 03:28:00 and I just realized how dumb it was that for most of my life I've been pouring boiling hot water through some piece of plastic before drinking it in my coffee every morning. And so the ratio 8 is a, first of all, it's aesthetically a very beautiful machine, but it's basically a high-end precision automated pourover. We'll link to it in the show notes makes delicious coffee, especially when paired with, there's another service I've been trying called Trade Coffee, where on a schedule they deliver a different coffee for you to, try every two weeks or one week or whatever you want the frequency to be. And I oscillate

Starting point is 03:28:35 decaf and regular so that I can mix them and make half-calf coffee in the mornings. Oh, nice. Nice. Yeah. That's all I got. Nice. Well, I am going to surprise you. I think I have two carve-outs, one of which is a TV show and one of which is a movie. A movie, David Rosenthal. I know, watching movies and TV shows. This is not my normal outside of acquired behavior. The first one is the TV show quarterback on Netflix. It's August here as we're recording this, and I am so starved for football. Man, Netflix does such a good job with quarterback. It drops right at the right time, right at the start of training camp when you're desperately in need of some football content.

Starting point is 03:29:21 This season, Cam Ward of the Tennessee Titans, I didn't watch a lot of Titans games last season, and so I didn't know much about Cam Ward, former number one pick last year in the draft. I'm excited about him. I think he can be a star in the league going forward. Sweet. All right, quarterback on Netflix. And then my second carve out is the old Jerry Seinfeld movie comedian,

Starting point is 03:29:46 which I watched upon reading a tweet from a friend of the show, Jeremy and Jifon. This movie is so fun. It follows Jerry. right after Seinfeld the show ended when he goes back to the clubs in New York, to the comedy clubs, and builds up a whole new stand-up routine

Starting point is 03:30:10 completely from scratch. And it's like, he's Jerry Seinfeld right after the show ends. So the most famous person, you know, maybe in all of New York. And he's just going to the clubs, trying out new material. And he's bombing.

Starting point is 03:30:23 And it's great. It's so fun to watch. Oh, sweet. I got to check it out. Do you know my favorite game when I go stay at a hotel? Ooh, no. I turn on the TV and I try to see if there is an hour where a Seinfeld rerun is not on any channels. The syndication rights are so distributed that I feel like Seinfeld, the show, is on 24-7 somewhere.

Starting point is 03:30:47 It's got to be. And on Netflix now. Yep. All right. Well, we have some thank yous for folks who helped us this episode. First, I've been talking about a while episode. but Arvin Navarutnam at Worldly Partners, he always does these great 100-page studies.

Starting point is 03:31:02 And this episode is particularly in his wheelhouse because in his quest to find the next 100x company to invest in and hold for decades, he does this on-the-ground research. He goes to stores, and he employs someone full-time at Worldly Partners who is traveling the country, walking through Home Depot, Lowe's, Costco,

Starting point is 03:31:22 other stores, doing price comparisons and actually generating real first-party data on how do these stores evolve and change over time, how do their prices change, how did the experience change. And so his write-up on this one is particularly awesome. So you can check it out at worldly partners.com. All of his other studies are there. And this time, Arvin teaches a class for HBS and Boston College students, usually they're private. He interviewed Ken Langone, and he has agreed to make that video public alongside the release of this episode. So he's also going to put that on worldly partners.com. So thank you so much to Arvind for your research help. Thank you to Ken.

Starting point is 03:32:02 Yeah. So fun to talk to him. Great storyteller. And to friend of the show, Frank Blake, Frank is just the most ridiculously humble person you will ever beat. Ken would insist that he saved the company and it would cease to exist if not for Frank coming in and saving it. Frank, of course, says that is absolutely not true. And turns out it wasn't that dire of a situation. I think I'm with Ken in his opinion on this one. Yes. Thanks, Frank. And thanks to Russ and Dylan Murphy, my contractors, for being my partner in building and restoring and maintaining my 115-year-old house here in San Francisco and helping us with this episode.

Starting point is 03:32:42 Yes. A huge thank you to our partners this season. Sierra, our presenting partner, Sierra helps the great companies of the world build better, more human customer experiences that's Sierra.A.I. slash acquired. To WorkOS, start selling to enterprise customers with just a few lines of code, build authentication in minutes instead of months, workOS.com, to Anthropic. Claude is a truly incredible AI product that thinks with you, just like it thought with me in preparing for this episode. That's claw.aI slash acquired. To Century, application monitoring software considered not bad by millions of developers, Century.io slash acquired. And if you're in the Bay Area, on

Starting point is 03:33:22 September 17th, just a few days after this episode comes out, you should join us for the official 2026 Acquired Meetup with our friends at Century. That's Acquired.fm slash meetup. If you like this episode, go check out our other episodes on great retailers, Costco, Walmart, Trader Joe's, IKEA, and Amazon. We're really creating kind of this retail through line here, the great American retailers. We might have to make some t-shirts with some more saving, more doing slogans on it. That's right. You can do it. We can help. That's right. And for all of you who have been asking for visuals with our episodes, you can check out our companion PDF. It will come out the day that this episode drops and it will improve over time. So if you checked out our Disney PDF from part one or

Starting point is 03:34:11 part two, both of those have been dramatically improved since those first dropped. That's library. dot Acquired.fm for all those tables, charts, and illustrations of key concepts. Join the email list, Acquired.comfm slash email, where we send out behind-the-scenes photos from research, past episode corrections, and vote on future episode topics, and come talk about this with David, me, and the whole community in Slack at Acquire.fm. Slack. Listeners, with that, we will see you next time. We'll see you next time. We've got the truth now.

Acquired - Home Depot

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