Internet and Mass-Market Merchandisers Assignment
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Internet and Mass-Market Merchandisers Assignment
Read the Finding the Best Buy LISTED NELOW
- Corporate governance has become a hot issue in the U.S. over the past two decades. From your analysis of the case study, determine two possible corporate governance challenges that might be faced by Best Buy as a result of its rapid growth and why they could become corporate governance issues.
- Make recommendations for how Best Buy can overcome these challenges. Provide specific examples to support your response.
Introduction
In the battle to become the largest consumer electron- ics retailer in the US, some might say that Best Buy is up by a few rounds. Beginning as a single location car and home stereo store in 1966, Best Buy has grown into a massive firm with 1,400 stores in North America and over 2,600 stores in Europe and China.1 As recently as 2007, Best Buy was seen as the team to beat, boast- ing a strong lead in market share over its competitors, large and consistent profits, healthy stock returns, and a global expansion strategy. In accomplishing this feat, Best Buy brought down its biggest competitors—Circuit City and CompUSA.2 With CompUSA out of the way (at least temporarily) in 2007, the economic recession and the ensuing reduc- tion in consumer discretionary spending added the last bit of leverage needed to topple Circuit City in 2009.3 This allowed Best Buy to emerge as the clear champion of the large format consumer electronics retail segment; a position many consider prophetic of future success. However, whether the downfall of its competitors is the result of Best Buy’s superiority or simply the inevi- table demise of a retail model that is becoming obsolete remains to be seen. Unfortunately for Best Buy, recent results suggest that the latter might be the case. As shown in Exhibit 1, Best Buy’s recent stock returns have been consistently below those of the S&P retailing group as well as those of the S&P 500.4 In addition, revenue growth slowed to a miniscule 1.6 percent over the course of fiscal year 2011.i While the recession can be blamed at least in part for this reversal of fortunes, more of the blame likely lies with the presence of new competitors in the industry including the better diversified Walmart and Costco, additional “go straight to the source” Apple stores, and the monster of online retail—Amazon i Best Buy’s fiscal year 2011 closed on February 26, 2011. .com. In fact, Amazon’s stock price increase is a near mirror image of Best Buy’s stock price decline.5 Likewise, these new competitors have been gaining market share in the consumer electronics segment while Best Buy has been losing it.6 The threat of these new entrants is particularly ominous in that they are quite different from Best Buy in terms of their structure, focus, and features that customers find attractive. For example, it is not uncommon for a customer to browse Best Buy for a particular product, use Amazon’s app on their smartphone to scan the barcode, and then purchase the product from Amazon at a better price while still in Best Buy—a scenario that has led to a new—and painful— nickname for Best Buy—“Amazon’s showroom.”7 History In 1966, Richard Schulze, disgruntled that his suggestions for improvement weren’t being taken seriously, quit his family’s electronics distribution business and, together with a partner, started his Minnesota-based home and car stereo store called “Sound of Music.” The firm grew through acquisitions and the opening of new stores and hit the million-dollar revenue mark by 1970. During the 70s, Schulze’s company experienced significant financial success, allowing him to expand the chain and buy out his partner. Even early in his managerial career, Schulze showed an uncanny ability to adjust to market trends and seek out profitable opportunities. For example, his position on a school board gave him insight into the fact that the customer pool of 15- to 18-year-old males (his target demographic) was shrinking. Consequently, he adjusted his business approach by diversifying into appliances and video equipment with the goal of targeting the expanding demographic of older and wealthier customers emerging in the 80s. As another example, when a tornado destroyed one of his stores but left the inventory largely unharmed, Schulze held a “no frills parking lot sale with reduced prices. The approach was so successful that in 1983, Schulze reorganized the business into a superstore format under the “Best Buy” brand name and in 1985, took the new company public.8
