Home Depot: The best-performing stock in the S&P 500 since IPO (Audio)

I'm sorry, I got tripped up. You used power tools, David Rosenthal?

I built this whole door. I got the blank door from Home Depot. I had to cut it down to size to fit a nonstandard-size door opening in my studio.

Wow.

I drilled the door handle. I put the doorknob on myself. It all worked great.

We've 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.

1. Home Depot Defies Expectations

Home Depot is an astonishingly large company. Before I started this research, I thought of it as a big store in the middle of a bunch of shopping centers, but not really as an important company to the world. But I was wrong. And the stats are large, David.

Yes, large.

It is the world's largest specialty retailer. The only retailers larger are general retailers, not retailers in a specific vertical like home improvement. So think Walmart, 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, Alibaba, Goldman Sachs, or LVMH.

Or Disney, which we just covered.

Yes.

Which is wild, because unlike all of those other companies, Home Depot is only in North America.

Yes, 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, 1 year after Apple Computer. Astonishingly, if you put $1,000 into Home Depot and Apple at their IPOs and held them until today, your investment in Home Depot would beat your investment in Apple. If you reinvested the dividends that it paid out, it has compounded at nearly 25% per year for 45 years. Imagine if your stock portfolio did that.

Yeah, Home Depot is an all-timer. I can't believe we haven't done this episode yet.

Right? That makes it the No. 1-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. Well, as we go, we're going to get into who holds that equity, because it's actually a critical part of the company's strategy, or at least it was.

Listeners, if you're trying to contextualize this, 45 years is a long time. How does that $17 million stack up? Ben and David love their index funds. We love Vanguard here. If you had bought the S&P 500 with that same $1,000, instead of $17 million today, you would have $170,000.

Wow.

Today, we will tell the story of how it happened. It is an unlikely story of 2 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—5 times more square footage than any other hardware store at the time—which seemed risky at best, maybe unthinkable. We'll try to answer the question: How and why did that idea become so large? Of course, it's bigger than Lowe's, but also IKEA and Trader Joe's. It's bigger than nearly all dedicated grocery store chains. 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, and more than almost every car company and hotel chain. They have more employees than any restaurant chain, including Starbucks. So listeners, this is the story of Home Depot.

Woo, let's go.

2. The Retail Avengers Assemble

The story of Home Depot is kind of like the Acquired version of an Avengers movie. There are these 4 business and retail superheroes who come together. They don't save the world, but they save customers a lot of money.

They provide extreme value propositions to the American consumer.

Yes. 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, while reading Bernie's book, Kick Up Some Dust, the foreword of which was written by his good friend, the rapper Pitbull. Amazingly, the 2 of them bonded and became good friends later in Bernie's life.

Yeah, when you sent me that book cover, I had a serious double take at the foreword.

Yeah. So Bernie, despite his rough upbringing and gang experience on the streets of Newark, is 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. 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 to him becoming a concessionaire in a New York-area discount store—a store within a store. This begins Bernie's retail education.

From there, he would go on to join the New York-area discount chain Two Guys. Ultimately, a couple of years later, in his 30s, this leads him to an executive role at the Daylin Corporation, which was a retail conglomerate based in Los Angeles with a whole bunch of different stores. 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 are shopping malls being built everywhere in the suburbs across America here in the postwar period. Sears is building big anchor-tenant stores attached to these new shopping malls. 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 in retail is dynamic. The postwar 1960s baby-boom American suburbs are alive and well with their shopping.

Daylin was this holding company that operated almost like a portfolio or an index fund for all these retail concepts. They would go out and acquire small chains of all these types of post-general-store concepts serving the American suburbs. They had pharmacies, hardware stores, clothing, home furnishings, discounters—you name it.

For the most part, all retail in America at this point, except for Sears, Kmart, and some department stores, really didn't have these big national retail giants the way that we do today. It was these regional chains.

Yep. So Bernie's now a corporate executive at Daylin. He has no equity in the company. He's just an employee, but it's a stable job. He's doing well. He's certainly moved up in the world from his upbringing.

Then he gets an opportunity. In 1972, Daylin makes Bernie the CEO of its Handy Dan subsidiary, which is a chain of hardware stores based there in Los Angeles. Again, he has no equity. He's the CEO, but he's just an employee.

And he comes at it from the retail side, not the hardware-expertise side. This is my favorite part of this whole story: Of the people who would go on to found Home Depot, none of them are general contractors or grew up in the hammer-manufacturing business. They're people who just knew retail.

These are retail guys.

Yep.

Exactly. Well, retail and finance guys, as we'll see.

Yes.

Once Bernie becomes CEO of Handy Dan, he quickly recruits another younger company man from within the Daylin empire, a financial whiz named Arthur Blank, to come over to L.A. and join him as his CFO at Handy Dan. Bernie knows himself, as we'll see. He is an incredible retailer, an incredible CEO, and an incredible leader. But his weak spot is finance.

You might be wondering, wait a minute: If Handy Dan is a subsidiary of Daylin, why does it have its own CEO, CFO, and management team? Handy Dan was also a standalone publicly traded company.

And Daylin didn't own all of it, right? It just owned the majority of the shares?

Yeah. So Daylin had bought all of it, but then there was this kind of crazy fad going on on Wall Street in the '70s, 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. Nineteen percent was below 20%, so the parent company could still consolidate the division's financials on its books.

I see. So it actually looks like, oh no, this is a division of ours. Nineteen percent of it just happens to be owned by someone else.

Yep.

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. That's not public information.

Right? If you're the CEO of a publicly traded company and someone who is discussing the price of your stock with you calls and says, “I'm so interested, I'm going to fly across the country right away,” it's like, okay, I really have to watch what I say to this guy.

Yeah. They have lunch, and it quickly becomes apparent that Bernie is a gifted retail operator. The company's doing great, and 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. This is a Daylin subsidiary, even though we're publicly traded.”

Ken says, “Okay, I'm going to go back to New York 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 call up your banker, mortgage your house, and do the same, because your stock is about to go way, way up.”

Now, this is exposing Bernie's weakness with finance. While he's brilliant and street-smart, he's also innocent about Wall Street, finance, investing, and all this stuff.

And negotiating. I think in some ways he overtrusts people.

He's weirdly risk-averse in this area. So he says, “Oh, well, I can't do that. That's too risky. I've got a family.” And 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. The price will go up. There's no risk.”

Bernie says, “Nope, I can't do it.”

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. So Ken says, “All right. I told you.” He flies back to New York and 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. I looked this up, David, in the book Built from Scratch, which is the awesome book—it's kind of the canonical Home Depot story—written by Bernie and Arthur. 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 priest, just as he called every other shareholder. 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 says, “Langone, is that an Italian name?”

Ken says, “Yes.” The priest asks, “And are you Catholic?” Ken says, “Yes, I am.” The priest says, “Then, under the pain of hell, tell me what I should do.” Ken 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, and by the time he was done, he had 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 are 2 shareholders, plus a church, in 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 tip over in that series of events.

Right. This is how Ken Langone becomes a co-founder of The Home Depot: He gets his buddies Bernie and Arthur fired accidentally.

Accidentally.

Okay, David, so how does Ken hoovering up all the shares—even though he's sort of become buddies with Bernie and Arthur—lead to their ousting from Handy Dan?

Yes. Ken is essentially the de facto board member of Handy Dan now, and he loves everything 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 stores. Ken basically becomes part of the crew.

This is very different from the new Daylin CEO's approach to managing Bernie and Handy Dan.

And quite bothersome. This guy who's the minority shareholder is closer with your management team than you are.

Right, even though you consider Handy Dan one of your divisions.

Yes, right.

So on one of Ken's trips out to L.A., Bernie says, “Hey, you should probably go see our actual CEO at Daylin, a guy named Sandy Sigoloff, and build a relationship with him.”

Sigoloff, 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 as the bankruptcy value-recovery artist here, shall we say.

Yeah. Didn't he give himself a nickname? Was it Ming the Merciless?

Yes, after the villain in the Flash Gordon comic series. 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 Sigoloff guy is bad news, but he's got this close to 19% equity position in Handy Dan. It'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.

Finally, Sigoloff 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.

Okay, so Ken has no intention of selling here. Let's just 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 Sigoloff sends his lieutenant, Jeffrey Chanin, to try to negotiate something.

This is from the book Built from Scratch:

Chanin says, “The stock is selling for about $8 a share. How about if we pay you $10?”

“No way,” Langone says. “The price is $12.”

Chanin was shocked. “Forget it.” Langone left and went to the men's room. Barely 2 minutes later, Chanin 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? That offer's off the table. That is gone. We had an offer and a denial. No deal.”

Chanin goes, “What?”

Ken goes, “I suggested a price of $12 in my office, right?” Chanin nodded. “And you declined. Well, that's it. I don't want to sell now.”

We're in the men's room now. The price is different.

Chanin says, “You must have some price.”

“Okay,” Ken says. “$14.”

Chanin left in such a blind rage that he almost banged his head on the door. About a week later, Sigoloff called Langone.

“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. Chanin said no. That offer's off the table.”

“I don't understand,” Sigoloff said.

Ken goes, “It's this simple. You had a chance. You turned it down. I've reconsidered my position. I don't want to sell.”

Sigoloff hung up the phone madder than hell.

It's like in The Empire Strikes Back—

“I am altering the deal.”

“Pray I don't alter it any further” is the Darth Vader line.

So this continues for a while. 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 Sigoloff. He's breathing down my neck. This situation's getting bad. It's making my life difficult. Just sell. It's fine.”

The business is doing great, so this is actually my biggest headache.

Yep. And Ken says, “Bernie, what are you talking about? Don't you understand? I am the only thing protecting you from Sigoloff. 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 Daylin. You know, that's not him.”

Bernie, though, again, is surprisingly trusting about this stuff. He says, “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.”

And it's funny. I think it's actually this trusting nature of Bernie, even though he's got a rough exterior, that makes him a great leader and later on, at 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.” In early 1978, Ken sells to Sigoloff. This, I think, is basically the one time that he sells out of a company that he's invested in.

Yeah, 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, which he started buying at $3.

Do you know over what period of time?

I think it was only about 2 years, this whole saga.

From $3, his average entry price was probably, I don't know, $5 or $6—

Yeah, $5 or $6, whatever, to—

Up to $25.50 to sell. And the story is great: Sigoloff 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, “$25.50.” And he goes, “Why the odd number?” And Ken goes, “Well, just to look like we had some real hard bargaining here.”

