By Patricia Sellers

Bernie Marcus and Arthur Blank were having dinner at an Italian restaurant in Atlanta, as they often do, when the conversation turned to Bob Nardelli. Marcus and Blank, founders of Home Depot, co-chairmen of the board, and the only guys ever to run the company, had just hired Nardelli from General Electric to be CEO, and the hard-charging newcomer was giving them plenty to talk about. Only weeks into his new job, Nardelli had already eliminated a layer of managers, realigned divisions, and reassigned top executives. He was even planning to scale back the number of store openings in the coming year--a retreat from Home Depot's 20-year strategy of conquering first and worrying about market saturation later.

The 71-year-old Marcus liked what he saw. "Bob's made so many right decisions," he told Blank. It was a bittersweet assessment for Blank, 58, who had stepped aside as CEO to make room for Nardelli. Sweet because Blank owns $1.4 billion in Home Depot stock and wants the right decisions to be made. Bitter because he had intended to stay on as chairman and show Nardelli the ropes for a couple of years. But he couldn't deny reality. "That guy doesn't need me anymore," he told his friend. And so, on Feb. 21, Blank announced that he's quitting the board and leaving Home Depot altogether.

The decision saddened many, not least of all Blank, who founded the company with Marcus in 1978 and had been CEO since 1997. But the explanation is pretty simple: Home Depot's board and Bernie Marcus, its resident visionary--and Blank as well--concluded that the company is at a point in its evolution where it needs a sophisticated leader. Blank, a tightly wound former accountant, wasn't that man. In a letter to Home Depot's 230,000 associates (as the employees are called), Blank wrote that Nardelli "needs the space" to act as CEO, while he himself needs time for family, because he and his wife, who have a 4-year-old son, are expecting twins this summer. Clearly, nothing about this decision was easy. Asked whether Home Depot requires a "more complete" leader than himself, Blank replies wistfully, "The word 'complete' is fair. This business is more complex than before, and the leadership has to be at a higher level."

Over two decades Bernie Marcus and Arthur Blank turned a no-frills, hangar-sized home-improvement store in Atlanta into a phenomenon: 1,155 stores in North and South America, $46 billion in sales, a great brand, the instantly recognizable "orange apron." Thanks to their leadership, Home Depot is No. 6 on FORTUNE's Most Admired Companies list this year and has topped the specialty retail category for eight years straight.

Great accomplishments, yes. But now the company needs a fix-up. Home Depot is a sprawling manse whose owners kept adding wings and pretty porticoes. It looks beautiful from the outside, but it's buckling under its magnificent mass. Costs have spiraled. Same-store sales have flattened. Inventories have ballooned, and profit growth has slowed. In Home Depot's fourth quarter, ended in January, earnings fell 20%, the first decline in 15 years. The stock, as high as $70 last spring, has dropped to around $41.

Like a lot of companies confronting the economic downturn, Home Depot can't continue to thrive by just opening more stores. It must squeeze profits from productivity improvements, other efficiencies, and brand-new strategies. To do that it needs a renovator, someone who will pay attention to the details. Nardelli, 52, is the fix-it man. He comes with a great rep; he was one of three contenders to succeed Jack Welch at GE. He brings a box of tools--Six Sigma quality programs, financial controls, best practices--that Home Depot's freewheeling cowboy managers have never seen. A GE man through and through, Nardelli has an unbreakable conviction that better processes lead to better products and more profits. "What I'm known for is transferring best practices," he says. "That's particularly important in this economic environment, when you have to maximize revenues through existing assets." Told that Home Depot execs in meetings with Nardelli are counting the number of times that he says "process," Nardelli chuckles. "Well, if you're hearing that," he says, "my message is getting across."

Bernie Marcus and Arthur Blank were ALSO pretty damn good at getting a message across. Their energy inspired a pumped-up corporate culture. But for all Home Depot's "orange blooded" passion and standout training and retention, Marcus and Blank failed in one important way: They never prepared leaders inside the company to replace themselves. "Because Arthur and I were always there, our people never developed the talent they need to run the company," says Marcus. "Our presence created this wall."

So about two years ago they went outside the walls and started looking for someone whom they could train as a successor. Their hottest prospect, before Nardelli, was Jamie Dimon. Marcus and Blank courted Dimon for about six months in 1999, after Sandy Weill ousted him from the presidency of Citigroup. Dimon says he was blown away by Home Depot's culture: "Bernie told me, 'We think we get things 67% right.' I loved that they're so critical of themselves." Dimon says he would have been happy to work under Blank for a few years to learn retailing. Ultimately, though, he joined Bank One as Chairman and CEO.

