3 Reasons to Stay Clear of Best Buy

Shares of Best Buy (NYSE: BBY  ) rose nearly 5% yesterday after the consumer electronics retailer posted better-than-expected quarterly results.

Best Buy is pretty popular around Fooldom. Several of our newsletter services like it. Fellow Fool Alyce Lomax feels that "value-minded investors should give the electronics retailer props" after yesterday's report.

I have to respectfully disagree. Best Buy may not be the second coming -- and going -- of Circuit City, but the chain has nonetheless peaked.

Let's go over the reasons why I think yesterday's buyers are running into a burning building.

1. Relative improvement isn't absolute improvement
After posting back-to-back quarters of cascading revenue, comps, and earnings, investors were delighted to find that just profitability and same-store sales took a hit. Revenue managed a 1% uptick.

Exceeding hosed-down expectations does not a turnaround make. The trend here remains ugly. Net income fell 12%. Comps slipped by 1.7%. There is nothing to indicate that a turnaround is actually taking place.

2. Media's digital makeover leaves Best Buy out in the cold
Walk into your local Best Buy, and you'll find that CDs, DVDs, video games, and books make up a large chunk of the retailer's selling space. That makes sense. Folks may not always need a new washer or a high-def TV, but there's always a fresh slate of new music, books, movies, and games worth buying.

Alas, all four of these platforms are gradually moving toward digital distribution. There's no longer a need to drive to a store to make things happen. It's true that Amazon.com (Nasdaq: AMZN  ) has been eating Best Buy's lunch through the convenience of online orders, but ordering from home isn't the only reason for Best Buy's decline. Physical distribution is dying, caving in to the immediacy of digital distribution.

Best Buy has given digital distribution a half-hearted effort, and now it lags the more vibrant ecosystems that Amazon and Apple (Nasdaq: AAPL  ) have created.

You naturally have plenty of big-ticket items at your local Best Buy that will never be e-replaced, but the company can't save itself by simply becoming hhgregg (NYSE: HGG  ) , a 175-unit chain that devotes a large chunk of its 30,000-square-foot stores to appliances. The booming Best Buy that you remember is no longer there -- or possible.

3. Best Buy can't win
The chain hosted an analyst day two months ago, hoping to woo investors to its ambitious goals. But every strategy that Best Buy laid out for its investors carries a pile of attendant risks:

  • Best Buy is starting to think smaller, opening Best Buy Mobile stores selling the latest smartphone gadgetry within the next five years. It sounds great, but copying RadioShack (NYSE: RSH  ) doesn't sound like a recipe for success.
  • Best Buy plans to double its online sales to $4 billion in the next three to five years. How? It's not going to compete with Amazon and Buy.com unless it slashes prices, and if it does so in cyberspace, it can't cheat in-store buyers by not following suit in its stores. In other words, growing online sales will come at the expense of overall margins.
  • Best Buy wants to double sales in China over the next five years. It was smart enough to hook up with China's Five Star appliance chain several years ago, but selling stoves in China is a low-margin affair.
  • Finally, Best Buy wants to grow its video game and appliance sales. Well, GameStop (NYSE: GME  ) may be holding well, but anyone at E3 can tell you that digital delivery and social gaming are the future. Selling more appliances makes sense, but it's a strategy that didn't save Circuit City.

So where do I have this wrong? What scenario makes Best Buy more relevant in three years than it is today? Its last three quarters have been stinkers, and any growth in the quarters before that were related to Circuit City's liquidation.

I hope I'm wrong. Way too many Fools whom I admire and respect see Best Buy differently. However, in every possible scenario and configuration I play out, Best Buy continues to sink -- and stink.

Let's pretend you are Best Buy's new CEO. What would you do to get the chain back on track? Share your thoughts in the comment box below.

The Motley Fool owns shares of Best Buy, RadioShack, Apple, and GameStop. Motley Fool newsletter services have recommended buying shares of Apple, Best Buy, hhgregg, and Amazon.com. Motley Fool newsletter services have recommended creating a bull call spread position in Apple. Motley Fool newsletter services have recommended writing covered calls in GameStop. 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.

Longtime Fool contributor Rick Munarriz doesn't shop at Best Buy as much as he used to. He does not own shares in any of the companies mentioned in this story. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.


Read/Post Comments (15) | Recommend This Article (9)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 15, 2011, at 5:29 PM, havvey wrote:

    I am anything but an expert on BB but you sure sold me on your artical. Do we remember sears Years ago it was once the largest retailer.

  • Report this Comment On June 16, 2011, at 12:59 AM, lucasmonger wrote:

    I think the only way to turn around best buy is to change their sales tactics and steal a chapter from Apple's playbook. Knowledgeable people who are truly helpful and care about solving your dilemmas w uld be a start. I was shocked while browsing at a Best Buy where a salesman tried to convince a naive consumer that the expensive HDMI cable would let more data flow from the bluray to the HDTV like cars on a highway compared to a city street. I had to restrain myself from informing the customer that HDMI is digital, digital signals move at a set rate designed in the spec and doesn't deviate.

