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Strategy & Progress

“We are pleased to report that both Argos and Homebase have performed well, benefiting from the shared infrastructure and capabilities of the Group while continuing to invest for future growth. The combination of a strong operational performance, together with a clear strategy for growth, means we are well positioned and confident of making further progress in what we expect to be another challenging year for UK consumer spending.”

Home Retail Group’s vision is to be a leading retailing group that delivers long-term, sector-leading sales and profit growth. We will do this by leveraging our combined strengths to support our retail brands – Argos and Homebase. Key elements of this strategy are: developing world-class, low cost sourcing capabilities that enables Home Retail Group to deliver even greater value to customers; and delivering end-to-end solutions that give our customers convenient ways to order, pay for and obtain the goods we sell.

The corporate objective of Home Retail Group is to deliver sustainable returns for all its stakeholders. Our aim is to deliver growth in total shareholder return that at least matches the top quartile of comparable listed companies over the medium to long-term. Home Retail Group aims to achieve this by delivering sales and profit growth throughout the group, supported by investment programmes that give returns in excess of our cost of capital. We recognise that these objectives can be affected in the short-term by external economic, social and political factors. However, we believe that consistent investment in businesses with competitive advantage will provide sustainable returns to stakeholders.

We also plan to grow dividends for shareholders broadly in line with earnings, subject to the investment needs of the business and an acceptable level of dividend cover. We will seek to maintain an appropriate capital structure, financing our operations through a combination of retained profits, bank borrowings and property leases.

We aim to act responsibly and ethically towards all of our stakeholders, including our customers, colleagues, suppliers and business partners and the communities around us. Our approach to corporate responsibility is summarised later in the Business Review. We believe that this approach will assist Home Retail Group in achieving its objectives for shareholder return.

Nature of business

Home Retail Group is the UK’s leading home and general merchandise retailer with pro forma annual sales of over £5.8 billion. It sells products under two distinctive and complementary retail brands, Argos and Homebase, which are both household names in the UK.

Argos is a unique retailer recognised for choice, value and convenience. It sells over 17,000 general merchandise products for the home, all of which are set out in its twice-yearly 1,700 page catalogue which is at the heart of its proposition. Customers can purchase products through its network of 680 stores, online and over the phone, with the option of picking up their purchases from a store or having them delivered direct. Argos’ Internet site, www.argos.co.uk, is the second most visited Internet retail site in the UK. Argos serves over 130 million customers per year through its stores and takes 4 million customer orders per year either online or over the phone. On average, 17 million UK households, or around two-thirds of the population, have an Argos catalogue at home at any time.

Homebase is the UK’s second largest home improvement retailer and is recognised for choice, style and customer service across the wider home enhancement market. It has 310 large, out-of-town stores, which sell over 30,000 products, as well as a growing Internet offering. It also offers its customers the convenience of home delivery for bulky, high value items. Homebase serves over 70 million customers per year through its stores.

Argos and Homebase are supported by an in-house financial services business, which provides a range of credit and insurance products to their customers through all customer facing channels of stores, online and over the phone. Home Retail Group Financial Services is one of the largest store card providers in the UK, with over one million active store card customers.

Home Retail Group has a leading 10% share of the home and general merchandise market in the UK, giving it significant purchasing scale and the opportunity to further increase market share. This scale, combined with its global sourcing skills, ensures value for the customer whilst supporting profitability. The shared infrastructure in the Group provides support for Argos’ and Homebase’s customer propositions, reduces their overall operating costs and enables speedy development of profitable routes to growth. This has enabled the Group to increase its market share in a competitive retail market place.

Markets in which we operate

Home Retail Group operates in the growing general merchandise and home enhancement markets in the UK and Eire. According to leading research sources in 2006, the UK general merchandise market had sales of £26 billion and the home enhancement market had sales of £32 billion.

The categories and the overlap between the Argos and Homebase businesses are
summarised in the following table:

Product markets	Argos	Homebase	Group position	Market size
Home Enhancement
Housewares			Number 1	£8.9bn
Furniture			Number 1	£8.4bn
Home Improvement (DIY/fitted kitchens/bathrooms)			Number 2	£11.4bn
Horticulture, Garden Furniture and Outdoor Living			Number 2	£3.1bn
General Merchandise
Small Domestic Appliances			Number 1	£1.4bn
Consumer Electronics			Number 3	£14.8bn
Large Domestic Appliances			Number 3	£4.0bn
Toys			Number 1	£1.8bn
Jewellery			Number 1	£3.1bn
Sports and Leisure Equipment			Number 1	£1.2bn

Note: all market positions are for 2006 and by retail sales value except jewellery, which is measured by volume.

