Home Depot Ad Account Review Puts Agency Bills Under Spotlight

Four agencies are waiting to hear the results of Home Depot's creative ad agency review: The Richards Group in Dallas (independent and the incumbent), Omnicom's GSD&M Idea City in Austin, Texas; Interpublic's Hill, Holliday, Connors, Cosmopulos in Boston; and WPP Group's JWT in New York. After making its creative decision, Home Depot will next turn to look at its $580 million media buying account. Here's a look at the context of Home Depot's decision:

It isn't news that Home Depot is suffering mightily in the recession. The company was plunged head first into the maelstrom because it is so dependent on the sector that started the trouble, real estate. In Q3, Home Depot's sales tanked 6.2 percent to $17.8 billion; its net income sank 30.7 percent to $756 million.

Is anything going up? Yes. Selling, general and administrative expenses rose 2 percent, to $4.2 billion. Put simply, it would appear that part of Home Depot's trouble is that as sales decline, its marketing and admin expenses are eating its profit.

The math tells us that its annual advertising expenses must be roughly 4 percent of that SG&A number. As paid media is roughly 40 percent of all marketing, then Home Depot's total marketing spend is probably somewhere near 9 percent of SG&A. That's not a huge portion, but it's large enough to warrant attention at a company that desperately needs to cut costs if it is to continue returning positive net income to its shareholders. HD is already on an efficiency drive inside its IT department. The company said it would turn to advertising next in its Q3 call:

CFO Carol B. Tome: For the fourth quarter we expect our expenses per average store to be down from what they were a year ago. Two reasons for that, primarily lower advertising spending in the fourth quarter this year versus last year.

Of the three agency networks involved in this review, IPG has the lowest net profit margins and the lowest revenue per expenses invested. (This may not hold true for Hill Holliday specifically, but we're going to ignore that for a moment.) That may mean IPG is least efficient at generating its own revenue, or it may mean that IPG keeps less of the ad expenses that its clients funnell through the agency. If the latter is true, then IPG may be the cheapest network to go with. Trouble is, Hill Holliday is based in Boston and the client is based in Atlanta. Who wants to fly to Beantown in January?

The other agency that I'm scratching my head about is JWT in New York. Home Depot is a suburban brand. Driving to the Big Orange Box in the South and Midwest is just not the same as taking the subway to West 23rd Street in Manhattan, where HD's main NYC location is. The W. 23rd St store is essentially a home decorating studio with a tiny part devoted to actual construction materials. Out in America, it's often the reverse.

That leaves GSD&M and Richards. My money would be on either shop in the South.

Side note: Don't write off JWT completely. Note that Home Depot's customer transactions are down and sales per store are down. Discounts haven't worked (none of you pitched a discount strategy, right?)

It might be that Home Depot would do well to move its business away from residential home construction more toward the high-margin trinkets sold in the NYC store, especially as in the recession fewer people will be remodelling. If it's true that over the next few years there will be a bigger market for fancy lamps than kitchen-wide do-overs, then perhaps JWT's weakness here -- its staff's familiarity with Home Depot's least typical store -- is its strength.