As Best Buy continued to evolve, the sales approach used in the superstores changed from that of a specialty electronics retailer with highly knowledgeable commissioned sales staff, to a mass merchandiser with a larger variety of products, discounted prices, and a more dispersed and non-commissioned sales force.9 Although customers seemed to appreciate the increased variety and did not seem to mind the reduction in sales assistance, some suppliers were skeptical of the superstore concept and, for a time, pulled some of their products from Best Buy’s shelves.10 Since the introduction of the superstore, Best Buy has refined the concept to allow for moderate levels of customer service, balanced with displays and product groupings designed to allow customers to shop for many items without extensive assistance.11
This moderated approach was successful and prompted the brand to expand rapidly throughout the US between 1989 and 1995—opening 47 new stores in 1995 alone. However, Best Buy’s rapid expansion brought with it high debt levels and low profit margins that eventually forced the firm to slow its expansion and reconsider some of its low-cost strategy. This setback notwithstanding, Best Buy began to expand again in 1999, opening new superstores in additional regions of the US and launching a separate subsidiary—BestBuy.com—to claim its stake to the online market.12
If Best Buy experienced rapid growth in the last 34 years of the twentieth century, it was paltry compared to the meteoric rise it experienced during the decade beginning in 2000. Growth came through
Globe: © Jan Rysavy/iStockphoto.com
organic means (opening new store locations), new ventures within the firm (Best Buy Mobile stores), and both domestic and overseas acquisitions.13 Domestic acquisitions included Magnolia Hi-fi (a chain of 13 high-end stereo electronics stores) in 2000, the Musicland Group (comprised of over 1,300 Sam Goody, Suncoast Video, and Media Play stores) in 2001, Pacific Sales Kitchen and Bath Centers (a chain of home appliance and remodeling stores) in 2006, and Napster (an online music download website) in 2008.14 Also domestically, the firm acquired Geek Squad (an omnibus computer/electronics installation, repair, and support service) in 2003 to offer after- purchase support services to customers, and Speakeasy (a provider of broadband voice, data, and IT services to small businesses) in 2008.15
International acquisitions were even more extensive starting with Future Shop (the largest electronics retailer in Canada) in 2002.16 Next up, Best Buy acquired 75 percent of Five Star Appliance (a major Chinese appliance and electronics retailer) in 2007, and scooped up the remaining 25 percent in 2009.17 In 2009, Best Buy formed Best Buy Europe and entered a 50/50 joint venture in Europe with Carphone Warehouse, a company that included over 2,400 stores and, not coincidentally, had acted as a consultant when Best Buy opened its US mobile stores two years earlier. These acquisitions were all followed by the opening of Best Buy superstores in their respective markets of Canada, China, and Europe. Best Buy also opened superstores in Mexico in 2009 and Turkey in 2010.18
Not all of Best Buy’s expansions were successful, however. Due to poor performance, the firm closed almost 100 Musicland Group stores in early 2003, and sold all remaining Musicland assets later that year.19 Best Buy’s Speakeasy acquisition ultimately did not provide the strategic advantages Best Buy had expected, and was sold in 2011. Due to the lethal combination of non- existent brand equity and cultural mismatch, the Best Buy branded stores in Turkey and China also performed poorly, resulting in the decision to close (or in the case of China, convert to Five Star branded stores) those locations in 2011 and 2012 respectively.20
Managerial changes at Best Buy have been infrequent over the course of the firm’s history and because most of the changes that have occurred have been internal leadership promotions, managerial succession has had little impact on Best Buy’s overall strategy. Dick Schulze led the company from its founding in 1966 until he resigned from the CEO position in 2002 and continues to be a driving force as Chairman of the Board. Upon Schulze’s retirement from CEO, Brad Anderson, who had been serving as the firm’s vice chairman, took over the position and worked as the company’s CEO until 2009 when he retired. Brian Dunn, who started his career with Best Buy working as a sales associate over 25 years ago, accepted the CEO position in 20
