I hate to state the obvious, but electronics retailer Best Buy (NYS: BBY) is a sinking ship. When the company's CEO, Brian Dunn, went on the defensive recently in a lengthy blog post to critics, it was clear that Best Buy refuses to acknowledge the full threat posed by online merchants. Let's look at the retailer's greatest weaknesses and what it needs to do to compete in today's web-based marketplace. 

Comparison shopping
With more than $50 billion in sales last year, it is not surprising Mr. Dunn seems overtly optimistic. The big box retailer claims nearly a third of all consumer electronics sales in America. Strong cash flows and attractive quarterly profits may disguise the chain as a winning bet. However, fierce competition from rivals such as Amazon (NAS: AMZN) , and Target (NYS: TGT) threaten that lead.

Best Buy's biggest problem is that customers are using its stores to comparison-shop -- often making purchases elsewhere online. Dunn is quick to point out that his stores offer value where online retailers like Amazon cannot by providing home installations and customer care through its Geek Squad. However, those services are added costs and these days the customer that's using their smartphone to comparison shop is often the same person searching Google for how to setup the products on their own.

Costly pricing strategy
Of course, Best Buy employees are trained to upsell you on the warranties, which account for nearly 6% of total annual sales. Geek Squad coverage on a $300 television will cost you about $60. If you also want the service and customer care that Best Buy's been boasting about, well, you're going to have to pay up for that too. Delivery and mounting will cost you between $199 and $265 - essentially doubling the price of your TV. If Best Buy plans to beat the competition with expertise and service, it needs to offer more competitive pricing.

Best Buy should appeal to the changing needs of its customers. More people are choosing to shop online. According to comScore, "U.S. online sales for the 2011 holiday season rose 15% to hit an all-time high." That breaks down to ecommerce sales of $37.2 billion for November and December of that year, compared to $32.4 billion a year prior. That handily beats the growth of traditional brick-and mortar retailers, which grew just 3.8% for the same period. 

The growth in ecommerce makes sense. Why wouldn't you buy the same product for less money online? Best Buy will match a competitor's store price on identical products, but refuses to beat its competitors' website prices. In order to compensate for its overhead costs, Best Buy needs to markup products more than some online retailers like Amazon. The company's cost structure shoulders it with the burden of huge rent payments and wages for 180,000 employees.

Amazon, on the other hand, doesn't have a physical storefront and with just 33,700 employees generated net sales of $34.2 billion, in 2010. See the chart below for a side-by-side comparison of annual operating data for the two companies.

Company

2010 Employees

2010 Net Sales Per Employee

Best Buy 180,000 $279,289
Amazon 33,700 $1,179,448

    

Even industry rival RadioShack (NYS: RSH) understands the importance of keeping overhead costs to a minimum. RadioShack operates much smaller stores at 11,469 square feet, compared to Best Buy's 58,105-square-foot warehouses. At the end of the day, Best Buy is burdened by supporting its large store format.

If Best Buy wants to continue to compete in this evolving retail environment, the company will need to modernize its business model. Yes, there are plenty of customers who choose Best Buy over ordering online because they have questions about a product or want to talk to a real employee. But appealing to the next generation of consumers is Best Buy's only shot at being profitable in the future, and those are the customers shopping online for better deals.  

At the very least, Best Buy should take a cue from Target and jump-start ways to curb the increase in comparison shoppers using its stores as a showroom. Recently, Target reached out to suppliers for help protecting its stores against sales lost to e-retailers. Target hopes to work together with its vendors to offer exclusive items that can only be purchased in the chain's stores. Where special merchandise can't be arranged, the retailer is asking that suppliers help Target offer more competitive pricing on popular items.  

So far, Best Buy has done nothing to proactively defend its stores. Is Best Buy's industry leading market share enough to keep the big box profitable in the future? I want to hear from you. Let me know in the comments below whether you think Best Buy is headed for a slowdown or a turnaround.

A better buy

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At the time this article was published Foolish contributor Tamara Rutter owns shares of Amazon. Follow her on Twitter, where she uses the handle @TamaraRutter. The Motley Fool owns shares of Amazon.com, RadioShack, and Best Buy. Motley Fool newsletter services have recommended buying shares of Amazon.com; and writing covered calls in Best Buy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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sptt144

I don't even think about going to Best Buy if I need anything electronic. I worked at Circuit City for 16 years. Loved being in the business but there was no profit left in the electronic boxes so we kept having to push services and warranties even harder. Customers have the internet to educate them now. Back then, we were the internet for customers. They had to come in and see and hear. I don't see how Best Buy can hang in there but I do hope there is a brick and morter business left in there somewhere. Retail is just a nightmare anywhere nowadays.

See full article from DailyFinance: http://srph.it/ycud5X

January 26 2012 at 9:30 PM Report abuse rate up rate down Reply