So good. So good. So, January 1978, Sigoloff buys Ken's shares and now owns just about 100% of the company, except for the Catholic Church in Brooklyn.

Yep. And then, just as predicted—

Yep. Just as predicted. 3 months later, Sigoloff fires Bernie and Arthur and the audit manager at Handy Dan, a guy named Ron Brill.

The pretense that Sigoloff trumps up is an accusation that the 3 of them had violated national labor relations rules in negotiating with unions. Sigoloff 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 Sigoloff, I think, couldn't do this while there was still a 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 out of here.”

“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 is just losing it. He's freaking out. He's like, “Kenny, this is terrible. 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?”

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.

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 to all these store openings, when Bernie was opening a Handy Dan in Houston, Texas.

Houston. Yep, Houston, Texas.

And Bernie should have been all excited about this. This is the best version of the store yet. 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 till 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.”

Ken says, “Well, tell me.”

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 going to hold on to it.”

And Ken's like, “No, come on, dude, tell me.” So now Ken knows the idea too.

3. The Warehouse Idea Takes Shape

The reason that Bernie's so bent out of shape about this is he'd just been down to visit one of his buddies, another retail guy down in San Diego. He goes by the name of Sol Price. That Sol Price.

Of Price Club, and then what would eventually become Costco.

Yep, yep, yep. And Bernie spills the beans to Ken. He says, “Well, I went to see Sol, 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 Sol's concept to hardware, puts us out of business, and brings it to all sorts of other categories. We're all going the way of the dinosaur.”

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 back room.

All the square footage that we're paying for on our lease is shoppable square footage.

Yep. And even more than that, there are 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 marking them up just a little bit, selling them 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 into the warehouse and buying stuff right off the pallet. There's no cost in this business.

Yep. And there's no reason why it shouldn't work just as well in hardware. Someday soon, somebody is going to see Price Club. They're going to do this for hardware, and we're going to be out of business.

A couple of months later, at 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. 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 have to put in it.”

Yeah.

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 million, $8 million, $9 million in revenue, and we're not just going to stock 8,000 items, 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.” More on that in a second.

Bernie's in. He says, “Okay, but there's someone I need to go talk to first. I need to go back down to San Diego and see Sol.”

Yep.

Bernie goes back down to San Diego. He sits down and has dinner with Sol. He explains the whole situation—the firing from Handy Dan, the labor relations suit from Sigoloff, et cetera, et cetera.

Sol listens to all of it and says, “Bernie, do you think you're talented?”

Bernie says, “Yes, I think I'm talented. I did a great job at Handy Dan.”

Sol says, “Do you think you have the ability to build something, to create something, to do this on your own?”

Bernie says, “Yeah, yeah, I think this could be really successful.”

Sol says, “Then tell Sigoloff to go f— himself and just do this thing.”

And so, with Sol's blessing, Bernie's in.

This is important to keep Sol 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. They would diverge over time, and we'll talk about all the differences. 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 the 45% that was industry standard in hardware retail at that time.

It's going to be a little bit different from Price Club in that they actually think they're going to have the best selection. We're going to have tons and tons of SKUs.

We're going to have tons of SKUs versus Price Club and Costco's famous low SKU 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—

Yes.

—for any job that you want to get done. You don't want to go to the outdoor lawn and garden store and over to the lumberyard and to the tool store, right?

And the plumbing store, et cetera, et cetera.

Yeah, being a warehouse unlocks putting all this stuff together under one roof for the first time.

But it is different from the Price Club model of only having 4,000 items. They're going to have to have 25,000 SKUs 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. 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.

So we can already see there are 2 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 SKUs.

Yeah, I think Bernie really did need the pep talk from Sol, and he also wanted to make sure Sol wasn't going to do this, too.

Yeah.

Sol wasn't going to do this, too.

Yeah.

All right, so back to the money. 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 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 Perot 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 Perot to put up the money for what would become Home Depot.

$2 million.

$2 million, in return for 70% 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. Ultimately, the sticking point—you can't make this up; it's all in Built from Scratch—is the car that Bernie drives. He drives an old Cadillac.

Which was actually his Cadillac from Handy Dan, his company car there, that somehow in the separation he managed to keep. But it was old. This is not an expensive car.

Yes. Not a new, fancy Cadillac.

Yes.

This is an old, fancy Cadillac. Perot says, “Hey, well, this is important to me. My guys—my guys here at EDS—they don't drive Cadillacs. They only drive Chevrolets. We're scrupulous here about our costs.” Bernie's like, “Cost? What are you talking about? This is an old Cadillac.”

Right. Pragmatically, this is actually exactly in line with your ethos.

Yep. And Ross is like, “No, no, it's the principle of the thing.”

Ben

And it's a sticking point of 2 things. One, Bernie's like, “No, we should be pragmatists. We shouldn't follow some dumb—”

David

Yes.

Ben

“—virtue-signaling thing.” But two, “You're treating this like this is a division of your company, isn't it?”

David

Exactly. “You're treating me like an employee again.”

Ben

“This is our company. You're the financier. This doesn't feel right.”

David

Yep. So he blows up the deal. And this might be the most expensive disagreement in all of business history.

Ben

Let's see. I'll do the math here live on air. So 70% of a market cap of $350 billion.

David

Yep.

Ben

They did a ton of dilution along the way, but then counteracted 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.

David

Yep.

Ben

So Ross Perot insisting on a Cadillac cost him $223 billion—

David

Yeah—

Ben

“—assuming he held, assuming he would have held.”

David

Right, right. Which Ken did, by the way. He still holds all of his shares. Yeah, you didn't mishear Ben there: $230 billion. That's with a B—dollars. Oh, man.

Ben

So they're screwed, right? I mean, there aren't a lot of places to find the capital. This thing requires a ton of money to get off the ground.

David

Yeah, for ordinary people. But they got Ken Langone here, the greatest investment banker of all time. So he says, “Nah, no big deal. All right, you know, I get it. That was pretty heavy-handed of Ross. I'll just go round up a bunch of other investors instead, and we'll put a syndicate together. All right, let's rewrite the deal for this. 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.

Ben

Which is a little facetious. In my mind, what happened here is when you're negotiating with 1 counterparty that's coming in for all the capital—

David

They have leverage. Yeah.

Ben

They have leverage. But Ken goes out and he finds 40 individual people.

David

Yep. To put in $50,000 chunks.

Ben

Yeah, and so Ken basically writes the term sheet and then is just going around to 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 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—

David

Lower.

Ben

—not as friendly to you, yeah, as the number that you write on your own SAFE.

David

Yep. It's still a great line, though.

Ben

It's a great line.

David

Totally sums up Kenny. All right. So Ken gets the money. They all get back together in L.A., and they get to work.

Ben

And the way the cap table breaks down now is the investors own 50%, Ken gets 5% in exchange for putting this deal together and finding the capital. I think he put in something like $100,000 of his own.

David

Yep, he put in $100,000.

Ben

And then Arthur, Bernie, and the rest of the management team would get 45%. At this point, the founders of The Home Depot are set. It's Bernie, Arthur, and Ken.

David

For the moment.

Ben

Yes, they are missing 1 superpower that you need in an Avengers of Retail team.

David

Yes. Yes. Well, let's get to that. So Bernie and Arthur go back to L.A. and they get to work. The first question is, all right, where are we going to put the first store, the first warehouse? And as we talked 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. Also, Handy Dan is still there. Handy Dan is still the best operator in the industry. Maybe it's not great if we start in our previous backyard here. We should go somewhere else in the country. 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 beaten 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 Farrah. So Bernie and Arthur go to see the store, they walk in, and—

Ben

It's the exact vision that Bernie had.

David

Yep. It's a 130,000-square-foot warehouse.

Ben

Which is way bigger—

David

It's not even Home Depot then. It's Home Depot today.

Ben

Right?

David

Yeah.

Ben

It's way bigger than those early Home Depots that would open, which were like 60,000 or 65,000 square feet.

David

Yep. It's got every hardware and home improvement item that you can imagine piled up high to the ceilings and priced cheaper than consumers had ever seen it before. In retail parlance, the strategy here is known as “stack ’em high, watch ’em fly.”

Ben

I mean, it's a bonanza. The consumers walk in and they're like, “Oh, what? This is crazy.”

David

Yep.

Ben

“This is fun.” It's like our Walmart episode, where they were doing crazy stunts in the parking lot to attract people.

David

It's a party. Yeah, it's a feeding frenzy.

Ben

Yes.

David

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 have the 3 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:

“Pat, the Homeco owner-operator, 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 1 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 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 1 of the most creative people any of us had ever met. Pat is to retailing what Michelangelo was 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 bedbug, but he was a genius.

Ben

I mean, crazy, yes, but this is the missing piece of the puzzle.

David

Yes.

Ben

You've got Bernie the retailer, Arthur for finance and operations, and Ken finds the money and is sort of the spiritual glue holding this team together. But they don't yet have the genius merchandiser—

David

Yep, Pat is the merchandiser.

Ben

—who is going around to suppliers, figuring out what the best stuff you can get from them is at the best terms, having a crazy nose for what consumers want, and making sure to find those items from the suppliers. Then cleverly figuring out how to display it and what the pricing and packaging look like to whip consumers up into a buying frenzy.

David

You gotta create heat in the store.

Ben

Yes, yes, this is all of the universe of Pat.

David

All Pat.

David

There are so many legends about Pat, including driving forklifts through walls, and so on.

Ben

Wasn't it that they wanted to tear down a wall, but they couldn't get a permit?

David

Yeah.

Ben

So Pat just drove a forklift into it. When the inspector came out, he said—

David

Something happened.

Ben

It was an accident, but we definitely have to take out this wall now.

David

Yep. So despite the reservations about Pat's character, they sign an LOI, or letter of intent, to buy Homeco from Pat with this new, well-funded company that Bernie, Arthur, and Ken have started.

Ben

Well-funded? They got $2 million. That's not nearly enough—they're operating on a shoestring budget here, but I'll come back to that.

David

Yes. So they start digging into due diligence on Homeco, and they discover that while Pat is a genius, all the revenue, all the sales, and all the customer demand are real. The store itself is actually insolvent because Pat has not been paying any of his suppliers.

Ben

Ugh, Pat needs an Arthur.

David

Yes, he does. He has just been ignoring the invoices that the suppliers were sending him—30, 60, 90 days later.

Ben

That sounds malicious. I get the sense a lot of what he was doing was incompetence.

