Why Best Buy Will Never Be Great Again

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Oct. 19, 2011 - U.S. - At the Best Buy store in Eagan, Brian and Rebecca Eichenberger were shopping for a new laptop when they s
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These are good times to be a Best Buy (BBY) shareholder.

Shares of the consumer electronics superstore chain have nearly tripled this year, hitting fresh two-year highs earlier this week after posting better than expected quarterly results last week.

It was a surprisingly resilient report, but there's no reason to believe that Best Buy is worth three times what it was when the year began. Things aren't going that great, and the turnaround that the market's baking into the future may not happen at all.

Blue and Khaki to the Rescue

Best Buy was in a bad place early last year. Its CEO was dismissed for having an inappropriate relationship with a subordinate. Its founder was taken to task for not divulging the information soon enough. Sales were sliding as savvy customers found lower prices online.

The Best Buy board's choice for a new CEO -- Hubert Joly, a Frenchman who previous headed travel and hospitality giant Carlson -- seemed like an odd one at first. There was even a bonus that Joly would have collected if he hadn't been able to secure the necessary visa to begin running the stateside retailer.

He arrived, and the market eventually bought into his strategy to cut overhead, reduce prices, and combat the showrooming trend by improving the brand's perception.

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He's been making some welcome headway on many of those fronts, but the one thing that hasn't happened is the most important thing: Shoppers aren't back.

The market loved the unexpected increase in profitability in its latest quarter, but at the end of the day, sales actually declined. Comparable store sales slipped 0.4 percent domestically, and things are even uglier overseas.

The Best Buy brand is showing signs of life, but it's no comeback kid. We're already at the point where it can't go back to where it once used to be.

Electric Blue

Circuit City moved to liquidate its stores in 2009. At the time, many believed that Best Buy would be a major beneficiary. With its biggest rival out of the way, Best Buy would be the undisputed champ of consumer electronics.

It may have felt that way at first, but Best Buy wasn't immune to the same trends that were eating away at Circuit City. The booming popularity of Amazon.com (AMZN) was driving tech savvy customers to kick the tires of products and physical stores before ordering them online for less. But a bigger problem is what people are buying.

The major gadget rollouts in recent years have been of products that replace physical media with digital files. Best Buy may be selling a ton of e-readers, smartphones, and tablets, but that ultimately translates into fewer sales of DVDs, CDs, and video games: categories that Best Buy used to draw in repeat purchases. You may only need a new dishwasher once a decade, but new media comes out every week. Best Buy used to sell people their hardware and their media, but now it's mostly selling them hardware.

The recession at the time of Circuit City's implosion also didn't help, but it's telling that Best Buy's sales have been weak -- even when it doesn't have to compete with Circuit City for customers and the economy continues to take baby steps in the right direction.

Have a Holly, Joly Holiday

Investors who have been bidding up shares of Best Buy will argue that they're not betting on the chain's past. An investment is a wager on the company's future. And the next three months should be big ones for the consumer electronics market.

Apple (AAPL) should announce the new iPhone next month. Microsoft (MSFT) will hope to turn PC sales around in October with its anxiously anticipated Windows 8.1 update. In November, we will see gamers lining up for the PS4 and Xbox One.

Despite all of the buzz, analysts still see Best Buy posting lower sales this critical holiday shopping season. New gadgets may be nice, but we're in a changing marketplace where the manufacturers can reach out directly to the owners. The PS4 and Xbox One come with meaty hard drives and cloud-based gaming platforms because developers want to market directly to gamers. Folks streaming videos and music on their new Windows laptops or the upcoming iPhone 5S don't need to go back to Best Buy.

Investors are back. Shoppers are not. That's a problem.

Motley Fool contributor Rick Munarriz has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and Apple. The Motley Fool owns shares of Amazon.com, Apple, and Microsoft. Try any of our newsletter services free for 30 days.

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Why Best Buy Will Never Be Great Again

Showrooming -- the troublesome practice for local store owners that finds potential buyers kicking the tires of products before buying them cheaper online -- isn't going away.

