Why Best Buy Is Best-in-Class

CEO Richard Schulze says a shift toward more lucrative digital gear and appealing store design helped drive profit growth in a tough year

Since he founded Best Buy (BBY ) in 1966 at 25, Richard Schulze has built the company into the nation's largest consumer-electronics retailer. Sales last fiscal year totaled $19.6 billion, more than double that of its closest rival, Circuit City Stores (CC ).

In late February, the Eden Prairie (Minn.)-based retailer announced that Schulze, 61, would step down as CEO this June while remaining chairman. Schulze, who will be succeeded by Best Buy President Bradbury Anderson, is going out with a bang. Despite weak sales growth resulting from the slow economy, Schulze capped his final fiscal year as chief executive with a 44% increase in profits. Net income for the fourth quarter, ended Mar. 2, rose 84%, to $350 million, the company announced on Apr. 2.

In an interview with BusinessWeek Correspondent Robert Berner, Schulze explains how Best Buy last year positioned itself to benefit from the growing demand for digital products and why the company launched its own line of personal computers (see BW Online, 2/1/02, "Best Buy's Bid to Be a Player in PCs"). Here are edited excerpts from their conversation:

Q: Last year, sales at Best Buy's existing stores were soft, but profits surged. How did you drive profits?


What went on was two-fold. The most important driver was the digital-product cycle. For the first time, there was a clear benefit in technological performance over the preceding analog offerings. Whether it was digital television, digital video disk (DVD), digital imaging, or the heightened opportunities surrounding the cellular world, all of that created a tremendous amount of excitement among consumers at what was otherwise a very cautionary time.

What people probably didn't pick up on is that there was a shift in the overall mix of merchandise sold at Best Buy. The home-office category, which includes personal computers, was the largest percentage of our business the last five years -- about 36%. Last year, for the first time, it dropped to the No. 2 position -- around 32%.

Consumer electronics went from No. 2, at around 30%, to No. 1, at around 34%. The gross margin on all this new digital product and [other] consumer-electronics merchandise is much higher than the home-office category.

Q: It would seem that your biggest competitor, Circuit City, would have had that same benefit from the mix shift in merchandise. Yet your profit growth surpassed Circuit City. Why?


We were the dominant home-office player. If you look at the next player in line [Circuit City], they were never more than around 22% in home-office sales. Their consumer-electronics portion was always in the high 30s as a percentage. [Because they were always heavy in consumer electronics] they probably had less of a [boost] in their gross margin overall.

They had also dropped out of the major-appliance business the previous year, and they still have not been able to replace the magnitude of that business.

Q. Do your stores give you an advantage over Circuit City in terms of layout and format?


We have the entire 45,000 square feet of retail store open to the customer. Whereas a showroom-style retailer, such as Circuit City, has approximately two-thirds of their store as display, and one-third is storeroom. [At Best Buy,] the consumer sees a much larger store, and it's much more brightly lit.

All of our sales personnel are noncommissioned, so the shopping experience is less pressured. They are product specialists, and they are trained to bring the consumer what's right for them, not necessarily what's best for the salesperson.

Q: So many electronics chains have failed with private-label PCs. Why did you launch Matrix, your own store brand of personal computer?


The big driver there was the pending combination of Hewlett-Packard and Compaq. They are two of our largest suppliers that would be under singular control. HP and Compaq admit that PCs are the most difficult area for them to be profitable.

The vulnerability for Best Buy is that we sell between 3 million and 4 million PCs a year. We're the No. 1 seller to consumers through the retail channel. If HP and Compaq decided to exit the consumer portion of the business because it wasn't profitable enough, we could be left stranded. We needed an alternative that we could depend on. So what we have done is design the Matrix line around gaps in the HP or Compaq product lineup. This allows us to enter with a third brand and, we would hope, have peaceful coexistence.

Q: Do you see limits to the store growth of your Best Buy division?


We see an additional 260 stores we could put into the market, about 60 a year. So in about four years, we're pretty well full-stored.

Q: Is that part of the reasoning behind your acquisition of Musicland just over a year ago?


Musicland's mall-based stores focus on the Gen-Y consumer, the younger female who isn't as apt to go to a Best Buy. [Our Best Buy] customer is the young technophile male, traditionally 16 to 40 years old.

[At Musicland,] we have added more lower-priced and easy-to-carry audio and video products -- things the Gen-Y customer would be apt to buy at the same time they buy CDs or DVDs.

We will eventually broaden this strategy and introduce the entire gambit of digital electronics, digital audio, DVD, camcorders, and digital cameras. They would be fashion-oriented products that are color-coordinated, lightweight, and easy to use.

Q: Are you looking at stores that are smaller than your traditional, 45,000-square-foot Best Buy to go into smaller communities?


Yes -- 30,000 square feet is where we are right now. We are looking to see if 20,000 could be viable. One thing we are careful about is not changing the tenor of our stores. If you bring it down to a size where you really can't represent what you stand for, you're setting up customers for disappointment.

Edited by Patricia O'Connell

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