When we examined Circuit City's
Investors like you were probably not surprised. The Motley Fool CAPS community gave Best Buy a three-star rating, compared with Circuit City's single star. But it may be surprising just how much Circuit City seemed to wither once the competition really heated up.
Best Buy isn't immune to the competition, as we saw in an analysis of its latest conference call. But it does seem better prepared than Circuit City to weather the challenge that Wal-Mart
The blow to Circuit City was so intense that it led my Foolish colleague Ryan Fuhrmann to conclude, "In a face-off with Best Buy, I can't think of how Circuit City could win." It's a rather grim assessment of the retailer's prospects, to be sure.
Is it time to throw in the towel? The best way to make such a determination is by gathering as much relevant information as possible. In this edition of Fool on Call, we will dive into Circuit City's latest third-quarter earnings conference call, to get a better sense of what went wrong and how management plans to fix it. The discussion will center on these topics:
- The market-share battle.
- Urgency for expense-saving measures.
Instead of placing the blame elsewhere, CEO Phil Schoonover and the executive team were willing to take responsibility for some of the failures in the quarter. Schoonover admitted, "During the quarter, we were responsible for some of the slippage in our execution." One of those missed opportunities was the company's promotional activity, particularly related to pricing.
Schoonover indicated that the most significant factor affecting the company's third quarter was the acceleration in flat-panel TV price drops among its three major vendors. The company was caught off guard, since price declines for medium and large LCDs were 50% greater than it had anticipated. For plasma TVs, the rate of decline was three times greater than expected.
The price declines actually provided greater-than-expected sales in the HDTV segment. However, the top-line gains were more than offset by the intense pressure on Circuit City's profit margins. Exacerbating the effect was Circuit City's 30-day price-matching policy; many of its customers were returning to the store to get the match after finding other local retailers with better deals.
Sales of things such as accessories are one way that an electronics retailer can counter the impact of falling HDTV prices, since these items carry higher profit margins. Unfortunately, the price declines on flat panels were too great for accessories to make up the difference. Circuit City expects these trends to continue through the fourth quarter.
One of the biggest differences between Best Buy and Circuit City -- one that became more apparent than ever -- was the greater cost-efficiency of Best Buy's operation. Such efficiencies give Best Buy much greater flexibility when intense price wars are unleashed. Not only is Best Buy able and willing to participate in the price-cutting game to gain market share, but it can also do so while remaining profitable.
Getting up to speed
Circuit City is sticking with its long-term profit goal of earnings before taxes (EBIT) as a percentage of net sales of 5%. With this most recent setback, however, the company is going to have to "accelerate" the implementation of various initiatives to reduce its cost structure.
The supply chain is one of the primary ways a retailer can reduce costs. Circuit City is satisfied with the progress it is making in this area. Thanks to better alignment of the receipt of merchandise with the timing of sales, Schoonover noted that inventory was down $363 million year over year.
Direct sales are another way to reduce costs, and Circuit City seems to be making solid headway here. Web-originated sales increased 67% for the quarter, while call-center sales increased 87%. A new circuitcity.com website was unveiled on Nov. 7, which should further accelerate its efforts.
These multichannel sales opportunities appear to be one of the primary ways the electronics retailer can throw jabs at the competition. According to recent data, Circuit City increased its market share by 77% in direct sales, tying it for third with Amazon.com
It plans to further capitalize on its direct channel presence by offering its firedog services (which include home theater and networking installations) to Web customers. The presence of this option on its website should lead to some stabilization of its margins, since firedog services are much more profitable than slim-margined products. The company is seeing nice gains with the firedog brand; revenues rose 72% in the quarter.
Time for urgency
It's not game over for Circuit City, but it's clear that the electronics retailer needs to accelerate its cost-cutting measures in the face of substantial challenges. Of these efforts, gaining market share in direct sales might present it the greatest opportunity. Can the company continue to improve profitability by capitalizing on online sales? Foolish investors should keep their antennae tuned to this question going forward.
For related Foolishness:
- Circuit City Goes Haywire
- Short Circuit: Fool By Numbers
- Fool on Call: Best Buy's Advantage
- Fool on Call: Flexing Its Circuitry
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