he retired. Brian Dunn, who started his career with Best Buy working as a sales associate over 25 years ago, accepted the CEO position in 2009.21 Industry Suppliers Due to the variety of products Best Buy offers, the firm maintains relationships with hundreds of suppliers. Even so, in 2010 Best Buy purchased almost 65 percent of its products from just 20 suppliers with 5 of those suppliers (Apple, HP, Samsung, Sony, and Toshiba) providing almost 40 percent of its merchandise.22 Although there are no signs of supply disruption from any of these major companies, supplier firms themselves are evolving. In the past, major electronics producers like Sony would sell only to specialty electronics retailers like Best Buy or Circuit City. Today, the major electronics suppliers are increasingly allowing their products to be sold by warehouse clubs and online distributors. As suppliers extend the scope of their distribution, Best Buy loses the exclusivity it once enjoyed.23 Compounding this problem is the fact that major supplier firms like Apple are integrating forward and distributing their products through websites and bricks-and-mortar stores.24 As Best Buy has increased its emphasis on cell phone sales through the Best Buy Mobile store-within-a-store format, the major cell phone carriers are becoming more important as suppliers than in the past.25 However, because the cell phone business is becoming increasingly concentrated and commoditized, the cut for middle- man distributors is dwindling. In the end, vendors such as Best Buy may find it too difficult to achieve profit margins sufficient to continue this foray.26 Customers Like many firms that focus on retail sales, Best Buy’s customers represent a broad array with no single customer profile accounting for a significant portion of overall sales.27 Nevertheless, in its effort to meet each customer in an efficient manner, Best Buy has worked to understand its customers better. As an example, the firm has recently worked to increase its offerings to business customers—training designated staff to provide consultation services to business purchasers as well as showcasing products specifically designed for business applications.28 Of course, technological trends have important implications for firms in the consumer electronics industry. The increased use of the Internet provides businesses with multiple challenges and opportunities, both in terms of the range of products offered as well as new ways to conduct business and access customers. The trend toward a decrease of retail prices in the consumer electronics industry combined with an increase in market saturation could become problematic for firms.29 Additionally, the smartphone and tablet trend toward the consolidation of functions (i.e. computing, messaging, phone calls, GPS navigation, games, camera, etc.) will influence not only the demand for these products, but the products they replace as well. The increasing rate at which technology is changing offers firms in this industry an endless supply of new products, but carries with it the threat of being caught with unsold stock that is newly obsolete or simply suddenly unpopular. To offset this particular risk, firms with the ability to bring products to an international market could benefit from economies of scale. In addition, offering products considered by advanced markets as obsolete to secondary and tertiary markets would extend the shelf life of a product and give sellers the opportunity to move products from inventory that could not otherwise be sold. International access to inexpensive labor and production facilities also affords firms in the industry the opportunity to consider backward integration in terms of developing their own “house brand” products with lower financial risk than would be the case without international options. Specifically in regard to the US, the aging population suggests the need to offer products and use marketing approaches that appeal to older customers. Likewise, the increased ethnic diversity of the population, the staying power of the dual career family, and the subsequent increase in the purchasing power of women mark opportunities to provide and market electronic products to consumer groups beyond the typical white-middle-aged-male segment. Also, stagnating population growth in the US and expanding international populations and economies fuel opportunities in international expansion-opportunities that come however with the threat of increased competition from international firms.30 The economic downturn and tightening of credit late in the most recent decade resulted in decreased growth for several consumer electronics firms and likely contributed to the demise of Best Buy competitors such as Circuit City and CompUSA. In general, firms selling lower-end electronic products are thought to benefit from this trend while those selling cutting-edge technologies are expected to suffer. Clearly, the speed and extent of economic recovery will influence future growth opportunities. Recent indicators suggest that personal income is on the rise in the US, a change that will likely increase the demand for luxury, high-end, and discretionary products once again.31 However, recession induced trends such as increased financial prudence could at least temporarily delay this effect. Responses to the recession that influence inflation and trade balances internationally—and by extension, exchange rates—will affect the viability of international expansion. With increased competition in the consumer electronics