Why Tech Bows to Best Buy

For the past four years, employees at Best Buy (BBY) have taken regular tours of what the company called its "retail hospital." A group of about a dozen would don white lab coats, walk a row of real hospital beds, and scan charts describing the maladies afflicting each of the giant retailer's major competitors. But this fall, Best Buy staffers made their last trip to the darkened room on the company's Richfield (Minn.) campus. The retail hospital is closing because all of Best Buy's major rivals have succumbed to terminal illness. "It's kind of like ultimate fighting," says Barry Judge, the company's chief marketing officer. "One retailer goes down, and then who's next?"

At least for now, Best Buy stands as uncontested champ. It's the last major consumer electronics retailer in the country this holiday season, after the liquidation of Circuit City earlier this year. But Brian J. Dunn, who became Best Buy's chief executive officer in June, isn't taking success for granted, especially with rising competition from nontraditional rivals such as Wal-Mart Stores (WMT) and Amazon.com (AMZN). So Dunn has ambitious plans to take advantage of Best Buy's newfound clout: He wants to go beyond the typical big-box retailer role of selling commodity products such as televisions and personal computers and become a central player in determining which products come to market and how big-spending customers choose the latest gear.

The plan is already under way. Rather than waiting for electronics makers to ship Best Buy the same products that its rivals get, Dunn's lieutenants are walking factory floors with executives from companies such as Hewlett-Packard (HPQ) and Toshiba, influencing product development and design. The retailer is pushing suppliers to use standardized software and digital services so consumers can listen to music or watch movies on any device. And Best Buy has set up its own venture capital fund to pour millions of dollars into startups from Silicon Valley to Asia. The goal is to shape development of new technologies in promising fields such as green vehicles, digital health, and home monitoring. "We are talking to players deep into engineering the future," says Dunn. "It leads us nicely to a space where we can make a real difference to consumers."

"AVANTE GARDE"Shoppers wandering Best Buy aisles this holiday season will see the difference. Along with the latest flat-screen TVs, digital camcorders, and computer games, the company's shelves are stocked with exclusive items. Among them: the thinnest laptop on the market, a motorcycle that runs solely on electricity, and a watch-like gadget you attach to your wrist to monitor daily activity and sleep patterns. "We want to become a digital playground where people come in, experience it, try it, and find out how all these things can work together around their life," says Dunn.

The strategy, for all its ambition, could backfire. As Best Buy broadens its focus, it risks clashing with crucial partners. The company is already selling certain products in competition with suppliers, and will likely push other products off store shelves to make room for gear it's developing. Best Buy's new role makes it a kingmaker for companies that play along and a serious threat for those that refuse. "Best Buy is avant-garde in its thinking," says Eugene Fram, a retail expert and professor emeritus at the Rochester Institute of Technology's College of Business. "The big question is whether they can succeed without alienating their partners."

Executives at several major consumer electronics companies worry privately about Best Buy's growing influence. They're concerned that Dunn and his team could block them from getting innovative products in front of customers or favor Best Buy-backed goods over their own. "We used to call them the 800-pound gorilla," says the executive of one company that sells televisions and other products to Best Buy. "Now with a lot of competition gone, they're the 1,000-pound gorilla."

One example of the rising sensitivity is Best Buy's recent move into digital services, including music and movies. The company acquired the online music service Napster a year ago and then took a stake in CinemaNow, Sonic Solution's (SNIC) movie-streaming service, in November. Now the retailer is giving prominent play to Dell (DELL) computers loaded with Napster, beginning with a free year of the music service, and plans similar promotions with CinemaNow through participating partners. Hardware makers, which usually get paid bounties to load such software on their PCs, may find it tougher to get payments from rival services such as Netflix (NFLX) or Rhapsody if they want a piece of the $300 billion digital services market.

Apple (AAPL), Sony (SNE), and other manufacturers could retaliate if they feel Best Buy is getting too heavy-handed, although they would think long and hard before doing so. They could pull products out of the retailer's stores or forge closer relationships with rivals such as Wal-Mart. Michael Fasulo, Sony Electronics' chief marketing officer, says that so far his company and Best Buy have avoided serious rifts in part because their executives talk every week and the discussions tend to be more cooperative than adversarial. "They are so focused on the customer experience, and they give us great insights into how to translate technology for customer needs," he says. "We are both pretty aligned with that."

Dunn is clear about why he's pushing for change. He wants to give Best Buy a strategic edge over other retailers. Slugging it out on price with Wal-Mart, Amazon, and Costco is a brutal business, especially as strapped consumers grow hesitant to buy new televisions and home theater gear. If he can make Best Buy the go-to store to test out the latest gear or get exclusive goodies, he can insulate the company from some of the competition.