David

No, 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 just go and get the stuff, and then I sell it.”

Ben

As part of the due diligence, they bring in auditors to ask, “Are these financial statements correct?” The auditors determine that the margins at this store are not anywhere near what this owner thinks the margins are. Bernie and the crew have to break this news to Pat.

Pat is distraught. He's like, “What do you mean? This thing's going to run out of cash in the next few months. I'm doing great.” And they're like, “You're not doing great, man.”

David

But God bless them. 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've 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 4th full co-founder here. 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. But you are going to come in, stack them high, and we're all going to watch them fly.”

Ben

I mentioned that $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 with that. It forces 2 things.

First, they have to get the longest possible financing terms from suppliers. Once the goods arrive at the store, it's a ticking clock to make sure that they can move those goods. They don't want them arriving anywhere other than the day before opening day.

Second, 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 come due. This is what Pat was not doing. As a result, about half of The Home Depot's inventory at any given time was actually being financed by the suppliers, which is still true today, based on payment terms. They can sell about half the items before they have to owe those dollars to the manufacturers.

They realized they couldn't afford to extend payment terms to their customers. They were already thinking this way, but what it did mean is they had to focus on retail customers—consumers who would just pay cash or use credit cards when they're buying an item—so that The Home Depot could get money right away, versus businesses.

David

Those businesses are going to want credit—

Ben

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.

David

Right.

Ben

So if you're 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. They just have to be generally very scrappy in every area of their business to get the most bang for their limited bucks, especially in the early days.

David

And thus the founding team, the Avengers of retail, is complete. They're all assembled: Bernie, Arthur, Ken, and Pat. There are just a couple more things they need, like an actual location and a name.

Ben

4. The First Home Depots Open

All right, so how is this company born in Atlanta? So far, we've been talking about California.

David

So after the HomeCo interlude and bringing Pat onto the team—

Ben

Who, by the way, we should say: 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 they had lost in his first venture to make them whole. If they held, that would be a giant amount of wealth for them in the long run.

David

They got very wealthy if they held, yes.

Ben

Yeah.

David

So pretty quickly, they all decide on Atlanta, as you said, Ben, for 2 reasons. The first is that the demographics of the Southeast are good and 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.

That leads us into the second reason they choose Atlanta. Speaking of good real estate locations, they end up getting a sweetheart deal from J.C. Penney, the big national department store chain, to sublease a couple of their locations in Atlanta. J.C. Penney had started a Kmart copycat subsidiary.

Ben

Is that what Treasure Island was?

David

Yeah, I think it was a Kmart copycat.

Ben

I was trying to figure it out.

David

It was in the Southeast and it was called Treasure Island, and they had great locations. J.C. Penney was a big company, a big national retailer, and 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 4 of the Treasure Island locations in the Atlanta suburbs.

Ben

As a sublease, right?

David

As a sublease, at least to start. Bernie, Arthur, and Pat all pack up their families and move to Atlanta. But now they really need a name. They've got the locations, and they're going to open these stores, so they hire a marketing consultant who comes up with a great idea. He can't wait to present it to the team: “Bad Bernie's Build-All.” It's alliterative. Get it? It's awesome. You're Bernie. You're Bad Bernie. We're going to have all this advertising with you behind bars in jail: “They put me in jail for these prices. They're too good.”

Ben

Is that what the shtick was?

David

That was what the shtick was going to be.

Ben

I could not figure out why they would want to call it Bad Bernie.

David

Yeah.

Ben

Oh, that is awful.

David

It's like he must be a crook because these prices are too low.

Ben

Which, of course, is exactly what the loan officer wants to hear at the bank.

David

Yeah, exactly.

Ben

Speaking of being scrappy, they're constantly going to lenders and trying to get capital so they can buy inventory. They're trying to get loans so they can run the business.

David

Yep.

David

Yep. 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. 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 this was intentional or not. But what are the initials of Home Depot?

Ben

And the stock ticker today.

David

And the stock ticker. Yeah, HD. Where did they get fired from by Sandy Sigoloff? Handy Dan. HD. Nice little—

Ben

Homage.

David

A little tweak, shall we say. A little nod.

Ben

Yes.

David

Yeah. Let's put it in a positive spin. A little nod.

Ben

Yes.

David

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. Because, Ben, 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 to save money. And that's how orange became The Home Depot color.

Ben

Perfect.

David

Which is totally brilliant.

Ben

It's distinctive.

David

I mean, the orange apron stands out. It's distinctive. It's great.

Ben

Yep.

David

So that leads right into the opening of the first 2 Home Depots in Atlanta on June 22, 1979. They opened 2 stores on the same day. This all happened pretty fast. This is just over 1 year from when Bernie, Arthur, and Ron get fired from Handy Dan.

Ben

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.

David

Yeah.

Ben

I mean, it looks like that. 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, Kmarts or even kind of J.C. Penney stores.

David

Yep.

Ben

It's pretty low ceilings. The racks that things are on are standard Kmart-style racks. It's nothing like The Home Depot that you know today. The floors are these sort of linoleum-type floors. So, yeah, they're selling table saws, hammers, and lumber out of a discount—

David

Kmart knockoff.

Ben

Kmart knockoff, right.

David

Yep—

Ben

Second-use real estate.

David

Yep, yep, yep. There are some pretty fun legends around all this, around the first store openings. The first is that they decide they're going to go big and blow a lot of the budget on a huge newspaper ad in the weekend paper that week to really drive homeowners to the store. Weekend newspaper delivery was highly correlated with homeownership.

Ben

Which is why they did 4 stores. I mean, 2 right now, but then quickly 2 more in 1 metro. Because they wanted to, much like our Trader Joe's episode, amortize the cost of their advertising.

David

Exactly.

Ben

If you blitz 1 local geography's radio, TV, and newspapers, then you can justify the cost of all that marketing expense if you have stores in different ZIP codes around the city that can all benefit from the same marketing. This is actually the playbook that they would run for the next 45 years: open in 1 city, saturate that city, become number 1, and then move to the next city. Don't sprinkle some stores here and there. No, go into a city with force.

David

Yep, yep, yep. All this sounds good on paper, except there's a mix-up and the newspaper ad doesn't run. So they got—

Ben

Oops.

David

Nobody knows about these stores opening. Instead, Bernie and the store associates—the retail workers on the floor in the stores—go out into the parking lots of the 2 stores with a bunch of signs advertising that they're giving away free $1 bills to lure people into the store. An inauspicious beginning to Home Depot. The other great legend around the first store openings is that the night beforehand, the 2 store managers get together. They've got a great idea: they're going to impress the founders, so they have a cleaning crew come in and polish up the linoleum floors as a surprise for everybody coming in the morning. It's all going to look great. Pat Farrah comes in at 4 in the morning on the day of the opening. He sees the polished floors and goes nuts.

Ben

Oh, yeah, that was a thing with this entire company for decades. They all worked from the wee hours of the morning, and it was just expected of the entire culture: if you're not sleeping, you're here working. Also, it's fun. It's a party, and we just work all the time, all of us.

David

Yes.

Ben

So when Pat sees these sparkling-clean floors, he loses it. He calls Bernie and Arthur, gets them out of bed, and the 3 of them come in and start careening forklifts around the store floor to scuff up the linoleum so it looks like it was busy. Pat says, “We can't have this be clean. It looks like nobody's been in here.”

David

And it sends the wrong message.

Ben

Exactly. 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 in work boots. 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 quote about this that he would write is, “Our stores are 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 reason that it works—is that if you are mid-job, The Home Depot is the place that you use for real-time replenishment.

Yep.

Sometimes that means you're swinging by every morning on the way to your job site. Sometimes it means—

If you're a pro. Yep.

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, that you could count on, and that 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.

Yep.

Another classic story is that they're capital-constrained. They don't have enough to actually buy all this merchandise, 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.

That's right.

A week before opening, they didn't have enough merchandise to fill the whole store. So Pat Farrah calls the Del Mar Cabinet Company and asks if they can borrow—not even buy, borrow—500 boxes of all different sizes. The team stays up all night folding them and putting them on the racks around the stores. Apparently—I haven't seen this video—they filmed themselves walking around the store because it looked, in their words, “fabulously legitimate” that they had this big expanse of 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 on them so they would know not to investigate too significantly, but stacked them 10 feet high.

Whenever I go to Home Depot now, I'm going to have to start knocking on cans and boxes and make sure that they're actually full.

Well, capital constraint is no longer their issue.

Yeah.

5. The Flywheel Finds Scale

So despite the rocky launch of the first few stores, within a couple of months they do get all these kinks ironed out, and the first stores start humming. By the end of that first year, 1979, they open the third store in Atlanta and do $7 million in total sales for that 6-month operating period of the first year. So, a startup retailer does $7 million in sales across 2 stores and then, at the very end of the year, brings a third store online. This is right in line with the aggressive financial projections that, Ben, you were talking about, which they needed to make this work.

Part of the appeal is that they're blowing stuff out. Friend of the show Arvind Navaratnam, who I'll bring up several times on this episode for his extensive research on the retail sector, and especially Home Depot, found that in the early days they were 10% to 25% below the prices of their competitors. 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 pallet into the store, so they can take relatively low margins—not Costco-low, but 30% gross margins on these products—and offer these screaming deals. I mean, 10% to 25% below competing retailers. This should create crazy word of mouth: “You have to see the store. I just went there. They have everything. I'm discovering new projects to do, and it's all cheap. It's amazing.”

Yep. I mean, just like Costco, it's a 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. In some ways, it's not high convenience, because high convenience to me is that I can walk literally 2 blocks from here to a hardware store. Granted, it has a low SKU count, but it's close. The twist on convenience is that, yeah, you're going to have to drive out into the sticks—or here in Seattle, down south of downtown in the neighborhood of SoDo—and you can get everything. You only need to go to 1 store.

Yeah, it's 1 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.

And then the next year, in 1980, J.C. Penney calls him back again and says, “Hey, we’re finally going to pull the plug totally on this Treasure Island thing. We’ve got a bunch of locations that are now going to be empty down in Florida. Do you want them?” And, yes, of course they want them.

Right.

The whole plan here is to expand nationally, and this is great real estate. We should jump on this.

Yep.

There’s just one problem, which is that they are maxed out on capital. So, in 1979, that first 6-month period that the company was operating, they lost about $1 million. So, $1 million of the $2 million of startup capital was blown in 1979. In 1980, this next year, they made $1 million in profit. This is incredible. This shows how well the model is working.