industry coming from online retailers, the political/legal segment is becoming increasingly important to firms like Best Buy. This is because when a company operates even a single bricks-and-mortar retail outlet in a US state, all sales made within that state, both in-store and online, are subject to sales tax.32 Alternatively, if a firm does not have a “physical presence” in a state, they do not have to charge its online customers sales tax. The issue up for debate is whether distribution centers fall within the definition of “physical presence” with online retailers threatening to pull distribution centers— and the jobs they provide—from any state that says it is so. With retail locations in the majority of US states, Best Buy would like to see state legislators level the playing field by clearing up the definition to explicitly include these distribution centers.33 Competitors The industry in which Best Buy operates is in an unprecedented state of flux. The recession finished the job of eliminating weak competitors in the specialty consumer electronics store segment that started years earlier with the advent of the Internet and mass-market merchandisers. With the elimination of Best Buy’s traditional head-to-head competitors (i.e., those like Circuit City and CompUSA that sold the same products and used the same format), Best Buy is left to compete primarily against unfamiliar rivals on unknown terrain. The strategies and tactics used by competitors coming from the online retail, warehouse club, and mass market approaches differ from those traditionally used by bricks-and-mortar electronics stores. Major competitors in the “new” consumer electronics industry and their effects on industry competition are discussed below. Amazon.com. Jeff Bezos developed the idea for Amazon.com in 1990 when he was struck by the goodness-of-fit of book selling via online marketing because of the need for precise and automated inven- tory controls in each. Over the next four years, he developed the idea for his new company and launched the online bookstore in 1995. Sales grew rapidly and the company went public in 1997. Realizing the potential based on its unprecedented success, in 1998, Bezos contracted with AOL and Netscape to increase Amazon’s visibility to Internet users, and later that year, Amazon added music, video, electronics, and toy segments to its product offerings.34 Since its inception, Amazon has continued to grow— sometimes through its own ventures including the development of Endless.com, Amazon’s online shoe store, its own e-reader device, the Kindle, and the addition of media downloading services including music, TV shows, and movies—but oftentimes through acquisitions of online retail firms. Each representing a product market niche, the firms Amazon has acquired offer a range of products and services including audio books (audible.com), to pet care (pets.com), and groceries (homegrocer.com). Acquisition of a European version of Netflix suggests that Amazon may be considering entry into the mail-delivered DVD rental business in the US. While most acquisitions serve to extend Amazon’s reach into markets it can effectively and efficiently supply, some come with additional benefits as well. For example, Amazon’s acquisition of Zappos.com not only increased its presence in the online shoe market but also made it possible for Amazon to integrate some of Zappo’s customer service skills into its main operation.35
Not one to be behind the curve, Amazon quickly capitalized on the smartphone trend as a way to sell new products and attract new business. Early in 2011, Amazon went into direct competition with Google’s App Marketplace with the launch of its Appstore for Android. Amazon’s site allows customers to “test drive” an app before purchasing, carries ad supported free apps, and has a “premium-app-a-day” giveaway to increase market share and encourage customers to regularly check back with the site.36 In a major coup and as mentioned previously, Amazon’s new shopping app allows smartphone users to say the name of a product or take a picture of its cover art or bar code (presumably in a store) and receive instant information on the price of the product at Amazon—as well as the opportunity to make the purchase.37
There are two factors central to Amazon’s suc- cessful bid as a consumer electronics retailer. First, its operating expenses are lower than those typical of a bricks-and-mortar operation with less than aver- age lease obligations, payroll, insurance, utilities, and the like.38 Because of these cost savings, Amazon has been able to engage in price wars to increase market share and profits. Second and as previously discussed, because Amazon does not have physical retail locations, it is able to sell its products without sales tax in most locations, giving it an automatic price advantage of several percent over bricks-and-mortar competitors in most states.39 As might be expected, Amazon’s operating results—even in the midst of a recession—have been impressive. The firm has averaged 32 percent annual revenue growth between fiscal years 2008 and 2010 and, with growth of almost 40 percent during the last year, this growth is accelerating. During this same three-year period, the firm’s net profit margin remained stable at 3.37 percent.40 These results support investors’ optimism for Amazon’s future and account for the 33 percent increase in its stock price.41
