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OFFICE OVERHAUL

OfficeMax tries to regain ground lost to Staples, Office Depot

By Maura K. Ammenheuser

If there’s an unwritten rule somewhere that office supply stores have to be boring, it is one that OfficeMax appears determined to break. Take the wall of bulk supplies at the chain’s newest store prototype, for instance. It includes a buffet of pens and similar small stuff, all displayed in bubble-shaped bins and sold, prix fixe, by the box.

Selling basic supplies penny-candy-style is arguably the most innovative idea OfficeMax built into that new store design, but it is surely not the only change from the company’s traditionally spartan, warehouselike stores.

Itasca, Ill.-based OfficeMax unveiled its Advantage store prototype in October in Macedonia (Ohio) Gateway Plaza. Since then, the company has opened one unit each in Appleton, Wis., and Oak Creek, Wis., two in Georgia and one each in Dallas, Houston and Florida.

The design combines checkout and customer-service areas, includes a central “hub” for high-tech products and relocates the heavily used photocopy and document-services area from the rear of the store to the front. It boasts a coffee shop with wireless Internet service and provides lower shelving for better sight lines and a kiosk where customers can refill printer cartridges with fresh ink — a service that until recently was widely available only over the Internet. (In mid-February OfficeMax was testing this in about 50 stores with an eye to doing a chainwide rollout.) The new look also features warmer, brighter colors than OfficeMax, or any office-supply retailer, is generally known for.

The redesign is the most tangible evidence yet of an overhaul of OfficeMax, the third-largest U.S. office supply chain, behind No. 1 Framingham, Mass.-based Staples and No. 2 Office Depot, of Delray Beach, Fla. But a turnaround plan OfficeMax announced in January during a conference call with analysts went beyond mere looks. It had to. To that point OfficeMax had already lost $30.7 million in just the first three quarters of 2005. The full-year figures, which were to be released a month later, would bring worse news still.

OfficeMax did not return calls seeking comment about the company’s problems or turnaround strategies. But during the conference call, executives pledged improvements, predicting that the changes will boost pretax earnings by $100 million this year, keep sales flat or lift them slightly and provide comp growth in the low single digits.

One major aspect of the turnaround is the closure of 110 underperforming U.S. stores, which, at press time, was to be completed by late last month. Five stores were shut in Canada late last year. But OfficeMax also plans to open 70 new U.S. stores in “high-growth regions” this year.

Executives cited other, internal changes under way, including the consolidation of two data centers into one and the creation of a single supply chain for both retail customers and businesses that purchase on an ongoing, contract basis.

They acknowledge they face a big challenge. “OfficeMax has not lived up to its potential in the recent past,” CFO Don Civgin said during the call. The fundamental business is sound, he said, but “poor execution puts OfficeMax behind its peers.”

Scott Rothbort, a finance professor at the Stillman School of Business at Seton Hall University, is blunt in his observations. “What OfficeMax needs to do is, it needs to be Staples,” Rothbort said. “Staples is the best-of-breed and OfficeMax is an also-run.” Staples offers better inventory and a more informed sales staff and positive shopping experience, he says.

One major OfficeMax investor is clearly unhappy. Boston hedge fund K Capital Investors, frustrated by OfficeMax’s performance, has reduced its stake and called for the company’s sale. The fund declined to talk to SCT.

OfficeMax announced its fiscal 2005 results on Feb. 22. The company lost $73.8 million for the year ($41.3 million in the fourth quarter alone), versus a net income gain of $173.1 million the year before. (By contrast, Staples says fourth-quarter profit jumped 9 percent to $1.3 billion on a 10 percent rise in sales.) The previous year’s results, according to OfficeMax’s formal announcement, “included income from the company’s paper, forest products and timberland assets, reported as the Boise Building Solutions and Boise Paper Solutions segment, which we sold in October 2004.”

In the retail portion of its business, OfficeMax’s sales did rise 6.8 percent in the fourth quarter, to $1.2 billion, and 1.1 percent for the full year. Comp-store sales on the retail, noncontract side fell 1 percent for both the quarter and the year. The retail results for the quarter included a $17.9 million charge, mostly attributable to the store closures. In the fourth quarter OfficeMax opened 18 new stores and shut three. OfficeMax executives reiterated their January expectations for sales growth this year.

As far as the Advantage stores are concerned, CEO Sam K. Duncan said they are exceeding expectations for sales per square foot and average consumer dollars per purchase, though he offered no specifics. Duncan also said the company is more focused than it was a year before.

