Best Buy Adds New Services

Richfield, Minn.-based Best Buy is reinventing itself at the top of its game. Its 750 North American locations, including Canada, give the company a 16 percent share of the $130 billion-a-year market for electronics and packaged media, the number one spot. It's rolling toward its best results in five years, with earnings per share projected by analysts at $2.37, up 24 percent, on sales of $23.5 billion for the fiscal year ending March 1, 2004. Same-store sales rose 8.6 percent in the third quarter. The retailer has $1.8 billion cash and is buying back up to $400 million in stock; last year it started paying a 40-cent annual dividend. Despite a recent drop, shares have better than doubled in the last year.

So why mess with success? Anderson sees trouble ahead. Long-term, the store base is maturing. Best Buy still plans to open 60 to 70 new stores a year. But a lot of future growth will come from 20,000-square-foot stores (less than half the standard size) in smaller markets. Keeping annual returns on invested capital at 20 percent could be as tough as selling a used Betamax.

More worrisome are the short-term problems. The flood of imports and shorter product cycles exert severe price pressure on some of the most profitable products — digital TVs, cameras and home entertainment systems. A 60-inch Samsung DLP television that sold for $5,000 three months ago now sells for $4,700. No one believes that digital TVs can escape the price-plunging fate of PCs and anything else with transistors inside. Anderson counters that the lower the price of an LCD TV or a camcorder, the more of them he can sell.

But then there is Wal-Mart. Its share of the electronics market has galloped from 6.9 percent in 1996 to a current 11 percent, reports Credit Suisse First Boston. "If we do nothing, Wal-Mart will surpass us by the simple fact they are adding more stores than we are each year," says Anderson. With operating margins on electronics averaging 5 percent or so, there is no way Best Buy can win "trying to chase the customer out of Wal-Mart."

If it can't compete on merchandise alone, Anderson believes Best Buy can still get a leg up on Wal-Mart. One way is by bundling those goods with add-on services, from reselling Rhapsody, which charges $10 a month for Internet music plus 79 cents a song to burn CDs, to offering complete wiring packages to new-home owners. Another is to tap into private-label goods — not junk at low price points but gizmos that compete directly with major brands. In September Best Buy opened an office in Shanghai with the intent of sourcing goods directly. (Details remain scarce.) If it can increase its share of such merchandise from essentially zilch today to 15 percent of the mix by 2008, estimates Colin McGranahan with Sanford Bernstein, it could add a percentage point to its operating margin.

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