SAFE BETInvestors appear optimistic. The company's stock is up more than 80% over the past year, to 44, compared with a 20% increase for the Standard & Poor's 500-stock index. Analysts expect revenues for fiscal year 2010, ending in February, to rise 7.8%, to $48.5 billion, even as profit margins hold steady, according to consensus estimates from Bloomberg. Analyst Thomas Kurey of Gardner Lewis Asset Management, which held about 2 million shares in Best Buy at the end of September, says the company has a very secure position in the tech industry. "The thing about Best Buy is you're not betting on a single technology. Best Buy is going to be there regardless of where technology is," he says. "There's a big swath of customers that are going to want to get a little advice and to touch and feel that new gadget. Best Buy will continue to play an important role in that."

Dunn, now 49, seemed an unlikely future leader when he joined the company in 1985. At 24, he was working off and on and living at home with his mother, Ethel, who prodded him to find a permanent job. She was employed in accounting at Best Buy, which had a dozen stores at the time, and helped him land a position selling VCRs at one Minnesota outlet. The New Jersey native proved a quick study in learning from the best salespeople and managers. He worked his way up and became heir apparent in 2006. Brad Anderson, the previous CEO, says he wanted to stay in the job "until I found a leader who would take the organization farther than I could."

On a recent weekday in New York City, the burly Dunn strolled into a store in Union Square to check out the company's new "discovery zones." In the Best Buy Mobile zone, for instance, dozens of customers were checking out how Motorola's (MOT) new Droid smartphone stacks up against Apple's iPhone. Although it's too early to tell whether the strategy that lets users try out multiple brands in one place will goose sales and create a more loyal following, Dunn nods approvingly. "What we're able to do is show how all these things can work together," he says. "Convergence is actually here now, and all those roads will lead through the center of our store."

Best Buy isn't the first to try rewriting the rules of tech retailing. Since Apple started opening retail outlets in 2001, the company has turned its sleek stores into magnets for anyone who wants to test-drive an iPod, iPhone, or Mac. Amazon is trying to make up for its lack of physical stores by offering same-day delivery in several big cities.

BEYOND RETAILStill, Best Buy's strategic position is unique. It has more than 1,000 stores, compared with Apple's 280, and sells a wide range of competing products, while Steve Jobs' company doesn't. Best Buy has 155,000 people working in its stores, and its 20,000-strong Geek Squad is in the field every day, helping customers set up home electronics or fixing products on the fritz. Through its Reward Zone program, a sort of frequent flier card for shoppers, the retailer has built up a list of more than 2.5 million customers who shell out thousands of dollars every year for the latest tech gear. "Users come into Best Buy for reasonably good answers and solutions to the question of what's the right gadget to buy," says Manish Rathi, co-founder of Retrevo, an online product-tracking and review company. "Wal-Mart can't solve that today. Neither can Amazon."

The job of knowing just how far Best Buy can push before manufacturing partners push back falls in large part to Kal Patel, executive vice-president for emerging business. Former CEO Anderson hired Patel away from the consulting firm Strategos in 2003 to direct the retailer's strategy, and Dunn has given him broad leeway to transform Best Buy into a technology company. Patel suggests, unapologetically, that Best Buy and its partners will have to get used to a new relationship. "If you're in the technology business, we're going to have to learn to deal with constant conflict," he says.

Over the past two years, Patel has virtually lived on planes and in hotel rooms in an attempt to guide the company's technology push by learning from established giants and startups. On a recent trip to California, he huddled with executives at Cisco Systems (CSCO) to discuss partnerships aimed at connecting more consumers to more devices. While prepared for conflict, Patel also found plenty of collaboration.

In late 2007, Craig Bramscher, chief executive of Brammo, started searching for an investor and retail partner for the Enertia powercycle, a full-size motorcycle that drives like an electric scooter, with no clutch, gears, or transmission. He thought Best Buy was a natural fit, since the company already has service bays for car stereo installations. A few months later, while munching on hors d'oeuvres at a dinner party with a longtime friend, he discovered the friend knew Patel, and the two got in touch. "I thought they were the only company innovative enough to take a risk on us," Bramscher says.

Within weeks, 30 Best Buy employees were in Brammo's Ashland, Ore., headquarters to vet the Enertia. The team spent two days in the skunkworks lab, tearing apart the powercycle and grilling Bramscher's team to determine whether it fit into their growth strategy. They ultimately were convinced, and in August 2008, Best Buy invested $10 million in the company. As the retailer began lining up approvals in the test markets of California and Oregon to be licensed as motorcycle dealerships, Dunn sent Bramscher a brief note over Twitter. "We're exercising muscles we didn't know we had," he wrote. Best Buy is now pushing to expand the availability of the Enertia to other states.