It’s already profitable, and I think it would basically be profitable every year going forward. I think they had 1 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 and this great real estate down in Florida. So once again, Ken Langone says, “No problem, I’ve got this. We’ll just go public.”

Now, this is a crazy idea in any market. The pitch here, to be clear, is: We are going to take a 4-store chain—they’ve now opened the fourth store in Atlanta—public in 1981, 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?

Look, call me Warren Buffett over here, David.

Yeah. Once again, Ken is like, “I’ve got this.” But by this point, 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.

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 2×, in, call it, a year and a half to 2 years here.

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—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 rather than cashing out at slightly less than 2×.”

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. 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 2× return, those investors, if they had held until today, would have gotten well north of a 50,000× return on their capital.

Which—check my calculator—but I think it’s better than a 2×.

Yep. So the IPO gets done. They end up raising a little bit more than $3 million. They raise $4 million in total in the IPO at a $32 million initial market capitalization post-offering.

This, listeners, is part of the reason why it’s a better investment than Apple since its IPO and many other companies.

Nvidia, et cetera.

It went public at a tiny, tiny market cap.

Yep.

I mean, you could get in as a public shareholder at a $32 million valuation. 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 since the IPO that public shareholders 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.

Yes.

I mean, it’s IPOing as a 4-store hardware chain in Atlanta.

Right. This is not Anthropic, where everybody knows them and they’re giant.

A household name, right? This is a 4-store chain in Atlanta.

Yep. So after the IPO, they go to Florida. It goes great. Next, they go to Texas by actually acquiring a copycat chain that had sprung up called Bowater. 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. Then they go national, to the rest of the country. The company is just on a tear.

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 multiregional chain here—

And then quickly after that, in 1986, they hit $1 billion in sales.

With 60 stores.

They don’t stop there. In 1989, they pass Lowe’s to 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 there’s this interesting question here. We’ve talked about how they speed-ran to $1 billion 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 have this question in your head of: 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 1 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.

I don’t know. How do you think about why they were able to act like a scale company even when they weren’t at scale yet?

I think it was that they combined Pat Farrah’s aggressiveness that he put together at Homeco with Bernie and Arthur’s operations and finance genius to just barely make it all work.

And a lot of illusion along the way—

Yep.

—where they could sell the dream. And selling the dream is fine if the dream comes true.

Yep.

It’s only bad if you promise people all this volume and then you can’t get any volume. But, as long as—

Yep. Specifically, selling the dream to their suppliers, to the manufacturers.

Suppliers, and to financiers, to max out the amount of debt that they would extend this company.

Right. 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: 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 in 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 sheer force of will, keeping all these plates spinning and convincing everyone in 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.

That’s the American enterprise system here. The worst thing that happens if it doesn’t work is you declare bankruptcy and, like Pat Farrah, you go join the next thing.

Yes.

6. Specialty Retail Beats Copycats

So I think this is actually the perfect place to really talk about what the model is—

Yes.

—and why, here now in the late 1980s, there is capital available. It’s the Go-Go 1980s. Why aren’t copycats emerging, well-funded and 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 and home-improvement stores. I’ve been to a Builders Square, I think, when I was a kid.

Yeah. So, yes, exactly. This did happen. A lot of capital rushed into the space, trying to do this.

Yeah. Builders Square, HomeClub, Home Quarters Warehouse, and Mr. HOW Warehouse. These are 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 similar: 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, Costco, and Amazon are all built on. You also need to serve the customer in ways that are wholly unique and specific to each specialty market. If you think about tire and auto shops, they need to offer fast, quality installation of tires and auto parts.

Or beauty: beauty needs to offer in-store sampling and makeovers. Apple and Best Buy 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. You go grab your toilet paper and check out.

Right. 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 was basically no customer service in hardware. It was like you walked into a hardware store and good luck. If you knew where things were, good. If not—

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. This was after I had read some books and seen all the stuff about Home Depot's unique culture and its obsession with serving the customer above all else. They drop everything in order to serve a customer.

There are 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. The culture is this very real, service- and customer-obsessed orientation.

Ben, I noticed you said “headquarters” there. I don't think Home Depot has 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—

Yes.

—the headquarters of the company.

But that's powerful—

Yep.

—to name it that and instill that in the culture.

Totally, totally.

I promise you, I wasn't secret shopping and trying to prod for these questions, but I was making a copy of a key while I was there. I asked the associate how his day was going. This was the eighth associate who had walked by, and the store was chock-full of staff.

The words out of his mouth were, “It's going well. I have 8 things on my to-do list today. I've gotten to none of them because the customer always comes first, and I've had so many interesting customer problems come up today.” It is this very real, customer-service-oriented mentality.

Yep. I would say that's still the culture to this day, with some bumps along the road that we'll get to as we go.

What I mean, though, when I say that Home Depot invented what servicing the customer means in this segment is that before Home Depot, nobody would teach customers how to accomplish their projects. 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. Maybe you could go to a bookstore and buy a how-to book, if you found one for what you were looking for.

Right.

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.

Rather than going out and hiring separate teachers who are going to run clinics in Home Depots, they recruit employees from the trades—professional tradespeople and contractors—to be their retail staff in the stores. Then they create a culture of, “Hey, any time a customer comes in and asks you how to do something, stop what you're doing. You know how to do this stuff. Explain it to them. Show them. Get some products out and 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 cards.

Good point. 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 in 1985 or 1990, imagine you're a plumber, an electrician, or maybe 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, even if you're successful. First, it's not steady. Cash flow is lumpy and unpredictable. Second, it requires a lot of driving. Third, it's manual labor.

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 a big commercial contractor, sure. 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.

Now Home Depot comes to town and they're recruiting. It's a stable job with regular hours and other people like you. You don't need to drive around, and you don't need to manage clients. You need to stock the shelves, but it's not hard labor. It's pretty attractive.

Yep.

And there are all sorts of benefits to The Home Depot long-term from doing this. The most obvious is that if a former tradesperson works in your store and meets with a customer trying to do a pretty simple project—“Hey, I need to paint the walls of my living room”—you have a professional help them pick out all the right stuff they need and get the right amount of paint.

You suddenly feel empowered, and you're like, “You know what? I'm going to try drywall next time.” Your basket size at Home Depot over the years and the scale of your projects go up and up and up if you have good education and good service.

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 have 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.

Unless you copied Home Depot's labor employment model, 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 are a lot of other elements that have an escape-velocity component.

Yep.

So we've 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. You're shipping directly to the stores. You're passing savings on to customers, with 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 a super-high SKU count and lots of associates doing all this service. So they have to figure out how to succeed despite 2 big strikes—

Yep.

—short-term against the business model. Those are great—

Yep. Against the economics of the model. Yep.

—long-term, right, but it is horrible operationally having lots of SKUs. It's 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 SKUs, you have to have reasons for people to buy all of them.

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. The gross-margin percentages don't put food on the table; the gross-margin dollars put food on the table.

You're just trying to sell enough volume and turn everything over fast enough that those gross-margin dollars add up and justify holding all of that inventory at a Home Depot. So it's the crazy stunts, it's the heat in the store, it's the one-stop-shop-ness, 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, and we have lots of SKUs and lots of inventory of each of those SKUs, so how do we get as much volume as possible?

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 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 and make the whole thing spin faster: “Oh my God, they have even lower prices.”

So, to summarize all this, a friend of the show, Arvind Navaratnam 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 1979, 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 reinvested the resulting productivity into stores, associates, logistics, technology, and price, creating a self-reinforcing flywheel that became increasingly difficult to replicate as the company scaled.”

7. The Employee Equity Flywheel

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 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 associate onboarding and training was about the stock and the stock price, 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 built this real link and culture among the labor force: “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—really rich. There are thousands and thousands of early Home Depot associates who became multimillionaires because of this.

Yeah.

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. If you come from a Silicon Valley tech startup, this is second nature to you.

Yep.

But this really wasn’t done in retail. This is really the first time that a scaled company, with mass employment, has retail employees who are participating in this giant wealth-generation machine. And because it was compounding at 25% per year, it was 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 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 with the associates and said, “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 to the specialty-retailer model versus general merchandise.

Hmm.

Let’s say you’re Costco or Walmart. You set up the same thing. No associate on the floor is going to be so good at 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.

The legend is that a customer comes into the store with a faucet that he’s brought in from his kitchen sink. He says, “Hey, my faucet is leaking. 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, you don’t need a new faucet. We can fix this. Let’s go get a new washer. That’s all you need. We’ll get a new washer. It’s $0.25. Install it, and you’re going to be good to go.”

They do. The customer is so happy, he goes home, and he tells his wife and family. Next thing you know, a couple of weeks later, he’s back 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 a $100,000 sale because, in hardware and home improvement, 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 probably going to fire you. You could have sold a $200 faucet, and you only made $0.25 on the washer. You’re probably going to get fired for losing that sale.”

Bernie Marcus hears about this, and he calls the guy and says, “I think we should promote you.”

Yeah.

I think 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 was the Home Depot CEO from 2007 through 2014, going into and navigating the company through the Great Recession.

Yep.

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.”

Yep.

We want that. We encourage that here.

Yeah, it’s the opposite of prevailing Silicon Valley wisdom, where, “Oh, you don’t want 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 that the original hunch about why the business would work despite all the trade-offs was correct. In 1980, Home Depot stores were twice as large as Lowe’s, and they carried 3 times as many products.

Which, if you know us and our Costco zealotry, sounds like a lot of danger. These are all downsides, right? But what ended up happening is they had 4 times as many transactions as those smaller Lowe’s stores.

So there really was this benefit where, when you made those investments in more square footage, more inventory, and more SKUs, the return on that investment actually increased at scale. As you added more things, the word of mouth, the one-stop shopping, and the feeling of the buying frenzy more than paid for all that additional allocation that you were making in inventory and square footage.

That was a Bernie hunch before they actually opened the first store, but he was right.

Yep.

That is the key insight behind the whole thing: There are actually returns to your investment that increase once you get out beyond a certain SKU count and beyond a certain square footage.

Yep. And again, it 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.

Yep. So this is basically the core model that takes Home Depot to the $350 billion market-cap company it is today, except—

Except it’s not exactly a straight line.

Yes, there is a fall from grace coming, listeners, before we get to the Home Depot of today.

8. Nardelli Breaks Home Depot

So, back to Home Depot—not exactly a straight line from here. At first, things are going great. As we talked about, once the model’s 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 4 days.