Lack of retail experience didn't seem to trouble Nardelli, who swaggered through many businesses during almost three decades at GE. He moved from appliances to lighting to transportation systems--with a few stops in between. "I'm used to transition," Nardelli says. "Many of the skills are very portable." His last job at GE was heading Power Systems, whose main business is selling generators and other heavy-duty equipment to the energy industry. Nardelli goosed the "mature" business by shifting the focus from selling products to selling services. He signed up customers to long-term contracts to operate their entire facilities. It turned out that Power Systems wasn't mature at all. Revenues rose from $6 billion to $15 billion in five years. Profits multiplied too.

One person who was watching Nardelli's progress with more than a passing interest was Ken Langone, Home Depot's lead director and the investor who had given Marcus and Blank the seed money to launch their first stores in Atlanta. As a member of GE's board, Langone saw Nardelli work magic. While he didn't know that Welch was going to choose Jeff Immelt to succeed him, he was certain that the two "losers" in the three-way race for CEO would instantly be set upon by a pack of headhunters. Langone wanted to be the first to pounce. When Welch announced his successor on the Monday morning after Thanksgiving, Langone heard the news on CNBC. He immediately phoned Heidrick & Struggles recruiter Gerry Roche and gave him the go-ahead to swoop in. Within moments Roche, who had been courting Nardelli for months, threw the bait: Join Home Depot as president under Blank. Two days later Marcus flew to Albany, Nardelli's hometown, where the two had dinner. Nardelli won over Marcus that night, and then Blank that Saturday. Then he posed his ultimatum: He wanted Blank's job, CEO, immediately--or he wouldn't come. Blank agreed to step aside.

Nardelli hit Home Depot's cement floors running, sending the sawdust flying. After six weeks he removed five group presidents--a layer of management that Blank had installed. Nardelli has placed some of those people in charge of areas that he views as critical to Home Depot's future, like services (such as installation) and "new growth businesses," which include acquisitions--not a prime growth vehicle for Home Depot in the past. "It's easier for me to come in and change some things, because I don't have the institutionalized point of view," says the new boss. Marcus concurs, pointing out that only an outsider could be "objective" enough to trim Blank's plan for new stores this year from 225 to 200. "It's not about store count, it's about the quality of the store," says Nardelli, who is also looking to improve the way Home Depot deals with suppliers. "And it's not about head count. It's about head content."

The kinds of heads that have ruled Home Depot--independent and irreverent heads--tend to spin at some Nardelli-speak. In February, while addressing several hundred Home Depot buyers--who like to be called "merchants" if not "kings"--Nardelli referred to them as "the purchasing group." To some the gaffe was funny; to others it was insulting--especially when he repeated it several times. No one called Nardelli on it, but word spread fast. "Jesus, I want them to correct me," says Nardelli, who is now working on his language skills. "You know, I came in here saying S-K-U, and they say 'skew,' " he says, referring to the jargon for "stockkeeping unit." "I'm a pretty global guy. I can handle multiple languages."

The most important language Nardelli will have to learn is that of motivation. Retailing is largely the art of motivating people, something that the charismatic Marcus understood instinctively--and that the fastidious Blank picked up. Nardelli at least seems aware of the challenge. Three days after Home Depot announced Nardelli's appointment, he visited FORTUNE. Asked what he has learned from watching other GE veterans who have become CEOs, he said that the less successful ones "didn't realize they were in a different environment. They didn't have the respect of the culture and weren't sensitive to the pride of the employees."

At this stage Nardelli's key task may be to respect and keep talent. More departures will likely follow Blank's. Ron Brill, who was Home Depot's chief administrative officer, left March 1; he had planned his retirement before Nardelli arrived. Merchandising chief Mark Baker, known to be less than thrilled with Nardelli's bulldog style, might get itchy. He says he'll stay "as long as I'm adding value."

Nardelli has won over a couple of key players. Operations chief Larry Mercer, who started as an assistant manager in the first Home Depot store, was thinking last year about leaving but changed his mind after Nardelli told him, "I need you. You represent a lot of what's great about this company." Mercer says, "Bob validated my role."

Bernie Marcus is staying too. Marcus had planned to leave the board next spring, at age 72. Not now. "My plan is to stay on at least another year as chairman," Marcus says. So he'll be around to make sure Home Depot doesn't become "mature." At the mere mention of that word, Marcus wails, "Jesus, we're like little infants running around here. We can double in size and more." This could be the ideal pairing. Nardelli will help Home Depot grow up. And Marcus will keep Home Depot forever young.

Copyright AOL Time Warner 2001