Wednesday, August 08, 2012

Taking Best Buy Private

The Wall Street Journal reports this morning on Best Buy founder and ex-Chairman Richard Schulze's plans for the struggling electronics retailer.  As you probably know, Schulze hopes to take the company private.  The paper reports that Schulze "envisions a turnaround plan for the electronics retailer that involves cutting prices to better compete against Amazon and other online retailers while ensuring that the in-store customer-service experience is as good as Apple's according to people familiar with the matter."   Naturally, such a plan to lower prices, while not reducing costs aggressively, will shrink profit margins.

We need to know much more about this turnaround plan before being able to evaluate its prospects thoroughly. However, this initial news has not put investors and analysts at ease (understandably).   The Wall Street Journal cites skepticism from Sanford Bernstein's retail analyst Colin McGranahan, who says, "As long as the top line is slowing you have to cut costs at a similar rate or your cash flow starts to suffer." 

Beyond the simple math problem cited by McGranahan, the strategy may be flawed.  Schulze appears to be trying to compete on price, while offering a premium experience a la Apple.  However, we know that Apple achieves that premium experience by spending generously on branding, training, design, and the like.  There is no free lunch.    They make up for higher costs in some areas by charging premium prices.   Schulze appears to want that premium experience, but if he doesn't get strong pricing, how will he generate decent profits?  The risk here is clear.  Could Best Buy end up stuck in the middle?   They might not have the cost structure to compete with Amazon, nor the premium image and experience to compete effectively with Apple. 


Jagadeesh Venugopal said...

It appears that the business model of electronics retailers is becoming obsolete.

Think about clothes -- you need to see them, try them on, feel the fabric, ask your companion if it looks good on you, etc. These are things that are difficult to do over the web.

With electronics, it is different. For example, when in the market to buy a camera, the sensible buyer does not focus on the physical attributes of the device (color, whether it is metal or plastic, whether it has chrome trimmings, etc) as much as the functioning of the device (does it take good photographs). The latter cannot be determined by looking at it in a store. For one thing, when have you walked into a store and found their display cameras properly charged and in working condition? Secondly, there are a number of characteristics that cannot be tested in the store (e.g. landscape photography, dynamic range, low light performance).

However, the performance of a camera can be reasonably approximated by looking at the reviews on Amazon and elsewhere.

Having once made a decision to purchase a particular brand and model, the savvy buyer looks around for the cheapest price. There is NO differentiation in BestBuy's service that would induce higher willingness to pay. There is not one extra service that BestBuy delivers (in fact it irritates me no end when I see most Best Buy sales attendants chatting around in groups).

BestBuy cannot compete on costs with the centralized Amazon warehouse model. They cannot compete on service, because they offer precious little. They do have in-house brands (Insignia, Dynex) but their products tend to be poor quality imitations of major brands.

They are neither low-cost, nor are they differentiated. They are doomed.

Anonymous said...

Great strategy points Roberto, but it might not matter for Schulze. Look at the deal structure, he's working it like an LBO with barely any equity. Just running the numbers quickly he's buying the company at about 8 times cash flow and leveraging at 70%. He'll pay off all the debt in 4-5 years and basically have gotten the company for nothing. So long as he doesn't turn it belly up he'll make 3-4x his money. Just my two cents!

Professor Booker said...

Be the 'Best Buy' of Asian Electronics. There you go, that was easy. Rumours are there's a growing demographic there? ; )

james said...

Best buy is not the only retail stock that may go private their are many others.