Walmart. Sam Walton opened a five-and-dime store as a franchisee in 1945. After the franchise owners dismissed his idea of opening discount stores in small towns, he and his brother Bud opened their first Walmart store in 1962. The firm grew quickly and is now the largest retailer in the world. Although most of its sales come from Walmart and Sam’s Club stores in the US, Walmart’s international divi- sion is growing rapidly and has established its presence in Canada, Mexico, Europe, and Asia.42
Walmart stores epitomize the “big box” model of retail. The firm operates stores that range from large to gigantic with product offerings designed to meet most of the needs of the average consumer. While the mega retailer officially falls within the “Discount and Variety Retail” industry, depending on location, its major product offerings may include groceries, pharmacy goods, gasoline, clothing, furnishings, music and video entertainment, software, office products, sporting goods, toys, consumer electronics, and appliances. Additionally, the firm has a significant online presence, has dabbled in online music downloads, and is considering a video downloading venture.43
Walmart uses its unmatched economies of scale and scope, considerable bargaining power with suppliers, as well as well-developed logistical competencies to offer a broad range of merchandise at prices that competing firms have a hard time matching.44 While Walmart does not classify itself as an electronics retailer, it is second in electronics sales only to Best Buy—and gaining. It is important to note however that most of Walmart’s electronics sales come from lower-end audio/video products where margins tend to be lower.45
Similar to most businesses considered in economic terms to carry inferior products, Walmart fared well during the recession. While revenue growth was
modest and stable from fiscal year 2008 to 2011 at 3.65 percent per year, the firm’s net profit margin steadily increased from 3.3 percent in 2009 to 3.89 percent in 2011.46
Costco. The firm known today as Costco Wholesale resulted from the merger of Price Club and Costco Wholesale in 1993. Price Club was founded by Sol Price in 1975, and the original Costco was founded by Jeffrey Brotman, a former executive VP of Price Club, in 1983. The merger of the two firms and its subsequent growth in the US, Canada, Mexico, Europe, and Asia makes Costco Wholesale the largest wholesale club in the world. Though Costco locations offer limited variety within each product type, the scope of its product offerings is wide and includes fresh foods and groceries, household items, clothing, jewelry, pharmacy, office supplies, tools, auto- motive supplies, consumer electronics, furniture, insur- ance, payroll and travel services, and even car sales.47
Costco offers products that are of a slightly higher quality compared to other mass-market merchandisers, often contracting with upscale brands for large quantities of a certain product. These products may then be sold under the original brand name (or a version of it) or, alternatively, rebranded and sold under Costco’s Kirkland Signature store brand that, as store brands go, has come to have an upscale image. Costco is able to offer low prices by almost exclusively stocking items that sell quickly, allowing it to take a smaller margin on each item while continuing to provide exceptional value to its customers and maintaining a high level of profitability. As is the case with Walmart, consumer electronics is only a portion of Costco’s business. Best Buy attempts to maintain an edge over discounters like Costco by offering superior service, a bigger selection, and cutting- edge technologies. However, with the recent economic downturn, consumers have been more reticent to jump into buying the newest technologies, making Costco’s “garden variety” offerings and low prices quite appealing. The firm has also made some progress on the service front. While its departmental service remains limited, the addition of its “Concierge” program— offering after-sale technical assistance via telephone and a free second year warranty—is beginning to encroach on benefits typically dominated by specialty retailers.49 In addition, Costco has begun to develop relationships with premium suppliers like Sony, allowing it to sell higher-end products that were once distributed only by specialty electronics retailers.50