Ron Johnson has a warning for Best Buy's (NYSE:BBY) management: Your current course could be a recipe for disaster.
In a recent appearance on Andreessen Horowitz's podcast, the retail legend criticized Best Buy's strategy: Although the electronics retailer is enjoying improving profitability, its sales are in decline. While Johnson acknowledged this may be great in the short-run, he warned that it could be devastating over the long haul.
From an analyst or outside observer, the criticism may be easy to brush off. But despite his recent struggle as CEO of J.C. Penney, Johnson was the driving force behind the creation of the Apple (NASDAQ:AAPL) store -- arguably, the most successful electronics retail operation in history -- so his word certainly carries weight.
Profits up, sales down
Best Buy shares rallied more than 5% last month after the retailer reported a quarter that exceeded analysts' expectations: Best Buy's earnings per share came in at $0.44 -- higher than the $0.31 estimate. Best Buy's sales, however, declined, down more than 2% over the prior year. According to Johnson, this is cause for concern.
A lot of the people in the bricks and mortar world have developed very bad habits. ... [T]hey've been competing, really, in an old business model and trying to survive ... very few are thriving. ... Best Buy ... reported sales down 2%. Stock went up because they earned more money. Well, if they earned more money, it's because either the vendors gave them more margin, or they reduced payroll for their employees. Both of these are good in the short-run for investors; long-term, they aren't ... good for shareholders, or stakeholders, or employees.
Since taking over Best Buy nearly two years ago, CEO Hubert Joly has focused on aggressive cost-cuts. Best Buy's "Renew Blue" campaign has centered around boosting efficiency, and has resulted in the loss of several thousand midlevel managers.
Clearly, this is strategy is working in the sense that Best Buy's profitability is increasing. But Johnson has a point: There's only so much Best Buy can cut, and at some point, it has to offer consumers a reason to shop at its stores.
Best Buy borrows Johnson's strategy
Interestingly, Best Buy has taken some inspiration from Johnson in recent months -- its shop-within-a-shop concept has seen Best Buy erect mini stores dedicated to particular brands, including Apple, Samsung, and Windows.
The strategy didn't work well for Johnson at J.C. Penney -- he was removed after less than two years on the job -- and it doesn't seem to be working particularly well at Best Buy, either.
Samsung was the first vendor to sign a deal with Best Buy, largely as a way to compete with the Apple stores Johnson had built. Best Buy stores equipped with "Samsung Experience Shops" allow customers to test Samsung's mobile products and receive support from Samsung employees. Microsoft soon followed, building Windows-branded stores in many Best Buy locations as a way to rapidly augment its own fledgling retail operation. Other shops include Magnolia home theater design centers and TV shops dedicated to 4K displays.
Does Best Buy have a future?
But ultimately, these initiatives mean little without corresponding sales growth. On its earnings call, Best Buy's management was relatively coy, admitting that it faced significant headwinds in the electronics retail space.
"We have a backdrop of a consumer environment that's a bit fragile," Joly admitted. "TV, while we're excited by ... new technology ... I think we have to appreciate the fact that the actual impact this year will be ... relatively limited ... as it relates to mobile, the uncertainty around the quantities you get. ... [F]rankly, we have ... a limited visibility at this point in time."
I cheered Best Buy on last year as the stock ran up ahead of a disappointing holiday season. Best Buy's shop-within-a-shop concept appeared to be the perfect way to transplant Johnson's Apple strategy to Best Buy, leveraging its relationship with a multitude of different vendors to approach something on the level of Apple's leading retail operation.
But as Johnson himself points out, that hasn't been the case. Investors may cheer Best Buy's cost-cutting initiatives in the near term, but until the company can demonstrate its enduring value to consumers -- reflected in sales growth -- investors could be setting themselves up for disappointment.
Sam Mattera has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and Microsoft. 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.