They have over 600, approaching 700 stores. They have 32 international stores.

Yep. That year 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, right up there with Visa, Coca-Cola, and Nike.

Not J.P. 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 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 a segment of consumer homeowners who also want pro-level tools, hardware, and supplies.

People with a high willingness to pay for the best—or if they want to have a tool for 20 years, sure, they 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 too. You just have to buy 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 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 giant driver of the business, whereas—and this is a 2015 stat, so we’re flashing forward, but I think it’s still a relevant data point—the average Home Depot DIY customer interacts with the company about 5 times a year and spends about $330. The average professional customer would interact 66 times a year, with an annual spend of $6,500.

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 and hands the title over to Arthur in 1997.

So, almost 20 years.

Yep, almost 20 years in, 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 masked. 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 Built from Scratch, 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, Home Depots up to this point were like a man’s place. It was guys buying hardware from other guys, and—

Which Lowe’s would go on to exploit by 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 are also all of Bernie and Arthur’s accounts in their book of the early days of partying hard in stores and drinking after hours. Obviously, they cleaned all that up over time, but—

Yeah, it was there for sure.

Yep.

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 in the right quantities, that they’re super in touch with the customer. And that leads to—I think Bernie estimated—15 to 20% 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 are chaotic operations, a lack of being able to use technology and systems because it’s so fragmented everywhere, a zillion decision-makers and a zillion negotiators with all these different vendors, and the thing you’re talking about, David: You can’t get the best prices from your suppliers.

Yeah, 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. Sure, there were still regional differences in what Arizona needed versus what Alaska needed. But a table saw is a table saw. You don’t need different table saws for different parts of the country.

Yep.

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 US housing market is rapidly inflating. 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—

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. They basically studied Home Depot and said, “That is the correct way to do this.” So I think it was 1990 when 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, 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 and 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, “Improving Home Improvement”?

Exactly. Exactly. Tracking the slogans in this industry will tell you everything that is going on strategically. “Improving Home Improvement” is aimed directly at Home Depot and directly at appealing to younger, more casual, often female buyers. These are buyers that aren’t necessarily doing home remodels. They’re doing home makeovers or home refinishing. They’re like weekend sprucers versus weekend warriors. They’re buying more kitchen and bath products and furnishings. They’re not buying lumber and plumbing pipes and stuff like that.

Right. 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 who are staffing The Home Depot.

Now, it’d be a while still before YouTube was founded. This is the late ’90s, not the 2010s.

Yep.

But you start to get people sharing information on forums and things like that.

Yep. All of this in aggregate, though, opens up the market for a real competitor for the first time.

Yep.

So once Arthur takes over Home Depot, he runs the company for a couple of years, but these issues start piling up, and he’s also getting tired, just like Bernie when Bernie retired. And the company is 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: “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 who could take your place?”

Right. When Bernie stepped down, we had you, but who’s after you?

And so Arthur goes away, thinks about it, comes back, and he’s like, “Oh man, Ken, you’re right.”

Actually, the answer is no. Pat certainly can't take my place. And you—we love you, but you're not an operator. You can't be CEO of this company. Yeah, I guess we haven't really cultivated an executive bench here in the company, someone who could take over as 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 figured out how to promote from within. 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 was going to succeed these founders.

So the board and Arthur together decide, “Hey, we have to bring in an external search firm and bring some more management talent into the company.” The plan is that they're going to recruit a president and COO, basically somebody to replace Arthur's old job as No. 2. Now that Arthur is CEO, this new person will be next in line to take the helm of the company when Arthur is ready to retire. Arthur actually chairs the search committee himself, and the first target is Jamie Dimon.

It's amazing.

Who has just gotten fired by Sandy Weill at Citigroup.

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, “I've never actually been to a Home Depot before,” considering this opportunity. I think he went in once because a friend told him, “You need to go upstate and go to that Home Depot.” And it just didn't work. He was like, “What am I doing here?”

Yeah, he was like—

“I'm pretending to be a home improvement person.”

Yeah. But this does burn a bunch of time. The whole process of meeting Jamie, wooing him, and recruiting him takes time. 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 Dimon interviews, and he references how awesome it is that their headquarters is called Store Support Center. That's a cultural indicator.

Yep. So the company burns about 6 months on the Jamie process. At the end of it, they've still got nobody, and the board is starting to get a little frustrated here. 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. At the time, GE was going through its own very public succession drama over who was going to succeed Jack Welch.

The most storied CEO in America at the time.

Yeah, history has forgotten this now because GE, frankly, has fallen apart. But—

It literally got broken into 3 pieces, so that's not a controversial statement. And before that, it incinerated more market cap than any other company before it in history.

Yes, it actually did.

These days, the drops that happen at big tech companies dwarf everything in comparison.

Yeah. Makes GE look quaint.

But at the time, the story was that post-Jack Welch, GE was completely destroying shareholder value.

Yep. But here we are in 1998, 1999, 2000. 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.

Yes, sounds great, right? Well, we'll see. So back to Home Depot. Here's Ken and The Home Depot board thinking, “We sure could use some of that operational excellence stuff around here. I think that would really be good for the company.”

And if you're going to 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 Dimon. We don't have him here. Let's start at the top.

GE is the consensus best place to look in America for management.

Which is crazy, looking at the 3 choices to succeed Jack Welch and how disastrous it was for all 3 of them.

Yes.

In the 3 places they went.

Yes. So in November of 2000, Jack Welch announces that Jeffrey Immelt will be his successor to take over as GE's next CEO. And, as you were alluding to, the other 2 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 become the CEO of Boeing.

Yeah, we all know how that turned out. And then the other candidate, Bob Nardelli, who Ken Langone, again being on the GE board here, knows well and loves. Ken 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 hit in the ass with a golden horseshoe.”

“Guess where you get to go work now?”

“Guess what we're going to do together now that you didn't get the GE CEO job? I'm going to bring you into Home Depot.”

So the board immediately pivots and offers Nardelli the president and COO job. They say, “You'll come in, you'll be here for a little while, Arthur's going to retire, and you will be his appointed successor.” 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. I clearly can't stay here at GE. I'm in.”

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. He's only going to come on board if he becomes CEO right away. He's not going to wait. This leads to an 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. Part of it, I think, was Arthur not being ready to let go. The other part of it, I think, was a genuine spidey 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 he was 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 a test to the board: what I would like is for you to come back to me and say, “Actually, we love you so much. Who is this guy? No, get him out of here. We think you should stay CEO.”

“Who does he think he is?” 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 between Arthur and Bernie and Ken, as chronicled in Ken's book, I Love Capitalism! Because Bernie is still on the board at this point, and I think it 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 of months, and within 6 months he fully steps away and is gone from the company. We'll come back to Arthur all the way at the end, but—

He's got his own golden horseshoe.

Golden horseshoe. Yeah.

Spoiler alert, he would, I think, become the highest net worth of any of these folks.

So Nardelli comes in as the new Home Depot CEO, and to the outside world, this looks like a huge win. They got essentially the most eligible corporate bachelor in America, one of the 2 runners-up to the GE job. And as you can imagine, 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. Now, to be fair, the first couple of years of Nardelli's tenure are great. Ken Langone still says to this day that for the first 4 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. There was a lot of low-hanging fruit around.

Maybe even the first 3 or 4.

When he came in in 2000, there had been 4 consecutive quarters of slowing comparable-store sales growth. There's clearly some serious underlying issue there. The older stores were getting really rundown.

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 operational-excellence yourself out of being entrepreneurial. If you take away all of people's ability to take ideas and act on them and have fun and all that stuff, you could kill the company.

Yeah.

The other thing he did was this: if you look across every system—purchasing, replenishment, merchandising, all operating functions—he would centralize. He took 9 separate buying offices and folded them into 1, so they were suddenly getting better prices from their suppliers.

He invested in a bunch of new technology systems. The answer here isn’t to decentralize or centralize. You have to have the balance where you centralize when there’s actually a benefit to getting all the data in one place, doing a bulk negotiation, or doing analysis on one dataset in a system of record. But you definitely don’t want to centralize when you can push decision-making closest to the customer, where people can see all the idiosyncrasies of any given situation.

Yep. Yeah. Here’s the way I would characterize it. There was a bunch of low-hanging fruit 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. 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. It’s not to say that GE doesn’t service its 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 a Six Sigma Black Belt. 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 $0.25 kitchen sink washer sale—

Yeah.

—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. If you’re going to invent, you need to wander. 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 an unbounded problem.

Yep. So what does Nardelli do? He replaces huge swaths of the associate-on-the-floor retail workforce at Home Depot with part-time general retail labor, doing away with the whole philosophy that made Home Depot: We have knowledgeable people who are going to make that $0.25 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 are just going to be fewer of them, period. According to Arvind’s research, associates per store dropped from 200 to 170 over the course of 2000 to 2006.

Yep.

A 15% reduction in headcount. We have 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 from store associates, Ben, as you said, and they were focused on their stores, the customers, doing what was right, and so forth. 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. What you’re telling them is: 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 and highly knowledgeable. They have trade degrees, if they have degrees at all. They don’t have college degrees. That has nothing to do with either knowing about hardware and home improvement or being a great retailer.

Yeah, it weakened the culture. Zooming out, there’s a great case to be made that the only sustainable competitive advantages this company had were its scale economies and its culture. This entrepreneurial, “We can figure it out” thing was heavily destructive to that in a way that you may never be able to fully rescue and get back.

So a couple of years into Nardelli’s tenure, customer satisfaction among Home Depot shoppers falls to the lowest level of any major US retailer. Among all the major US retailers, there are annual surveys of customer satisfaction 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 5 years. What do you mean there are problems? All the charts are up and to the right.

Yeah, yeah. So that then leads into the issue of Nardelli’s compensation. On top of the huge equity grant that he got when he joined Home Depot from GE, Nardelli also gets paid roughly $200 million by the board over the 6 years of his tenure running Home Depot. 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. Revenue’s 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. A stock price is just what the outside world thinks of you, not actually what you are doing. It has always struck me as a little weird that I’m comped on what other people think of the company.

Ben, it’s like you’re reading from Nardelli’s script right here. So BusinessWeek would report on this because this was uncommon for major CEOs at the time and through to today. 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 have my compensation tied to it.” The problem at Home Depot is that this is fundamentally going against a key part of the company’s model that we talked about a minute ago.

No stock go up, no machine work.

Exactly. And so, for all the associates on the store floor 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 bigwig 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 mostly does it by doubling store count.

