Best Buy’s stock jumped more than 10 percent today, after the company reported much better than expected results. Chief Executive Officer Hubert Joly, who is known as a turnaround expert, seems finally to have staunched the bleeding that I reported on last year:
“Clearly unsatisfactory” is what Best Buy CEO Hubert Joly called the company’s third-quarter earnings. It’s a droll bit of understatement -- so French! -- when words like “plunge” and “dismal” more accurately capture the numbers that the company reported on Nov. 20. Sales were $12.1 billion in the third quarter of 2011; a year later, that number had shrunk to $10.7 billion, with net income working out to just 3 cents a share. Five years ago, in December 2007, a share of Best Buy was worth more than $50; today the company is trading just under $13. This may be some sort of record -- from profit powerhouse to basket case in under five years.
This time around, the results are surprisingly good: Gross margins expanded to 26.5 percent this year, beating estimates of 23.3 percent. So does that mean that the patient is back on the road to health?
Not yet. At this point, Joly is simply better managing the decline. Same-store sales fell by 0.6 percent, and overall revenue was down 0.4 percent. This despite aggressive price moves by Joly, who set up a permanent price-matching policy in an attempt to win back sales from Amazon. The company expanded its profits by cutting costs. And in the long term, I just don’t see how Best Buy can cut costs enough to stay competitive with Amazon.
For one thing, Amazon isn’t even trying to be really profitable; it plows everything back into warehouses, servers and other capacity-building investments. The company can now site and build a warehouse in under a year.
In some sense, Best Buy’s big advantage is that it doesn’t have to do this kind of investment; it already has all its “warehouses,” aka stores, so it can return that money as profit to its shareholders. To be sure, the company is retooling to bring a more boutique feel to its stores -- specialty sections for prime manufacturers such as Microsoft, Apple and Samsung, high-end appliance and sound-system areas. But that’s not nearly as big a cost as putting up a giant new building. Something like 90 percent of the U.S. population lives within a few minutes of a Best Buy.
But at Best Buy’s stage of life, all that investment is as likely to be a liability as an asset. As I noted in last year’s piece, every retailer is ultimately undone the same way: Its real estate, once its greatest asset, becomes an expensive albatross. As sales fall, the company’s cash flow is drained away by long-term mortgages or leases that cannot be shed without paying penalties that they don’t have the cash for, which is, after all, why they need to shed the leases.
Moreover, every dollar that Amazon invests makes Best Buy’s real estate less valuable. It increases Amazon’s economies of scale, or moves the warehouses closer to Best Buy’s customers, cutting shipping times and costs and making them even more competitive against the big-box retailers.
I went into reporting that piece looking for the way that the big boxes could restore their former glory, but I came away pretty pessimistic. Oh, Best Buy may survive -- but it will do so by shrinking, and upscaling. It cannot match Amazon on selection, and while it can match the prices, in the long run it’s hard to see how it can make money doing so. Best Buy does offer instant gratification that Amazon can’t match; on the other hand, I can’t go to Best Buy in my pajamas. If Best Buy is going to survive, it will have to provide a service. The days of the commodity brick-and-mortar appliance and electronics retailers are numbered -- and in my opinion, the number isn’t all that large.
Ultimately, Joly’s job is to keep the company alive while turning it into something else -- something with a value proposition that Amazon can’t match. Early signs so far are as encouraging as they could be. But danger remains. To survive, he’s being forced to cut costs deeply. This slash-and-burn approach may clear the way for a fruitful next stage. But there’s always a risk, with these sorts of moves, that you will deeply damage the brands and the human capital that you need to carry you forward.