    Alas, the margins are thin, the media is going digital, and Best Buy may find themselves like photo development shops, bookstores, and video rental places.... An Circuit City, CompUSA, Or Montgomery Wards Electric Avenue.

  • Report this Comment On June 16, 2011, at 1:40 AM, EditorAdamSmith1 wrote:

    I bought some stuffs from BBY with $200. When I found they only costed $100 at Amazon.com, I returned them to BBY.

  • Report this Comment On June 16, 2011, at 5:48 AM, Risky88 wrote:

    i agree their customer service is terrible

    maybe they should pay their employees more and do more training than just sitting them on a computer for 6 hours straight and expect them to go out and sell the store, either that or actually give employees an incentive to sell a more expensive item.

    To me the bigger the company the more stuff they throw away, don't use or ignore and focus on one thing only unlike a small business that pays attention to every little detail.

    Bigger they are the harder they fall

    survival of the fittest

    fool on brothas!

  • Report this Comment On June 16, 2011, at 1:26 PM, Brent2223 wrote:

    The push to cloud computing will start eating into PC sales, tablets will start eating into the need for printers, wifi is replacing physical cables, etc. Content has started going digital so it's only a matter of time before the hardware we use to consume this media will undergo a fundamental makeover as well. I really don't see a place for big box computer/entertainment hardware stores like Bestbuy in this new environment, especially since their customer service adds zero value.

  • Report this Comment On June 16, 2011, at 8:16 PM, Varchild2008 wrote:

    I don't see a 100% digital future for Video Gaming. I never will.

    Not when Time Warner Cable is threatening USAGE fees for the Internet. They are the 2nd largest Cable company in America.

    Usage fees litteraly mean charging by the minute!

    Remember the 250 GB Cap? That goes away and you begin being charged by the minute.

    Pretty sure Digital Downloading 7GB video games ceases to exist if/when the usage fee for the time it takes you to complete the download skyrockets your cable bill.

    For the article on this see Yahoo Finance, NFLX chart....There's an article posted there from Bloomberg.

  • Report this Comment On June 18, 2011, at 4:33 PM, pjstallworth wrote:

    I always liked going to BB, it was clean, and the people were helpful. That was ten years ago. Now, If you are over 40, forget it. those kids won't even acknowledge you walked in the store. Even if you ask for help. I think if employees were more considerate and helpful, people would come back. There are lots of people who don't want or use smart phones, but still need to communicate. Let's bring back the service in Customer Service. And let's give employees incentive to sell. You know, like a tip.

  • Report this Comment On June 18, 2011, at 11:28 PM, mikeyc2010 wrote:

    Best Buy is a dinosaur. Like Circuit City, it will soon die off and become extinct. And ya know, rightly so. The last time I went in to a BB store, the staff were least helpful as could be, the store was messy, dirty, old displays, loud, confusing as hell to try and find your way around. And the products advertised that I wanted were out of stock or priced higher than the online prices given on the website.

    The fact that there is nothing I have needed so badly that I actually get in the car and drive to this store, tells you/me all you need to know about how much longer it is going to pass to the other side.

  • Report this Comment On June 20, 2011, at 1:56 PM, angyezzi78 wrote:

    Wow I am shocked at the negative comments. I can say for my family that we refuse to shop anywhere else due to the great customer service and the awesome warranty that you have the option to purchase. We purchase all of our appliances from there as well as all of our tv's in our home. Though they may be a little higher in price on some items we see it as worth while. Anytime we have had any issues with products they either replace it or repair it. My family does extensive research before we buy and we go into the store knowing about the products and nearly every Best Buy sales person has been very knowledgeable of the products and go beyond the call of duty to help us out.

  • Report this Comment On June 23, 2011, at 4:04 PM, NoRst4TheWickd wrote:

    I have to say, that I agree with everything on here. My family and I went in to Best Buy last weekend and I was really bothered by how the employees acted. (This was the store in NashvilleWest in Nashville.) Just in case. :) My husband is a Veteran and they laughed when we asked if we could get a Veteran's discount and we were ready to fork over 15 grand on kitchen appliances. What was even worse is the fact that all of the employees seemed determined not to be noticed. One guy kept holding his headset like he was navigating a firing squad to our location. And really. . . I ordered our washer/dryer/fridge online.. .at you guessed it. . . under 15. This is M in Nashville, signing off, -GET IT TOGETHER BEST BUY, YOU ARE LOSING.:)

  • Report this Comment On June 23, 2011, at 5:57 PM, JTibo wrote:

    I respect the advice on here about bestbuy improving its customer service in order to stay viable, but I have to respectfully dissent for a few reasons. Bestbuy's customer service is generally terrible, but here's why improving it won't help.