Hmm.

Ben, as you had said, same-store sales comps had already trended flat before Nardelli joins. They actually stay flat for his tenure. So Wall Street keeps bringing this up as a major red flag and comparing Home Depot to Lowe’s, which is growing same-store comps as they’re taking this new segment of the market, the weekend sprucers 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 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 being up due to new store openings, we do not think the future of this company is brighter.

Yeah. Yep. Yep. And meanwhile, during this same period, again, this is as the US housing bubble is reaching its peak inflation, Lowe’s stock price is up 200%. They’re winning the housing bubble.

Hmm. The other thing we haven’t talked about is that he tried to bolt a lot onto this company.

Yep.

He was growing by acquisition, expanding into adjacencies, and launching new business lines to create these new adjacencies versus just investing in the core business.

Yep, yep.

Which, 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 blowaway. 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. 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 28%, 29%, 30% range to pretty squarely 33% gross margins, which is not as low as Walmart, let alone Costco’s razor-thin margins. So they moved away from that—

Costco model, if you will.

The scale-economies-shared idea. They sort of realized, “Eh, 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? He’s trying to pull out all the tools in the tool bag to get Wall Street back on his side here.

Oh my gosh, 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, and you keep customers really obsessed. If your comp is tied to today’s numbers, you don’t store value inside the company.

Yes, yes—

You try to pump today’s numbers.

Exactly. It’s a paradoxical misalignment of incentives.

Fascinating.

Yep.

So, coming all the way back around, you actually 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.

Joe Nocera, a great financial journalist who wrote for The New York Times, wrote, “Mr. Nardelli has become this year’s version of Mr. Overpaid CEO. In the 5 years since he was recruited from General Electric, Home Depot stock has fallen 12%, while shares of its chief competitor, Lowe’s, have risen 173%. You’ve heard of pay for performance. This is pay for pulse.”

“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. 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 will tell me the next morning, ‘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.’ 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. 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. He just wanted to say a giant “F you” to the shareholder community of Home Depot, many of whom 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. 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, of corporate executives making too much.

Yep. In the weeks and months after this meeting, the company, Nardelli, and the board issue a series of explanations and apologies in escalating obsequiousness. It doesn’t do anything to change the narrative.

Finally, on January 2, 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 so-called “retirement package” valued at $210 million.

This is on top of the initial make-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.

When the news gets announced, the associates on the store floors at Home Depot—there are reports and videos of them celebrating, 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 much like Ford did as an independent company and GM did as an independent company. Oh, wait.

Ends up getting owned 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. Who do they turn to? 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 whom 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 whom Ken loved, but Bernie 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 pissed.

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.”

9. Frank Blake Restores the Core

But it would turn out that not only was Frank Blake nothing like Bob Nardelli, he was exactly what Home Depot needed.

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 context of all of this—we’re going to talk about all the personnel stuff and the cultural change—is that in 2006, the housing bubble burst.

Yep.

We know of the Great Financial Crisis in 2008, which is after this leadership transition, in 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 from 2006 into 2007. The actual ceasing of building new homes for all of these unqualified buyers took 18 to 24 months to wind its way all the way through the financial system and blow everything up.

But for Home Depot, 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 7-year span, 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’ve 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 Nardelli guys at this point in time. So if they were to get rid of Bob, the bench is only staffed with more Bobs.

Or so they thought.

Or so they thought.

To give some credit to Bob, even though his tactics were not the right tactics for this company—for their core competency, their culture, their mission, any of that stuff—the wind had been at Home Depot’s back for decades.

Yep.

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. So coming out of the board meeting on January 2, 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 had worked in D.C. in the federal government as a public servant, had been a Supreme Court clerk, had gone to GE and risen to become the head of M&A, came over with Bob Nardelli, and held a senior role at Home Depot, but he didn’t own a P&L.

Yeah—

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 choice is that he was in touch with the culture, with what made Home Depot special, with its original founding principles, and 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—was that his son worked at Home Depot.

Yep, 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: 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 on January 2, 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 fully retired from the board and was certainly just disgusted 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, and getting breakfast with him the next weekend. Then Bernie and Frank go out and do a store walk together, but it’s not a store walk 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 the young Jedi here. So that’s the first thing that Frank does: mend the Bernie relationship.

And really learn directly from him, “What do you think the culture is?”

Yep.

Because the whole time he’s been here, he’s been under Bob. Frank wasn’t here under Bernie. So it’s like, “Hey, I’m going to try to reinvigorate whatever was special about the culture. Help me understand what that is.”

Yep.

And one of the things that he brings up is this sort of fabled inverted pyramid at Home Depot. Imagine a pyramid, except it’s upside down. At the bottom is the CEO, and that CEO is just this tiny little triangle. At the top, the big, thick level is customers. Underneath customers are associates.

The belief is, look, the people who can actually affect the experience of the customers on their projects are the associates, and everyone under them just exists to serve them.

Yep.

And Frank sort of grabs this and brings it to the company as a kind of management tool: “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’ve got to get this whole issue of the Home Depot CEO’s compensation out of the newspapers. We’ve got to make it not a thing anymore.”

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 the right number for the CEO of Home Depot to be in stock options. I want 90% of that to be in stock options so that I’m aligned with the company, the shareholders, and 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. He says, “All right, if we’re going to return this company to growth, we’ve got to do it with same-store sales.”

So this is crazy. In 2008, they had grown to 2,300 stores. Today, 18 years later, they’re at just 2,400 stores.

Yep.

Here’s how it went from 2008 onward. 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. 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 4 or 5 stores a year here and there, they did not open any new stores.

Right.

They were flat for over a decade.

As they were 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. Sales per store went from around $30 million to about $65 million over those 11 years.

Yeah. Crazy.

They just cranked on store productivity.

Yep. And we’re going to get to e-commerce in a minute, which was a big part of that.

Yes, that’s funny. That was my next thing, too. That is the missing piece of this puzzle.

Yep.

But I think there’s an interesting cultural thing here. They’d always grown, ever since founding, by growing stores. It was this safety net that we would always show growth because we were always growing stores, which means, A, you don’t really optimize the stores you have. You don’t try to wring 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 are lots of stores they opened that probably shouldn’t have been open, and they either needed to close them or focus on getting their productivity up to where it should be.

Right, right. Like Starbucks has run into this several times in their life as a company.

Yes. Opening more stores is not inherently virtuous unto 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 was an amalgamation of several things they bought between 2000 and 2006. This was mainly a distributor—a business they built, Home Depot Supply, that served homebuilders, infrastructure contractors, municipalities, maintenance professionals, and big commercial customers.

The goal was this broader ambition than just their existing Pro Desk. They wanted to serve properties across their whole lifecycle and whatever needs popped up across the lifecycle, not just this single-job, single-contractor order stuff: “We’ll give it to you.”

It’s a super-different business model from their traditionally very focused model, where everything kind of runs through the store. They had to develop all these new competencies, which are good but also detract from your focus: wholesale distribution, offering commercial credit, specialized sales forces, and 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—”

Rocky.

Shady. I don’t think Frank would take credit for knowing that it would affect the whole financial system, but at least it was impacting homebuilding and home supplies.

Yeah.

So in 2007, they sold HD Supply to a private-equity consortium for about $8.3 billion and focused attention back on its core retail business. But it wasn’t just the attention that they focused back on the core retail business. Frank, under the extreme nudging from Ken—

Yep.

—realized the core of this business is awesome. The adjacencies around this business might be great, but I don’t know. The core is great, though.

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 did 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 outstanding shares in the first year. Frank would go on to buy back 30% of all outstanding shares over the course of his tenure. He dramatically shrank the size—

Yeah.

—of the shareholder base. Those buybacks—

Yeah.

—were done mostly at $30 to $50 a share. Today, Home Depot is $340 a share.

Yeah. This is “ballsy” is putting it mildly. Buying back 30% of your company’s share base starting in the summer of 2007, while you’re in the housing industry—

Well, you’re in the housing industry.

While you’re in the housing industry, as the housing bubble is popping in 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 perfect uphill-downhill curve centered right around 2001. 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 slowly started buying them back during the Nardelli era. 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 there were 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. This is 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%.

And then it continues after that. In 2013, it’s up 33% including dividends, 27% in 2014, and 26% in 2015. Compounding is back, baby.

Why is it just Wall Street suddenly believing a narrative that Frank walks on water, or what’s intrinsically happening that is driving the value of this company?

10. Ecommerce Rebuilds the Moat

Well, this gets into the next, and frankly probably the biggest, thing that Frank Blake did for Home Depot, which is how they grew the company despite not growing store count. That’s e-commerce.

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. You’re unbundling the core value proposition. The knowledge in the stores has gone, first to the internet and a little bit during the beginning of the Nardelli era. But once YouTube comes along in 2006 and 2007, this is 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 Home Depot store manager, how much this actually impacts you. I’m sure people come in saying, “I learned this on YouTube,” and then you’ve 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 projects and DIY.

High-quality. Yeah.

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. 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.

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 it also 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, right?

—out of the stores.

Yeah, you can’t really do that.

Except for one caveat to this: they also do that. So I had 2 e-commerce Home Depot experiences in the last week.

One, I bought on homedepot.com and it arrived 2 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 2 hours, because—

With in-store pickup.

—they had it at the store, and it wasn’t pickup. They had someone drive it out to me.

Oh, that’s awesome.

It was delivered later that night from the SoDo store in Seattle. It was about 20 minutes away from my house, but within a couple of hours, it was delivered to my house since it was fulfilled from the store. So they have the flexibility to do both ship from store and ship from distribution center.

Yeah.

E-commerce is actually an 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 Home Depot’s core bestselling products—things like lumber, drywall, plumbing supplies, roofing, siding, and insulation—just imagine that attempting to go through Amazon’s logistics pipeline.

They need to build a whole specialized system for it.

Totally. Amazon is not equipped to do this. I mean, could you imagine putting 200 cubic feet of lumber that weighs 6,000 pounds on an Amazon delivery van?

One of those little Rivians.

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, an Amazon or a Walmart actually doesn’t bring that much to bear to compete in delivery-based e-commerce for goods like this.

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.

That 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, you know?

Yeah.

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 build your deck or retile your bathroom, etc.

Right.

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 2 days later to get grout delivered? By that point, it’s the workweek, you’re at work, and you can’t finish your bathroom. You’ve got to wait until the next weekend. Hell no, you’re going to do anything you can to get that grout as soon as 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 bundled together 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.

