Investors, analysts, and the media were treated to the Beatles' new Love CD while waiting on hold for Best Buy's (NYSE:BBY) third-quarter conference call to begin. Was the announcement of the CD by the Investor Relations department a last-minute sales pitch to try and squeeze out a few extra bucks by Christmas? It's extremely doubtful -- the electronics giant isn't that desperate for sales. But the music did set the tone for the conference call: that Best Buy executives are still feeling pretty groovy about the company's position, despite the intensely competitive landscape.
My Foolish colleague Alyce Lomax, when recapping Best Buy's latest results, highlighted the price war that is underway in the HDTV segment. As she mentioned, Costco (NASDAQ:COST), Target (NYSE:TGT), and Circuit City (NYSE:CC) are vying for position among consumers by trying to offer attractive deals on hot-ticket electronic items. But by far the most feared player in this pricing game has to be Wal-Mart (NYSE:WMT).
Yesterday, I happened to catch a new commercial from Wal-Mart, which was selling consumers the idea that if they are looking for the best deal on a new HDTV this holiday season, Wal-Mart is the place to get it. The basis for this, as the commercial went on to describe, is that Wal-Mart doesn't tie HDTV sales together with other items like accessories or services, so the set is a no-frills purchase.
A weakness of Wal-Mart's strategy, however, and probably one reason Best Buy remains confident despite the move by the ginormous retailer, is that -- as we identified in an analysis of a recent conference call for Costco -- HDTVs are complex gadgets, and consumers are actually willing to spend a few extra bucks for a little help in the installation process.
Alyce pointed out that in the conference call, Best Buy's management indicated that the company actually managed to increase market share in the HDTV segment despite the competition. In this edition of Fool on Call, utilizing Best Buy's third-quarter earnings conference call, we will dig deeper to identify the long-term benefits of such an approach, as well as exploring what strategy made this possible. The discussion will center on these two points:
- Price cuts lead to market share increases.
- Market share increases lead to additional opportunities.
Two can play the price-cut game
From the outset of the call, CEO Brad Anderson made it very clear that promotional activity played a huge role in helping the company to not only maintain its position in HDTVs, but actually increase its presence. We can take "promotional activity" to mean "price cuts," as he further enumerated, "We chose to match or beat competitors' prices on the 'stake-in-the-ground' categories like name-brand flat-panel TVs." He added, "Honestly, if we could do it all over again, we'd make exactly the same decision."
The primary disadvantage of price cuts is that they erode profit margins. If we take a look at the numbers, it's obvious that Best Buy's profits were squeezed during the quarter, with gross margins falling almost a full percentage point to 23.5%. This resulted in less net income than expected. So why does Anderson remain so upbeat, sticking to his guns that this was the right strategy?
While price cuts erode margins, the advantage of such a strategy is its usefulness in maintaining or gaining market share. And getting the customer in the door during massive promotional events like 'Green Friday' -- as Best Buy calls the day after Thanksgiving -- is a significant step toward cashing in on other sales and services.
Offering the experience
What can a Best Buy or a Circuit City offer customers that a Wal-Mart or a Costco would have difficulty matching? In a word, service. COO Brian Dunn used the word "experience" to describe the company's service-oriented approach. For instance, the "experience" extends beyond simply buying an HDTV or a hot new gaming system from Microsoft (NASDAQ:MSFT), and looks at how that HDTV or gaming console fits within a more encompassing home theater system that has been custom-tailored to fit a customer's living room.
It is at this point in the pricing game that Best Buy might actually have an advantage over Wal-Mart. Whereas Wal-Mart or Costco is left with selling slim-margin HDTVs, Best Buy is able to capitalize by providing additional services and accessories to the customer -- services and accessories that, by the way, have better profit margins.
Mike Vitelli, Best Buy's chief merchandising officer, indicated during the question-and-answer portion of the call that the current penetration of HDTVs in the market is roughly 20% to 25%, but is estimated to grow upward toward 75% when all is said and done. As this important segment of the electronics market continues to rapidly expand, look for Best Buy's services to grow right along with it.
A quarter ago, when we looked at Best Buy's previous conference call, we learned that the company was rapidly building out its services business. During the Q&A of the latest conference call, we found that Best Buy is still very much in the development stages on this important initiative. Anderson admitted, "We are still early in the services business." Even so, the company is witnessing nice growth in this segment. One example provided that highlighted the growth was Green Friday, when Best Buy witnessed triple-digit growth in in-home theater installations.
Best Buy is well-positioned
If we focus our attention on the short term, it is hard not to notice the significant margin erosion that Best Buy is currently experiencing. But if we look at the bigger picture and see what management is trying to accomplish, it becomes clear that the steps it took in the third quarter to slash prices and bring more customers through the door can have a significant payoff down the road.
With its service-centered approach, over the long term I believe Best Buy is in a solid position to expand its opportunities among consumers. These opportunities include capitalizing on slim-margin products like HDTVs by linking these purchases together with more profitable accessories and services.
Such a customer-centric strategy makes Best Buy an attractive option for those with a long-term investment horizon.
More news on Best Buy:
- Best Buy Says: Bring It!
- Best Buy's Blue Today: Fool by Numbers
- Fool on Call: Gushing With Gadgetry and Growth
Best Buy and Costco are Motley Fool Stock Advisor recommendations. Wal-Mart and Microsoft are Motley Fool Inside Value picks. You can check out either service free for 30 days.
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Fool contributor Jeremy MacNealy does not have any financial interest in any company mentioned. The Motley Fool has a disclosure policy.
