Small Business, Follow Home Depot's Lead

The home-improvement chain slashed costs as the economy soured while other retailers floundered.
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We're used to hearing bad news, given the state of the economy. Every earnings report brings another tale of falling sales and vanishing revenue.

But not all bad news is equally bad. Investors need only look at the examples set by two of the country's largest big-box retailers:

Home Depot

(HD) - Get Report

and

Target

(TGT) - Get Report

.

Both companies have been hurt by declines in

customer spending

. But one has responded aggressively to its challenges, and the other has stumbled. The difference offers a valuable lesson for all business owners who are trying to withstand the weak economy.

It's a cautionary tale of two superstores. Home Depot and Target thrived when times were good and mortgages were easy to get. As homeowners traded up to larger houses, they flocked to Home Depot for remodeling supplies and to Target for decorative accessories. Both chains reached out to affluent customers, as Home Depot expanded its selection of stainless-steel appliances and Target called on trendy designers to create houseware and clothing lines.

Then it all went bust. As home spending became a luxury rather than a necessity, sales at both stores slipped. On Tuesday, Target said its

quarterly earnings

fell 41% from a year earlier. Home Depot had a

$54 million

net loss.

So why did Home Depot's stock jump 10% that day while Target's fell? Analysts consider Home Depot better positioned to take on the difficulties ahead. That's because the chain has been getting back to basics.

To slash costs, the company shed its decorating spinoff, EXPO Design Center, and other ancillary remodeling businesses. That meant cutting thousands of jobs, which likely devastated many employees. These efforts increased Home Depot's expenses, causing the quarterly loss. But they will probably generate millions in savings.

The company also evaluated its inventory, making sure it offered the goods customers wanted without overstocking shelves with merchandise stores might need to discount later.

"We maintained sound inventory control, reducing inventory by over $1 billion while achieving the best in-stock rate we have had for several years," Chief Executive Officer Frank Blake said in a statement.

Target, on the other hand, struggled to adjust its product mix to the new economic reality. The company may have thought its reputation for fashionable-but-affordable items would help it survive lean times. But price-conscious consumers were worried about getting their next paycheck, so they headed to

Wal-Mart

(WMT) - Get Report

.

Target says most of its products are priced within 2 percentage points of Wal-Mart's. But "guest perceptions do not reflect this reality," said Kathryn A. Tesija, Target's executive vice president of merchandising, on a conference call with analysts.

The company plans to give more shelf space to food and household essentials. Advertising and in-store displays will emphasize its affordable prices. But it may be hard to catch up to the retail steamroller,

Wal-Mart

.

Target's credit-card business has added to its troubles. As more accounts turn delinquent, the company has had to put aside millions to cover those losses. Pushing credit seemed like an easy way to boost profit during a boom time, but companies are now grappling with the downsides.

Home Depot and Target still face a rough year, along with every other retailer. But for now, Home Depot proves that relentless cost-cutting can pay off. Its approach is simple: Shed secondary product lines, offer exactly what customers need and be wary of extending credit.

And whenever you can boast of having the lowest price, go for it -- loudly.

Jim Cramer discusses the companies he expects to be the top two survivors on the retail island in this video.

Elizabeth Blackwell is a freelance writer based in Chicago. She is the author of Frommer's Chicago guidebook, and writes for the Wall Street Journal, Chicago, and other national magazines.