Out of grout, I don’t want to wait. I can get in 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. Crap. I’m ordering on my phone, and then I’m pulling out 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 an hour, an hour, or 2 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 changed its slogan from its longtime slogan that many Americans probably remember: “You can do it, we can help,” which we didn’t talk about earlier, by the way, but is so perfect to—

Yes.

—encapsulate the value proposition of the original Home Depot model.

Yes.

“You can do it. We can help.”

Their marketing consultants got much better over time.

Yeah, much better. So they scrapped that and changed it to “More saving, more doing.”

Hmm. How many entendres is that?

And it reflects this change in strategy, right? It’s “more saving.” So, hey, we get it. We’re not differentiated anymore by the education that we bundle, that we can help with. We’re going to rededicate ourselves to the “saving” value proposition—the Costco elements of our strategy—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. “More doing.”

Yep.

Pop online, go on your phone. We’re going to get it to you.

Yep.

So the net of all that is building toward what Home Depot’s strategy is today: 90% of all homes in America can get anything they need for any project—over a million SKUs delivered to their home or job site or a nearby store within 2 to 24 hours.

And what they need to pull that off is just an incredible amount of density. So, David, I texted you this. I said, “I can’t believe it. California alone has 250 Home Depots.”

Yep.

Washington State has 48.

And what did you say?

48.

By comparison, there are 2 IKEAs in Washington State.

There are 2 IKEAs. But if you want to have that value proposition—90% of homes can get anything they need for a project, a million SKUs within 2 to 24 hours—that requires 2 things.

One, being really close to lots and lots of stores, which was their initial market strategy: to go really dense before going to the next city. And 2, having a ridiculous distribution center footprint to facilitate the e-commerce component.

So I did as much research as I could to figure out what their distribution center network looks like today, because it’s evolved a lot since 2009, and they’ve really figured out how to have all these different specialty centers.

They have 7 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, and get the merchandise into stores. Then there are stocking and bulk 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 if you need huge quantities of things onto flatbed trucks. They also have 160 market delivery operations centers, which are cross-dock 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, which they started in 2014. Those stock way more SKUs than you would ever see in a store. That’s where all their online-only stuff comes from. That explains why one of the things I ordered last week took two and a half days to get to me—it was a battery for a camping lantern that I bought—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 SKU. And then, not to mention—we’ll talk about this later—they did reacquire HD Supply and make some other acquisitions. HD Supply on its own has 130 dedicated distribution facilities.

So it’s just this crazy footprint—

Yep.

—to accomplish that mission you talked about.

Crazy footprint and specialized footprint that looks super different than Amazon’s. So this becomes the story of the stock and the company after the financial crisis: “Oh, hey, it’s a 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 by large-dollar items, buy lots of them, buy every house in America, and 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.

The CEO of UPS.

Yep. Carol Tomé. She was the CFO of Home Depot for a long time.

And the CEO of Floor & Decor.

Yep. Tom Taylor, legend. So when Frank retires, he hands the reins over to Craig Menear. He runs the company for another 8 years, and then he retires in 2022 and hands the reins over to Ted Decker. Both of them come up through the company, practically lifers at Home Depot. And, yeah, speaking of 2022, all of this strategy and all of these people look like absolute geniuses when COVID hits.

Isn’t it insane? They just 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.

And then suddenly we’re all stuck at home, wanting to order things to improve our home and embark on home projects without necessarily going into stores in 2020, and they’ve got all this capacity built out and invested in.

Yep. Or be able to go into stores to get what we need, but do it in a way that minimizes 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.

Yep.

It was 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 in revenue.

In just 3 years. They obviously had some hangover after that, so revenue declined and then took 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.

So—

Exactly. Exactly. Yeah. Ben, you mentioned the HD Supply round trip in there. They spun off the company and sold it to private equity as the housing bubble was 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. They used all that capital to buy back the stock and then, 13 years later, bought the company back for the same price that they 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 then. It’s not really fair to call it the same price.

Right.

They definitely bought the best part of it for less than they sold it for. But, yeah, the purpose of doing this—leave capital allocation aside for a second—was that they wanted to better serve that maintenance, repair, and operations 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 in real time or one-off for a project.

Yep.

The next thing they do is buy SRS Distribution in 2024. This is a giant deal, an $18.25 billion acquisition—the largest deal in the company’s history. They actually pause stock buybacks here.

In order to do this. Yeah.

They’re like, “We really have to use the capital to swallow that.” SRS Distribution is a specialty trade distributor that serves professional roofers, landscapers, pool contractors, and other trades. You can 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 sites with a dedicated delivery fleet of vehicles. Again, a whole other set of distribution centers and vehicles that they now own that are specialized for their business, mostly facilitated outside the walls of their traditional stores.

This continues to grow, and they’ve already made another multibillion-dollar acquisition within SRS to do interiors—drywall, ceilings, things like that—in addition to SRS’s traditional focus on exteriors. So it’s like a parallel business that 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 while they’re doing a job in progress.

Yep.

So it’s interesting: Bob Nardelli growing via expansion into adjacencies wasn’t wrong. It was just the wrong time to do it—

The wrong timing.

—and the wrong way to do it.

Yep, yep, yep. 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—

Yep.

—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. So the business today is a $165 billion-a-year revenue business. It’s not a super-fast-growing company; it grows at 2.5% to 4.5% per year. A little over half the revenue is from pro contractors, and half is that 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. 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. They own 90% of their real estate; they only lease about 10% of the stores. Once capital stopped being an issue for them and they started generating free cash flow, they realized that a competitive advantage for us is to lock up the best real estate, hold it forever, and not 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 things like the J.C. Penney 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. 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 a lot of the best real estate in Georgia in the ’80s was perfectly available, and they grew up with the U.S. suburbs becoming extremely populous.

They have moved to Canada and Mexico; they’re branching out in North America, but they completely failed in China. They totally miscalibrated. Home improvement is not really a thing. A DIYer is not virtuous in China.

Hmm.

It’s like, why can’t you have someone fix that for you?

Hmm. Interesting.

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 Lowe’s, but it’s nothing crazy.

They turn their inventory about 4.5 times per year, compared to Lowe’s 3.3. Just for reference, Costco turns its inventory 13 times per year.

Right off the charts.

Again, very different category here. Costco sells the items on its shelves 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 given time, about half of their inventory is financed by suppliers who they haven’t paid yet.

Yep.

One big thing we should say here: it is totally unbelievable that The Home Depot can turn its inventory 4.5 times per year, given that the goods they carry are super high-dollar specialty items, and they have 35,000 SKUs against Costco’s 4,000.

Yep. In-store, and then a million SKUs online.

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 has about the same. The funny thing is, whenever you look at any chart of Home Depot and Lowe’s, they used to be super different, and now they’re about the same. They’ve really converged toward each other over time.

Yep.

One thing we didn’t talk about is private label. They started this slowly back in 1985, and it grew to become a really big part of their strategy: having house brands and brands that are exclusive to Home Depot. You may not realize this, but Behr paint—

Yep.

B-E-H-R, only available at Home Depot. Hampton Bay lighting and ceiling fans.

That was a Pat Farrah special, I think.

Yep. Glacier Bay fixtures. Ryobi.

Yep. Power tools.

Which is a very hot brand recently, especially in lawn care. Anything with lithium-ion batteries. Ridgid power tools. Anvil, HDX, Everbilt, EcoSmart lighting, Husky tools. There are actually a lot of brands that I didn’t realize were exclusive to Home Depot. They don’t actually disclose it now, but industry estimates are that 15% to 25% of their sales are—

House brands.

House brands.

Yeah.

Again, nothing compared to the one-third of Costco’s sales that are Kirkland Signature. But still, that’s a giant amount. I think house brands are getting more interesting, too, especially with electric tools. If you look at Ryobi, batteries create brand loyalty.

Right, right.

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—

Right. You develop switching costs.

Weed whacker, an EGO hedge trimmer, and an EGO leaf blower. That puts me out of the Home Depot ecosystem for all that stuff, I think. So imagine the thousands and thousands of dollars Home Depot could have gotten from me if I had first bought a Ryobi lawnmower.

Yep.

After all that discussion about e-commerce, it’s still only about 15% of their sales that 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 that the CEO of Lowe’s is a former Home Depot executive groomed under Frank Blake.

Really?

Yep. Today, the Home Depot executive CEO lineage tree runs across the street to Lowe’s.

Wow.

Marvin Ellison was head of stores under Frank Blake and then went to take over J.C. Penney as its CEO. Then, in 2018, he became the CEO of Lowe’s.

That’s such a deep bench that you created your competitor CEO.

Yep. I think Frank would be proud.

Yes.

So, the Home Depot story, to put a bow on at least the original Avengers plus Frank: Bernie Marcus passed away in 2024 at age 95 after a long, incredible life, including becoming friends with Pitbull in his later years. Pat Farrah is alive and retired in his 80s and 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. 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. He’s been a big part of everything we talked about on the NFL episode and all the strategic 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 1 year after fully leaving Home Depot.

Yep. He paid the then-crazy price of $545 million for the franchise. The Falcons today, by the latest 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 $9.5—

Yep. The Seahawks just agreed to a sale at $9.6 billion.

And since then, the Lakers at $12.5 billion.

Yep, at $12.5 billion. Even just comparing the Falcons to the Seahawks, Atlanta is about a 30% bigger market than Seattle, the whole metro area. And 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 onto something.

David, you nailed it. Now back to the show.

Continuing on, Frank Blake, whom Bernie Marcus so violently reacted to as another “goddamn GE guy” when he got the news that Blake was taking over the company, today runs Bernie Marcus’s foundation.

Amazing.

It’s about a $4 billion spend-down foundation. And Ken Langone, the GOAT, is about to turn 91 years old and 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 at 25% for nearly half a century. But the hard part is not actually about the stock-picking. The hard part is in the holding.

Yes.

So, in 1985—and this is a great Arvind stat—longtime listeners know Worldly Partners. Their whole thing is to 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. You look at Nvidia, and 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, it was down 70%, and he didn’t sell a share. Then, in 2008, there was the whole Nardelli situation and the housing bubble, and it was again down 70%, but he didn’t sell. In fact, if you bought the shares at their peak in ’99, your investment would’ve 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.

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 $2.5 million of Eli Lilly’s equity at the time. 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.

All right. Analysis?

11. The Enduring Home Depot Advantage

Let’s do it. So, we did a lot of analysis along the way. I have 1 major topic that I want to discuss with you, and I think it’s the perfect episode to—

Yeah, you foreshadowed this with me, but you didn’t tell me what it is, so I’m itching here.