OfficeMax has undergone a series of sales and acquisitions since its founding in 1988. In December 2003 it was acquired by Boise (Idaho) Cascade Corp., which sold OfficeMax’s wood-products business and moved its headquarters from Shaker Heights, Ohio, to Itasca. OfficeMax now plans another headquarters move, to Naperville, Ill., late this year.

The company also has new leadership. Former CEO Christopher Milliken resigned in February 2005 after an accounting scandal. Duncan took the helm last April, and Civgin arrived in October. Thus, fix-it efforts are to be expected. Future stores will follow the new prototype, and even some existing ones will be remodeled accordingly. Without offering specifics, Duncan predicts that Advantage stores will be more lucrative than those with the older look.

“They’re definitely hanging their hat on it,” said Michael Cipriani, managing member of GW Macedonia, which developed Macedonia Gateway Plaza, where the very first Advantage took 21,700 square feet. (The 165,000-square-foot big-box center also contains a Best Buy, a Burlington Coat Factory and a Petco.) The new design has “a cleaner look — that circle-track layout,” Cipriani said, and it is an improvement over “that old warehouse look that they had. It’s less cluttered.” The inkjet refill kiosk is “kind of cool,” he said, referring to $40-and-up replacement printer cartridges. “Everybody hates paying for those things.”

Store sizes did not change under the redesign. Future stores will continue to measure 20,000 to 25,000 square feet. Nor did OfficeMax make major merchandising changes.

But “there is much more fun put in it,” said James Lazzari, chief architectural officer at FRCH Design Worldwide, which designed the prototype. And that sense of fun is seen not just in the “grab-bag wall,” he says, but also in the graphics, the lighting and the store colors.

OfficeMax hired Envirosell, a New York City-based shopper behavior research firm, which found that “people were coming in the door, buying two or three things and leaving,” according to Paco Underhill, Envirosell’s president. Customers were unaware of the breadth of OfficeMax merchandise, a consequence for the most part of poor sight lines. OfficeMax needed to prevent shoppers from turning to discounters for their office needs, Underhill pointed out.

The strategy for improving OfficeMax’s retail business (as opposed to the contract side) will involve expanding the chain’s base of small-business customers, which accounts for 48 percent of sales, as well as boosting its printing and document services (last year’s highest growth category) and gleaning more revenue from inkjet refills.

But even if the turnaround tactics work brilliantly, they will not work immediately, Duncan acknowledged. OfficeMax will not catch up to Staples or OfficeDepot until 2008, at the earliest, he told analysts.

Investors should ask themselves whether this management team can salvage things and make OfficeMax a bigger draw than Staples, says Rothbort — questions he concedes he cannot answer himself.

Steven Chick, a retail analyst at JPMorgan Securities who rated OfficeMax a “neutral” in January, wrote in a research report that OfficeMax has seen “significant underperformance of the business.” Closing the weak stores will help, he says. Duncan said those stores combined generated just $300 million to $400 million in sales last year. “Only a few of the 110 were evenly profitable in recent months,” said Duncan.

But Chick points out that in the short term, the cost of the 70 stores OfficeMax plans to open will offset the benefits of these closures. The company “expects to incur $161 million to $166 million in charges in 2006,” Chick wrote, including $129 million for closures and about $25 million for headquarters consolidation.

Even as OfficeMax juggles all this, it must avoid losing market share in a fragmented industry. The company’s own research describes office supply retail as a $323 billion per year business, with nearly two-thirds of revenues coming from retail sales and the rest from contracts.

Of the roughly $206 billion retail portion, discounters and wholesale clubs account for about $63 billion, as do general retailers, while specialty stores sell about $61 billion and superstores $19 billion, OfficeMax says. So the chain is competing not just against Staples but also against Target and, for copying services, Kinko’s and FedEx, according to Rothbort.

Apparently, customers at the OfficeMax store in Corona, Calif., draw no strong distinctions among the chains. “They all carry the same thing,” said Shelley Vandenberge, of Riverside, Calif. Toni Rangel, also of Riverside, was at OfficeMax on a Sunday to buy a laptop case simply because it was en route to where her husband had to be that day. Rangel’s usual choice is Staples, she says, because the store is near her job.

But none of these shoppers seemed to be die-hard OfficeMax regulars, and nobody expressed significant loyalty to any chain. When you’re the No. 3 retailer, that can’t sound encouraging. Rothbort’s criticism of OfficeMax aside, he concedes that “the first step of a 12-step program is recognition that you have a problem. I think that’s what they’ve done. They should’ve realized it a long time ago.”

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