Dunn and his team, meanwhile, are working on a variety of similar deals. One key area is health and wellness. Earlier this month, the company launched new fitness zones in 40 stores across the nation that include devices such as a Bluetooth-enabled scale that sends weight information to a computer for charting. Next year the company will introduce a toothbrush that wirelessly reports to a PC the number of brushstrokes that a child uses. "We're scouring the world over, bringing in new talent to help us in a particular space," says Dunn.

The entrepreneurial spirit is filtering down to established businesses. Jason Bonfig, vice-president of the computing division at Best Buy, works closely with Toshiba and other PC makers to create notebooks under the Best Buy-exclusive Blue Label and Next Class brands. Based on customer feedback, the designs include perks such as backlit keyboards, bigger batteries, and custom chassis colors. It used to take weeks for color samples or material choices to make their way from Taiwan to the PC maker, then on to Bonfig in Minnesota. Fed up, Bonfig began joining the manufacturers on trips every six months to set road maps with their subcontractors.

BROADER FOOTPRINTThe cozier relations helped on the eve of the Oct. 22 Windows 7 launch, when HP offered to put together an exclusive bundle for Best Buy that included a desktop PC, monitor, laptop, netbook, and wireless router for $1,199.99. Best Buy also got the exclusive on Dell's sleek new $1,799 Adamo XPS notebook, in part because of its early involvement in the manufacturing process. "When you work closely together, there's more time to innovate elsewhere," Bonfig says.

Conflict still happens. Some top PC makers are upset about Best Buy's recent expansion of a service that lets customers reduce the amount of third-party software installed on new computers. Software companies pay HP, Dell, and others hundreds of millions of dollars a year to install trial versions of their programs for virus protection, photo-editing, and the like on new computers; PC makers get another check if buyers sign up to keep using them. Best Buy lets customers select just one antivirus program, say, and removes alternative products. The retailer's executives say they are simply responding to customer complaints that their new machines are overloaded and sluggish. But PC makers are concerned the retailer is trying to grab more of their scant profit pool.

They may be right. One unusual deal Best Buy has struck is with the antivirus company Kaspersky Lab. The Moscow-based company agreed to let Best Buy manage its software and subscription program in exchange for more prominent placement in stores, says Randy Drawas, Kaspersky's chief marketing officer. "We get a broader footprint within Best Buy and are seen as a premium brand," he says. Best Buy salesmen promote Kaspersky's software, and the retailer gets a slice of the revenues when customers use it. PC makers, though, may lose out on revenues as software from rivals such as McAfee are stripped off machines.

Although it is exerting more influence over the types of software installed on devices, Best Buy says it will continue to sell products from companies that opt out of its programs, such as the one aimed at reducing software clutter. That approach may help Best Buy skirt antitrust issues, even as its share of the U. S. consumer electronics market expands from the current 25%. "I hope we're not seen as picking winners and losers," says Dunn. "What we stand for is choice."

In another move, Bloomberg BusinessWeek has learned, Best Buy plans to launch its own advertising business early next year. The company will let movie studios, PC makers, and other companies run trailers, songs, or commercials on the thousands of televisions, PCs, and cell phones within its stores. Sony, Toshiba, and Samsung have already signed on to advertise. Still, the effort could prove controversial since rivals may end up advertising on each other's devices. Dunn won't reveal revenue projections but says the business will "grow into a big piece of what we do."

Dunn clearly relishes this kind of experimentation. As customers drop into stores around the globe this shopping season, they might run into kiosks where they can swap used games or movies, or DJ booths where would-be disc jockeys can pick up digital turntables, headphones, and lighting. Best Buy is testing out different logos and store layouts, even stocking solar panels in a few markets. Many of the tests won't pay off, but Dunn figures the retailer can learn and make adjustments for the future. "The easiest changes are when you are backed up against the corner and it's sort of 'change or perish,'" he says. "Now we're trying to change at a time when we are very, very successful."

Business Exchange: Read, save, and add content on BW's new Web 2.0 topic networkGeek ArmyBest Buy says that its biggest not-so-secret weapon is the staff of 155,000 employees worldwide who can talk all things electronic. The company's BlueShirts do most of their work in stores. But the retailer is increasingly using social media Web sites such as Twitter and Facebook to bringing young, technologically savvy customers into its stores. More than 2,300 Best Buy staffers now provide customer service through Twitter.To learn more about the initiative, go to http://bx.businessweek.com/best-buy/reference/

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