—do it on. 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.

Mm-hmm.

I’m going to throw out a few examples that I 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. Now, they definitely have loading docks in the back of the stores.

Yeah.

They talk about how merchandise is not fronted. There’s not someone walking around turning things and making sure they’re facing out. I walked around the store last week, and most items I saw were definitely facing out, to be the most presentable and appealing to the customer.

There is no back door or discount for contractors. We were priced right for everyone, not just a select group. They even talk this big game in the book about how they did everyday low prices, just like Walmart did, to not appear duplicitous to customers and not have people time their purchases.

Well, I got an email 3 days ago. It said, “Daily deals,” with a big dollar sign through the S: “Free delivery, online only, while supplies last. 84 offers for you, up to 30% off select home essentials. Shop now.”

I’m pretty sure I’ve been to some Home Depot Memorial Day sales.

You won't see aisle numbers in our stores. Why? Because if we had aisle numbers, when a customer asked where they could find something, it would be very easy for our associates to say, “Aisle 8.” If there are 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. The same thing happened with decentralized decision-making or having manufacturers ship directly to stores. These all changed.

So what is the lesson here? I think there are 2 ways to look at it, and I'm curious how you think about this.

Way No. 1: 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, Hermès, and Vanguard—these are companies that fight gravity. It's ridiculously hard to cling to the thing that made you so special and not look like everyone else.

But the other way to look at it is that it's actually completely the correct thing to do in most instances. All the special things that you did when you were little to get attention and be different, in most cases, actually hold you back when you're big. It's easy to think 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 for why you succeed now than you did when you were small.

Yep. Usually, the market changes, too. Case in point: in this story, early Home Depot would never have fulfillment centers and distribution centers. Home Depot today would be toast without them.

Totally. I think the second bullet point is actually the correct one: it is the rare case where clutching your pearls and holding on to this founding insight is the way to succeed at scale. A lot of the time, your scale is the reason you can be successful at scale, and you have to make decisions that make sense for a giant, scaled company.

Hermès hand-stitching their Birkin bags, even at the scale they are today, is a one-in-a-million example where it was 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.

Yep. I totally agree. Well, speaking of embracing your scale and your scale economies, I think this is the perfect transition to the powers for Home Depot.

Yes. So, listeners, this is the part where we do the 7 Powers framework from Hamilton Helmer's book of the same title, where we try to figure out what a company has that enables it to get persistent differential returns, or to be more profitable than its nearest competitor on a sustainable basis.

Those 7 are scale economies, network economies, counter-positioning, switching costs, branding, cornered resource, and process power. The first thing you'd have to believe is that Home Depot is sustainably more profitable than Lowe's.

They are, but it's not by as much as you would think. I think—

Yep. Home Depot is marginally more profitable than Lowe's.

There's been a very dramatic convergence over time.

Yep.

The biggest one to me is scale economies.

Yeah, it's got to be.

I suspect it is because they can negotiate for the very lowest prices with their suppliers and get the best manufacturers to do their house brands and that sort of thing, given that they're 3× the scale of Lowe's.

Yep, about 3×.

That's the biggest thing now. Early on, I think it was definitely counter-positioning.

Definitely.

Lowe's 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, which means—

Yep. 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 pull some of those magic beans that Home Depot had and convince people that the ride is going to be so long and fruitful together that even though you're not large yet, they should give you great deals.

Yep, yep.

It's unbelievable that any of those stores managed to adopt the Home Depot strategy.

Yep.

They probably used distributors, too. So you have to blow up all of your existing supplier relationships to go directly to manufacturers.

Yep. Yep, yep.

Today, there are some switching costs with the house brands, but I'd say the switching costs are probably greater for pros who have just integrated Home Depot into their workflow.

Yep. I think there are significant switching costs for pros for that reason.

Yeah, and probably branding for pros.

I think the hardcore weekend warrior segment also prefers Home Depot, but that's for the same reason that the pros do.

Yep, 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.

Good point. Yep.

Amazon is building out more specialized 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.

A lot of scale economies.

A lot of scale economies.

Which makes sense for a retailer.

Yes.

Yep.

Yes. All right. Quintessence on this one. Listeners, David and I chatted before, and we decided that for this episode, the quintessence—the main takeaway—we want to try to 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, Walmart, and Amazon retail. So how did it get that way? David, it won't surprise you that I have a several-part answer and equation to answer this question.

An equation. All right. You've certainly piqued my interest.

Because it's basically several things multiplied together.

Does it include shared scale economies?

Well, see what you think. The magical thing at the core of all of this is: forget home improvement. If you can get consumers excited about shopping in a warehouse with no frills, there is an insane number of downstream benefits that come from that.

We talked about them all episode, particularly as it relates to saving the costs of not having to have a separate back room and showroom. Normally, that is a huge if, but home improvement is the perfect category. You are delighted to go buy hammers and lumber in a warehouse, so it's not an issue.

Yep.

That's factor No. 1. No. 2: giant market. Today, the home improvement industry in the U.S. is $300 billion. For reference, a comparable market, U.S. furniture, is $180 billion. So even other large retail categories aren't playing in a market this large.

No. 3: they captured a huge part of the market. It 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 Menards, 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 led to winner-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 not true anymore.

It depends how you define the market. But yeah, if you define it as home improvement stores—

Yep.

—they're 51%. 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 be reflected in market share.

Yep.

Okay, so that's No. 3. No. 4: aging housing stock in the United States. I wanted to save this all the way for the end. Arvind did some amazing research on this one, and 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.

Mm-hmm.

With postwar construction, you kept adding new homes to the overall stock.

The American suburban build-out.

So the median age of a home stayed young because you were injecting so many new single-family homes. As of 1980, right when Home Depot was starting, that ended. By 1990, the median age of a home went up a little bit, to 25 years. Then by 2000, it was a 30-year-old home.

Mm-hmm.

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. This company was founded and went public into a market of houses that were only getting older and needed ever more 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 a very predictable one, too. One thing I know for sure: if the age of the median home in the United States is old right now, in 5 years, it's also going to be old.

Yep, it's going to be older.

So here's a market—this is a different way to slice the market, but another crazy stat. In 1975, U.S. consumers spent $28 billion on residential improvements and 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 all episode, but so many of the other great companies we cover on Acquired, Home Depot is also a story of impeccable market timing.

5. They massively grew and invented the do-it-yourself concept. 6. The pro market ended up having way more running room ahead of it than anyone thought. Home Depot smartly crafted these very flexible offerings and parallel ways that you could buy from them, with different business models and 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 a giant market, capturing a huge part of that market with scale economies, aging housing stock, inventing the DIY concept, at least at scale, and also consuming 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 that it’s also the product of the U.S.’s economic and property rights policy 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.

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 U.S. finances it. Yeah, yeah.

I mean, the fact that we have these 30-year mortgages—they’re 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.

Yes.

If you either had not-as-high ownership rates in the U.S., or, like China, if you had a fundamentally different kind of housing stock that people own—because the Chinese housing market is actually larger than the U.S. housing market—but it’s a terrible market for home improvement and Home Depot.

Yeah. Yep. Good point.

Yep. That’s what I got.

That’s a good add. All right. That’s our quintessence, ladies and gentlemen.

This was a fun one. A lot of characters along the way.

A lot of characters.

Carve-outs, what you got?

Carve-outs. 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 3. I think I’ve probably made a carve-out of Silo seasons 1 and 2 in the past.

I think so.

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. 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 until Friday night—and not for all the normal reasons to wait for Friday night. It’s because that’s when the new Silo drops.

Love it.

So I can’t recommend it enough. Great, great sci-fi.

Throwback to appointment viewing.

Yes. My second one is also season 3 of a TV show: Tires.

Oh yeah, this is with Shane Gillis, right?

Yes. Oh my God, it’s so funny. I try to watch it at night after we put my son to bed, and I’m 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 3 because Shane got very famous after they did seasons 1 and 2, and I thought, this low-budget thing that he did with his friends is done. 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 an all-glass, ceramic, and metal coffee maker. 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 my coffee every morning. The Ratio Eight is, first of all, an aesthetically very beautiful machine, but it’s basically a high-end precision automated pour-over. It makes delicious coffee, especially when paired with another service I’ve been trying called Trade Coffee, where they deliver a different coffee for you to try every 2 weeks or 1 week, or whatever frequency you want.

I oscillate between decaf and regular so that I can mix them and make half-caf coffee in the mornings.

Mm.

Yeah, that’s all I got.

Nice. Well, I am going to surprise you. I think I have 2 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. 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 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, the number 1 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, which I watched upon reading a tweet from a friend of the show, Jeremy Jaffan. This movie is so fun. It follows Jerry right after the show Seinfeld ended, when he goes back to the clubs in New York, to the comedy clubs, and builds up a whole new stand-up routine completely from scratch.

He’s Jerry Seinfeld right after the show ends—the most famous person, maybe in all of New York—and he’s just going to the clubs, trying out new material, and bombing. It’s great. It’s so fun to watch.

Oh, sweet. I’ve got to check it out. Do you know my favorite game when I go stay at a hotel?

Oh, no.

I turn on the TV and try to see if there is an hour where a Seinfeld rerun is not on any channel. The syndication rights are so distributed that I feel like Seinfeld, the show, is on 24/7 somewhere.

It’s got to be. And on Netflix now.

Yeah. Yep. All right. Well, we have some thank-yous for folks who helped us this episode. First, I’ve been talking about him all episode, but Arvind Navaratnam at Worldly Partners. He always does these great 100-page studies, 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—decades—he does this on-the-ground research.

He goes to stores and employs someone full-time at Worldly Partners who is traveling the country, walking through Home Depot, Lowe’s, Costco, and other stores, doing price comparisons and generating real first-party data on how these stores evolve and change over time, how their prices change, and how the experience changes.

His write-up on this one is particularly awesome. This time, Arvind 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. Thank you so much to Arvind for your research help. Thank you to Ken.

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 meet. Ken would insist that he saved the company and that it would cease to exist if not for Frank coming in and saving it. Frank, of course, says that is absolutely not true. And it turns out it wasn’t that dire of a situation.

I think I’m with Ken on this one. Thanks, Frank.

Yep.

And thanks to Russ and Dylan Murphy, my contractors, for being my partners in building, restoring, and maintaining my 115-year-old house here in San Francisco and helping us with this episode.