Tuesday, 26 June 2012

Are shrinking stores inevitable in consumer electronics?

"Best Buy has set plans to reduce its store square footage by 10% in the next five years."

The continuing threat to the business model of consumer electronics retailers posed by the internet seems to have elicited a consistent response: "honey I shrunk the stores." Or in the case of Comet/Kesa, sold the stores.

These retailers are determined to protect margins. Protecting margins means that price-based competition from pureplays eats into store sales. Ergo, fewer/smaller stores.

Protecting margins is rather understandable when you look at the panicky 15.5% drop in the share price of BestBuy when margins took a 0.9% hit during the last holiday season.

And yet curiously gross margins are historically quite high. US GAAP helpfully forces retailers to publish true gross trading margin figures. And Best Buy's margins look like this:

Pretty steady in other words, and despite the recent drop due to trying free-delivery for the holiday season, historically really rather high. Take a quick look at the longer historical trend:

In other words, since the dawn of the internet age (and of course the dawn of the Chinese manufacturing age), Best Buy has enjoyed historically high margins.

Dixons and Comet are rather coy when it comes to stating gross margin figures. When they are down, they tend to say things like "significant margin pressure" while when they are up they crow about "0.4% increase in gross margin". Solid data is rather absent, but a trawl through the financial reports for the last few years seems to imply a reduction of somewhere between 2% and 3%, recovering slightly recently, hardly a disaster.

Dixons and Comet's sales, of course are another story (although this doesn't - yet - seem to be such a problem for BestBuy). Effectively they've traded preserving margin for lost sales. But is this the only approach?

German giant Media Markt-Saturn thinks not. OK, they've got an extra problem - their stores are partly owned by franchisees, so announcing a programme of store closures is not really an option. Instead they've decided to go straight to the heart of the matter, and announced that they will reduce prices... by 5%-6%.

In other words, they've decided that they are actively going to try to protect sales (and their franchisees), by accepting a loss of margin instead, and planning for this strategically.

It has to be said that they've had a rather torrid time trying an alternative approach. This horror-story is from their 2010 pilot in Austria (where they tried it out before risking their core German market):

My online customer journey:
  1. I'm attracted to MediaMarkt by their slogan "I'm not stupid, (because I shop at Media Markt)"
  2. I go onto the site, where I have to declare my home store (instant loss of 50% of customers)
  3. I find that a) prices are cheaper at a different store; b) their online price is not cheap at all
  4. I decide I am indeed stupid because I shop at Media Markt. I go somewhere else, probably online
  5. I decide that Media Markt are also stupid, because their pricing strategy is a disaster area
The net result of this monsterpiece was the departure of the CEO and Finance Director, and a fresh think.

And now they've had a fresh think, they've reached a completely different conclusion from Best Buy. Quite simply, they have recognised that store price = online price is mandatory, (which is a conclusion all true multichannel retailers eventually reach: the customer experience is just absurd otherwise.) And then they've drawn the logical consequence from this - prices will have to fall:

You can find the full presentation at this link.

The summary is actually quite simple:
  1. we have to have one price across all channels
  2. in order to do this credibly, we have to reach down to median internet price or lower
  3. to do this prices have to fall, by about 5% from shelf price, and 3% from customer price (customer note: it's probably worth trying to negotiate a bit in a MediaMarkt or Saturn store)
  4. in order to make this possible, we will reduce the cost base (but not the store base) and also simply accept lower margins
It will be interesting to see if BestBuy follows suit. And if so, what it does to their share price if a 0.9% margin drop can reduce the value of the company by 15.5%... But then they are currently enjoying historically distorted high margins!

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