Competitive position

Home Retail Group faces competition from many players in many different product categories. They can be summarised as:

• specialist multiples, such as B&Q in home improvement, Currys and Comet in consumer electronics and domestic appliances, Woolworths in toys and wider general merchandise and H. Samuel in jewellery;
  
  
• specialist independents, such as regional and local chains selling single product ranges, such as toys and jewellery. With some exceptions, this group of competitors is generally losing share;
  
  
• supermarkets, such as Tesco, J Sainsbury and ASDA, which have been growing share in certain parts of the non-food, non-clothing market, building on their regular footfall and the increased space given to these ranges; and
  
  
• online retailers. Currently represent only a small but growing share of the non-food, non-clothing market.

Home Retail Group’s markets are expected to continue to be highly competitive. Our leading market position, together with our successful formats (such as using catalogues and mezzanines, for example), may represent attractive opportunities for some of our competitors. By leveraging the strengths of our businesses and by delivering on our strategy for growth, the Board believe that Home Retail Group will continue to strengthen its competitive position.

Key strengths

The Board believe that Home Retail Group’s key strengths include:

Strong retail brands with large customer bases
The Group operates two of the UK’s strongest retail brands with Argos being the leading general merchandise retailer and Homebase being the second largest home improvement retailer. Although there is some overlap between their customer bases, each business is strong in distinct consumer segments.

The two retail brands allow the Group to reach a broad range of customers in the UK and to present similar product ranges to them in two different shopping environments, thus maximising the opportunity to increase market share.

Market-leading position
Sales of over £5.8 billion in the last full financial year ranked Home Retail Group as the leading home and general merchandise retailer in the UK.

The Group has market-leading positions in a wide range of product categories: it is the UK’s leading retailer of housewares, furniture, small domestic appliances, toys, jewellery and sports and leisure equipment. It is also the UK’s second largest retailer of home improvement goods and garden related products and third largest retailer of consumer electronics and large domestic appliances.

Purchasing, sourcing and supply chain scale
Home Retail Group’s market-leading position means it has the scale of merchandise procurement that enables it to develop important and long-term relationships with suppliers. This leads to enhanced cost benefits and the ability to source exclusive products or to obtain advantageous quantities of products that are in short supply.

These scale efficiencies and supplier relationships have been used by the Group to deliver value for money to consumers across the broad range of products it sells, while supporting profitability in a highly competitive market place. The Board believe that Home Retail Group’s scale, sourcing advantage and supply chain infrastructure will be a key determinant of its long-term success in the UK retail market.

Choice and value-led product offering
Home Retail Group’s proposition is to offer customers choice and value across a wide range of products.

Argos offers a breadth of product categories and a level of choice within each product market that the Board consider is not equalled by any UK competitor. As a catalogue based retailer, Argos is able to present a very broad range of products to its customers cost effectively.

Homebase also offers a wide choice within the product ranges that it sells. Under Home Retail Group ownership, Homebase has broadened its product offering to encompass products that were already being sold by Argos and has significantly improved the range of products it sells as well as the level of availability within its stores.

Integrated multi-channel offering
The fully integrated nature of Argos’ multi-channel offering differentiates it from almost all of its UK retail competitors. A fully integrated multi-channel retail offering requires the support of a substantial and highly complex supply chain system, which the Board believe is difficult for competitors to replicate. Within Argos, regardless of whether the customer has made a purchase in store, online or over the phone, and irrespective of which delivery method the customer prefers, the overall experience is integrated and considered highly efficient by customers. Home Retail Group is positioned to benefit from continued strong growth in retail Internet sales, as the Internet is an integral part of its multi-channel offering and therefore fully supported by the Group’s supply chain infrastructure.

This multi-channel capability is also increasingly a source of competitive advantage for Homebase. These products are delivered using the Group ordering and home delivery infrastructure. In addition, the Argos online capability has been leveraged to provide Homebase with a cost-efficient, transactional Internet site providing a range of home-related products to the Homebase customer.

Shared infrastructure and logistics expertise
Argos and Homebase derive significant competitive advantage from their ability to leverage a shared infrastructure in the Group. This infrastructure supports their brand propositions, reduces their overall operating costs and increases the speed with which each business can develop profitable routes to growth. It has enabled the Group businesses to enter new product categories quickly and cost effectively and to rapidly build market share.

Key areas of shared infrastructure include: global sourcing operations, supplier management and related services and processes; home delivery services; customer service operations; catalogue production; financial services; and other support functions including property and information systems.

Experienced management team delivering a long-term track record of growth
Home Retail Group’s management team includes a wealth of experience of service, built from both within the Group and across the wider retail sector. As well as a long-term track record of growth, the management team has successfully restructured the Group while at the same time integrating the Homebase business.

Argos has a long-term track record of growth under the existing management. Since the financial year of the acquisition by GUS plc on 31 March 1999, sales have grown from £1.9 billion to £4.2 billion and operating profit before exceptional items has increased from £122m to £325m for the year to 3 March 2007. Following its acquisition, Homebase’s total sales have been increased by 13% between 2004 and 2007.