Amazon.com (AMZN) reported a 34% spike in net sales during its first quarter on Thursday. Best Buy doesn't operate on the same fiscal calendar as the leading online retailer, but analysts feel that the company's top line will inch less than 3% higher when it reports next month.

It's not Best Buy's fault. A company with the overhead of manning physical stores can't afford to sell at the prices that nimbler Web-based retailers can offer. The wide availability of the Internet as a research tool also makes the hands-on perspective that local retailers provide less necessary, and in some cases even less desirable.

Some real-world chains are fighting back through exclusivity. Cheap-chic discount department store operator Target (TGT) has been a strong player in stocking up on items that are only available through Target.

Best Buy doesn't have that luxury.

Best Buy confirmed on Thursday that it's killing Best Buy Connect, the retailer's private-label mobile broadband service. It never took off, and the service reportedly had just 11,000 customers. Yes, the company has private labels for home theater and other consumer electronics, but it's not as if the merchandise is considered unique. This isn't Sears (SHLD) with brand equity for its Craftsman tools and Kenmore appliances.

Walk into a Best Buy and check out the racks of CDs, video games, books, and movies. All four of those media platforms are losing physical appeal as those industries go digital.

In Thursday night's quarterly report, Amazon revealed that nine of the 10 best-sellers were digital products. Best Buy may think it's scoring a sale when it sells a tablet or a smartphone, but it's really simply handing over the tools that will result in that shopper relying less on in-store purchases.

Another nugget in Amazon's report is that 130,000 of the books in its virtual marketplace are exclusive to the Kindle Store. Yes, a lot of that is vanity press stuff from authors who couldn't land real publishing deals, but 16 of Amazon's 100 best-selling e-books were exclusive to its store.

Apple (AAPL), on the other hand, is the poster child of the modern ecosystem. The success of iTunes has turned Apple into the country's largest music retailer. There are now hundreds of thousands of apps in the company's iconic App Store.

Best Buy has tried its hand at digital distribution of music and movies -- even to the point of buying Napster and CinemaNow -- but that hasn't panned out. Brick-and-mortar chains just don't have the high-tech appeal to launch cool digital ecosystems.

The worst part about movies, music, books, and games going digital isn't just the empty space that Best Buy will have to fill. The company has enough sharp retail vets to put the space to work with store remodeling plans that are currently in the works.

The worst part of the migration is that these are the items that forced shoppers to come back to Best Buy. You may only need a new washer once every 10 years, but there are always new DVDs hitting the market every Tuesday. New video games, CDs, and books are also always coming out. As more people replace physical media with digital -- and you do realize that Apple and Amazon are selling millions of tablets every passing quarter -- Best Buy will be a less frequent stop for even its most loyal customers.

Best Buy conceded in its most recent report that it will have to get serious about lowering prices in the future. Its aggressive expense-shaving efforts will be partly passed on to shoppers in the form of better pricing.

"We intend to invest some of these cost savings into offering new and improved customer experiences and competitive prices," Best Buy explained last month.

The problem is that it will probably never be able to cut its overhead to the point where it's truly competitive with Amazon and even cheaper e-tailers. This will force Best Buy into sacrificing margins on products, but hoping to make a profit by selling extended warranties, obsolescence insurance, and Geek Squad services. It's a plan that sounds fine on paper, but consumers are already tiring of the hard sell during the checkout process for services that they may never need. If Best Buy sees this as its future, it's underestimating what shoppers do when they're annoyed.

They stop coming back!

hhgregg (HGG) and Conn's (CONN) are some of the rare survivors in this field, and it's because they key in on heavy appliances, furniture, bedding, and even lawn care equipment that's harder to secure cheaper online, given the bulk of the items.

Best Buy naturally sells appliances, but that's just 5% of its business. If Best Buy wants to emphasize big-ticket items that are purchased very infrequently -- thereby taking on the smaller hhgregg and Conn's -- it would probably have to close all but a store or two in each of its major markets. There just isn't enough business for these products to justify Best Buy's existing store base and square footage.

In short, it's not going to happen.

Best Buy may be in the process of closing nearly 50 stores over the next few weeks, but there will be more of that in the future unless trends reverse and positive catalysts emerge.

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