    To improve its customer service, Bestbuy needs to better incentivize its employees. If you pay somebody minimum wage, you can expect a minimum amount of effort from him or her. However, Bestbuy can't afford to further incentivize its employees. This is primarily due to drastically reduced margins on "big ticket" items, primarily televisions.

    Profit margins on television sets, before LCD's, plasmas, and internet ordering, used to be 30% or better (I'm talking pre 2000's). Those margins simply don't exist anymore on anything but the biggest or most technologically advanced sets. I'm sure that margins on Bestbuy's "Magnolia" stuff is much better, but "Magnolia" only caters to a small niche. Thus, the only way to get back some of that lost profit and pay associates more is to either A: sell you an extended warranty which carries roughly a 75% profit margin, or B: sell you accessories that you either don't really need (monster power "line conditioners") or can be had for much cheaper online (hello $5 HDMI cables available on Amazon.com). What we want are more knowledgeable friendly sales associates at Bestbuy, but the only way to fund knowledgeable friendly sales associates is through aggressive salesmanship, which we don't want.

    Computers have always had abysmal profit margins, so they aren't any help. All the profit from a computer sale came with the sale of "add-on's" like printers, printer ink, usb cables, and again, extended warranties.

    How do I know that Bestbuy can't afford to pay its employees more? Circuit city provides all the evidence we need of this. CC back in the 90's paid it's employees on a commission basis when a retail store could afford to do so. It was hard to educate oneself, and you couldn't get products cheaper elsewhere. Televisions carried much higher profit margins. In the early 2000's, CC changed its pay scale, took employees off commission, but still paid MUCH better than average for a big box retail store. "Home Theater" associates at a Circuit City in VT started at $9.50 back in 2003 and that particular store had sales associates from before commissions were taken away who were being paid $12, $13, $14 dollars per hour. But of course, in the age of shrinking margins, those wages could know longer be stomached, and all of those knowledgeable, helpful, well paid associates were fired and replaced with people making minimum wage for minimum effort. The rest is history.

    In an age of ever increasing consumer savvy and ever shrinking margins, Best Buy is simply dying a slower death than Circuit City did before it. The ONLY things keeping it afloat are mobile phones and appliances.

  • Report this Comment On June 24, 2011, at 4:06 PM, PAULinMN wrote:

    Reason number 4 to avoid BBY.

    Very weak senior leadership, lack of real vision. Poor execution of corporate culture development.

  • Report this Comment On June 24, 2011, at 4:19 PM, WikiCPA wrote:

    Best Buy doomed itself when they started discriminating customers. Years ago they labeled customers as 'angels' and 'demons', those demons being the ones who return items and buy 'loss leader' items. Supposedly this made their business better temporarily, but this outdated tactic left this outdated business in the dust. There is no way they can innovate themselves or catch up, they've got no leverage. Capital spents on opening new stores should have been spent on innovation...I feel sorry for the employees of Best Buy

  • Report this Comment On June 25, 2011, at 7:32 PM, soylentcorp wrote:

    Best Buy just needs to close A LOT of stores, find cheaper rent, continue with indoor mall stores, and they'll be fine. In a way, we are actually going 'back to normal' when you had to go to a 5&10 general store or some local hole-in-the-wall down the road. I go to those types of stores way more often than BBY today. Cheesy RADIO SHACK may have the last laugh now after decades of dork-dom, and stories of my dad going to Radio Shack to actually fix a device and staff letting him borrow tools any day of the week. That was service! Today, RSH revenue is up-up-up!

  • Report this Comment On June 26, 2011, at 8:34 PM, shanghaiman8915 wrote:

    I live in Shanghai,China and Best Buy has closed all its stores in Shanghai. The competition is great in China and the Chinese consumer especially the under 30 generation is a very savvy and informed consumer especially in small electronics. Best Buy had no idea about the Chinese consumers buying habits. They tried to open an American Model Store and failed badly. Their stores were exactly like stores back home. They don't understand the consumers mentality in China. Added value what am I getting extra. Their competition in China is against 3-giants. Sunning, Yolo and Gome 3 Company's that own the real estate but lease out floor space to all the brands. And they were expensive compared to the Big 3. Go into any of the 3 companies stores and buy anything and you get something for free."Added Value" example I purchased an HTC Mobil phone and they gave me a new rice cooker and a set of glasses. Plus they did absolutely no Promotional selling which is tremendous in China I mean they put on shows to bring people in and the pricing is excellent. I may be wrong but Best Buy can never make it in China their not the APPLE Store. They are a Vanilla Electronic Retailer from America. SO what.

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