Strategy for growth

Home Retail Group seeks to take advantage of four factors to drive sustainable growth.

1. Leverage extensive product portfolio, market leadership and purchasing scale by:

• building upon market leading positions by enhancing and developing both the product range and the offering in core areas
  
  
• using shared scale and expertise in sourcing and logistics as well as joint product ranges to provide value for money and wide choice

Our businesses have continued to carry out extensive range reviews, introducing thousands of new products over the last year. The level of direct importing has grown to over 28% of Group sales. Nearly half of this is now being sourced directly from the manufacturer by the Group’s overseas buying offices. This represents more than 5,000 products across Argos and Homebase.

2. Increase market share in targeted large product markets by:

• capitalising upon the strength of the Argos and Homebase brands to identify opportunities in product markets (particularly large, fragmented markets)
  
  
• utilising the inherent flexibility of the Argos and Homebase formats
  
  
• using shared infrastructure efficiently to make these products available to customers quickly and easily

Argos and Homebase have this year both expanded their trials of furniture and housewares catalogues in order to extend the Group’s leading position in these fragmented markets. The growth in sales of furniture and other large products will see the Group start work in the current financial year on its fourth two-man home delivery warehouse. Homebase’s utilisation of the shared supply chain and home delivery infrastructure has brought it the scale and cost advantage of the UK’s largest home delivery operation of large, bulky products.

3. Expand Argos’ and Homebase’s store networks by:

• opening approximately 30 Argos stores per year
  
  
• opening approximately 15 Homebase stores per year, with a further small number of existing Homebase stores also supporting a mezzanine level

The Group’s store base is approaching 1,000 stores and we continue to see the opportunity over time for Argos to exceed 800 stores and Homebase to exceed 450 stores. We also continue to develop formats and store presentations in both businesses, and run property as a central function for leverage and space management opportunities.

4. Extend and exploit multi-channel leadership by:

• driving incremental sales growth over and above that which is achieved through new store openings
  
  
• continuing with a customer focused, fully integrated approach to ensure that whether customers shop with Argos in store, online or over the phone they are able to find, order and receive goods seamlessly across the different channels
  
  
• leveraging skills, scale and infrastructure to support the Homebase proposition

The leadership of Argos in terms of fully integrated multi-channel convenience is such that over one-third of its sales are ordered and delivered across more than one channel. Skills and ecommerce infrastructure at Argos have led to the re-launch of the Homebase website which is growing sales strongly and profitably. Both businesses also benefit from our in-house financial services business which provides appropriate credit offers to drive product sales and is fully enabled across all customer channels.

Factors affecting performance

The principal factor that affects performance is UK consumer spending. Over the long-term, growth of the general merchandise and home enhancement market is expected to continue to be driven by factors including:

• increasing number of households;
  
  
• rising overall household disposable income;
  
  
• technology change and development;
  
  
• falling prices of necessary items such as food and clothing leaving consumers with more discretionary spend for home and leisure-related products; and
  
  
• expanding sources of low cost supply which will stimulate further consumer expenditure across these product categories.

The UK retail market is, however, undergoing significant change. This change is in part driven by the recent slowdown in consumer spending, but is underpinned by an overall structural shift in favour of large scale retailers such as Home Retail Group. This has led to an increasingly competitive market where scale, value and cost management are believed to be the key determinants of success. Retailers that cannot offer a differentiated service or shopping experience and are unable to compete with the large scale retailers on price are likely to continue to underperform, with some being forced to exit the market as has been seen over recent years.

The Board believe that there are opportunities for the Group to benefit from the weakness of other retailers, by continuing to take market share as a result of structural changes in the retail market. The Board believe that market conditions in the UK are likely to remain challenging during the 2007 calendar year and possibly beyond, particularly for discretionary, high value or housing-related product categories. It is anticipated that the future underlying volume and value growth rates for most product markets, although positive, will be below the levels seen in the last five years. However, within this there will continue to be areas of relatively higher growth, either due to new product innovation or consumers’ need to renew or replace existing products. The Board believe that Home Retail Group is well positioned to take advantage of these higher growth markets. Additionally, the Group also has leading positions in many fragmented markets where the Board expect that both Argos and Homebase can continue to increase market share.

With its strong brands, wide choice across a broad range of products markets, multi-channel offering, strong retail credit propositions and ability to open new stores, the Board believe that Home Retail Group is well positioned to trade through any continued cyclical retail downturn and to successfully benefit from renewed consumer confidence through the cycle. The support provided to the business by its purchasing scale, global sourcing capability, supply chain infrastructure, and the shared service platform further underpins the competitive position of the Group within the UK retail market.

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