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Best Buy formula working well, but "tranformation" still underway
by Jeff Horwich, Minnesota Public Radio
March 31, 2004

Best Buy investors are celebrating the 7th straight year of double-digit operating income growth. But there are changes in store at Best Buy, which is looking to carve out a more upscale, service-oriented niche. (Image courtesy of BestBuy.com)

Richfield-based Best Buy says sales soared in its most recent quarter, capping off what it calls a "banner year". The electronics retailer reported earnings for its fiscal year, which ended Feb. 28. Despite the financial success, in the coming year Best Buy plans to cut jobs, trim costs wherever it can, and roll out a new image to customers. Analysts say it's part of a plan to keep plenty of distance between Best Buy and the world's biggest retailer, Wal-Mart.

St. Paul, Minn. — After years of losing money at its struggling Musicland subsidiary, Best Buy dropped the music stores in June and saw profits jump more than 600 percent.

Even without that boost, operating income at Best Buy stores rose 29 percent last year. Executives say holiday shoppers came to Best Buy more than ever for items like flat-screen TVs and computers. Best Buy now sells more than half the laptop and desktop computers purchased at brick and mortar retailers in the U.S.

Chief Operating Officer Allen Lenzmeier told investors the computer growth comes as a "pleasant surprise," driven by consumers moving computers from the home office to the family room. "We believe that the consumers' recognition of the functionality of the computer as a hub for storing photographs, music, movies, and games is an important step toward building a personal entertainment library," he said to analysts on a conference call.

The Best Buy formula seems far from broken -- but executives are fixing it anyway. Though Best Buy may be trouncing its most direct competitor, Circuit City, University of St. Thomas retail expert Dave Brennan says competition looms from other directions.

With "the direct competitors they've done very well," Brennan says. "But you've always got the possibility of some of the low-end stuff getting sucked off through CostCo, Sam's (Club), but also Wal-Mart."

Wal-Mart and other discounters are a growing destination for inexpensive DVD players, stereos and even computers. Some analysts also see a threat from computer companies like Gateway and Dell, which have added TVs and other consumer electronics to their lineups.

Best Buy's strategy for this environment seems to have two prongs: The first is bringing costs down; the second is moving the image of the chain distinctly "up-market."

The cost-cutting strategy has a number of distinct elements. For example, this week Best Buy opened an online auction outlet on EBay. The idea is to reduce the losses that come from trying to unload discontinued or refurbished products.

Executives also decided recently that many Best Buy stores were heavy on middle-managers. They're changing or eliminating as many as 8,500 of these jobs nationwide.

And the company says it might dissolve its information technology department and use an outside company instead. About 900 IT jobs could be affected. Investors should like that idea, says Argus Research analyst Joe Bonner. "Consumer electronics is such a dynamic marketplace. You need to make these big changes to keep competitive," he says.

This change to so-called "outsourcing" is not new to Best Buy. Best Buy gave an award to a company in India as its "premier information systems partner" in late 2002.

Of course, not everyone thinks outsourcing is a great idea. An economist for the Communications Workers of America union, which does not represent workers at Best Buy, says shipping more jobs overseas could hurt employee morale and turn off consumers.

The company hopes shoppers will have something else on their minds: The more upscale store atmosphere they're likely to find in the coming year. By remodeling stores and focusing on higher-end products, analysts say the idea is to attract consumers with different tastes and more money than those who shop at Wal-Mart.

Best Buy also plans to differentiate itself with service: Employees who not only know the products, but know how to install and combine them into packages. An offshoot of this approach is "The Geek Squad." In 2002 Best Buy bought the Minnesota-based business of computer techs who make house calls. This year The Geek Squad will expand to 45 of Best Buy's biggest markets.

By serving a more upscale shopper, retail expert Dave Brennan says Best Buy can put some distance between itself and its rival.

"Wal-Mart is all over the place. They're something to everybody and they're basically targeting the low-end consumer," Brennan says. "I don't think that's where Best Buy sees themselves for the long-term."

Investors seem comfortable with what company executives are calling a "transformation." Best Buy's share price was up more than six percent for the day.

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