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Best Buy: Slowly Winding Down

22 Aug, 2013 By: Thomas K. Arnold

Best Buy’s transition into a digital distributor of entertainment received a hefty vote of confidence when the chain reported better-than-expected financial results, with its stock price soaring more than 10% after the company announced a widening of its second-quarter profit to $266 million, up from $12 million last year.

Gross margins, too, expanded to 26.5%, topping estimates of 23.3%. CEO Hubert Joly, a veteran turnaround expert who ran hospitality and restaurant giant Carlson — which includes businesses such as Radisson and T.G.I. Friday's — before he took the Best Buy job late last summer, was immediately hailed for his cost-cutting and other efforts, including instituting a price-matching policy, establishing dedicated “store-within-a-stores” for Samsung, Apple and Microsoft, and investing more money on training programs for employees.

And yet the numbers are deceiving. By gutting its entertainment section, the company has saved on expenses but also cut loose a huge revenue source. As Erik Gruenwedel reports in our story in this week’s issue, Best Buy posted a nearly 30% drop in same-store entertainment sales for the second quarter, with packaged media now accounting for just 5% of its $7.8 billion domestic revenue for the three months that ended Aug. 3.

Lost in the media hoopla over the sharp uptick in profit was the fact that overall, same-store sales fell as well, albeit by just 0.6%, while overall revenue was down 0.4%.

Joly’s strategy appears to be something of a slow march to the bottom. He’s shrinking Best Buy’s business, but cutting costs even more. And as long as he can stay ahead of the game, profits should continue to increase, at least in theory.

But he needs to be careful. Margins may continue to inch up, but by turning his back on packaged media and focusing on digital he’s not just reducing revenue, but also limiting choice — which is never a good thing to do when you’re dealing with consumer goods. And eventually there may come a point where margins may be fine, but the actual dollar amount of profit begins to decline — slowly at first, then more rapidly, as more and more consumers steer clear of Best Buy entirely because there’s no longer anything unique about Best Buy stores.

We saw the same thing happen with Blockbuster, when it began relying more and more on the same hits you could find everywhere else.

There are those who say Joly simply wants to do what Amazon does so well: Follow the consumer. But Amazon, with its pure online presence, can be much more nimble and quick than Best Buy, still saddled with a network of huge stores — and expensive leases.

The cynic in me questions whether Joly even wants to grow Best Buy’s business. Maybe he realizes he’s up against overwhelming odds, so all he really wants to do is manage the chain’s decline as best he can and jump off before things really head south.

I don’t profess to know the long-term solution to Best Buy’s woes. Maybe there isn’t one. I’m also not sure whether the chain wants to remake itself as a multi-brand version of Apple Stores or a brick-and-mortar Amazon — two objectives destined to fail because both Apple Stores and Amazon already exist and are doing just fine.

But I just don’t see the current trend, of soaring profits and declining revenues, continuing for much longer.

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