1, 2, 3, 4, hhgregg, I Love You More

| About: hhgregg, Inc. (HGG)

The measure of intelligence is the ability to change. ― Albert Einstein

hhgregg (NYSE:HGG) is currently an attractively priced retailer of predominantly appliances and consumer electronics that is navigating a very difficult competitive environment to not only be profitable but to steadily continue toward achieving their stated objective of becoming a nationwide retail presence and consequently deliver increasing value to shareholders.

hhgregg's strategy is rooted in delivering industry-leading customer service by utilizing very highly trained and commission-incentivized salespeople, by simplifying the product mix and uncluttering stores through reduced SKUs and by focusing increasingly on the sales of "large box" items like appliances, mattresses and fitness equipment that consumers are more likely to purchase in a store than over the Internet. Same day delivery, home installation and private label credit card financing that comprises one-third of sales is an important part of their success equation as well.

Identity Crisis as Opportunity

In the past, hhgregg was a consumer electronics company that also sold appliances. Adapting to the changing retail environment, today appliances is their largest category representing 42% of their business during the first nine months of fiscal 2013. As they continue to grow market share in appliances and other "big-box" categories, hhgregg is evolving to become a home product store that also sells consumer electronics.

Another major differentiator is in the use of commissioned salespeople with over 150 hours of training per employee, the highest level of employee training in the industry. hhgregg's belief is that better trained employees provide a better customer experience through better service and better information. The challenge however is that others will copy this strategy. Focusing on building extraordinary customer loyalty is their key defense against this challenge.

1, 2, 3, 4: Get them Coming Back for More

Below are four important elements of successful retail strategy that hhgregg understands and is executing. When the consumer has a choice, a business cannot survive without being excellent in these areas. You must get a commitment to a purchase and do it well enough so that customers return. Most business growth comes from repeat customers and HGG is meeting the challenge by working to provide a better shopping experience.

  1. Get them in the door. If customers don't come, you can't build your business. Inverting the "build it and they will come" aphorism, hhgregg is a new name in much of the country and like any new business, they need to find a way to get customers to visit stores. One challenge they have is that until you've visited their store, it kind of just looks like another electronics box store from the outside, like a Best Buy (NYSE:BBY), only smaller.

    To drive shopper traffic into its stores, hhgregg engages in regular print and television advertising-but their greatest strength in growing store traffic is through word of mouth that something special is happening here with regards to the shopping experience and that prices are good. Once in the door, hhgregg understands that you need to wow them somehow so that you can execute numbers 2, 3 and 4.

  2. Get them to buy something. Converting a store visit to a sale is an art best performed with a lot of assistance from science. hhgregg takes this challenge seriously by using their high-touch but non-invasive approach toward creating a better shopping experience.

    Simple electronics purchases can be complicated, and therein lays the opportunity for hhgregg - to simplify and make easier what can be an unpleasant process. If you can make a process easier or even better, if you can make it fun, you can build customer loyalty in a magical way, something that Apple (NASDAQ:AAPL) knows well. By reducing confusion and turning technology frustration into fashion and fun, Apple has proven that consumers are less price sensitive, willing to pay more for technology items when they feel more educated and more comfortable about them, and if they feel help is available if needed.

    According to the "2010 Appliance Retailer Satisfaction Study," consumers said their overall shopping experience had a stronger effect on their purchase satisfaction than the actual price paid for the appliance. hhgregg's president, Dennis May said "We have found that in the places where we have opened our stores, people already have a place to buy. What they are looking for is another way to shop." Through a "smaller-box" store size and an aesthetic sparseness with lower product density, hhgregg helps customers identify potential purchases with fewer distractions caused by too many choices on the shelves, which can lead customers to feel like they are searching a haystack to find a needle.

    hhgregg is trying to create enthusiastic customers not by being the cheapest provider but by being the retailer with the most expertise that leads to outstanding customer service. They do not ignore the issue of price however, offering price-matching against most major competitors both online and off. The most notable exception to this policy is that they don't offer price matching with warehouse clubs like Costco (NASDAQ:COST), BJs, and Sam's Club (NYSE:WMT).

    Digging deeper into these elements to create a better shopping experience and to sustain and increase sales, HGG employs the following influencing methods:

    • Reduce fear of buyer's remorse. To convert store visits to sales and reduce the fear of buyer's remorse, consumers need to have little worry that they will find the item for less elsewhere and also feel they have adequate time to return it without penalty. Price is addressed through competitive pricing and the price-matching policy. A friendly return policy is another element and is the not-so-secret secret of Costco who knows very well that you will sell more if the customer is not worrying about being stuck with something they do not wish to keep.

      The cost of returns is unpleasant for a retailer but behind many returned items there is a loyal customer who will spend a lot more with you in the future if they have comfort that they will be able to return something that isn't wanted. Understanding this, the volume of returns can be viewed in a more favorable light. To reduce the amount of revenue shrink from returns, technology can be employed to better verify that goods were indeed purchased from their stores.

    • Reduce choice, reduce confusion. Mae West wasn't thinking about electronics retailing when she said "too much of a good thing is wonderful." The idea of limiting choice is a vastly under-appreciated concept in much of retail today - that is, too much choice stresses out the consumer and stifles sales.

      Psychologist Barry Schwartz calls this choice paralysis. In this TED talk, Schwartz cites research that when people are given more options for their 401K account, they actually put off the decision instead of making it. Too much choice can actually work against the goal of building positive feelings about the shopping experience. Complexity leads to indecision.

      In Malcolm Gladwell's book Blink he cites an experiment where a store offering six types of jams sells much more jam than a store that offered twenty-four different types. hhgregg understands this. Upon my visit to the local hhgregg store, they were offering only three different models of computer keyboards. For comparison, the local Best Buy carried thirteen models. Most people don't need that many choices in keyboards, and if they do, they would be better served by making that particular purchase over the Internet.

  3. Get them feeling good about their purchase. When the sale is complete, the work is not over yet. People like to buy when they feel like they got the best price. Knowing that a good deal was had makes the consumer feel important and confident about their purchase which is the best feeling you can give a customer who you want to keep returning forever.

    Offering the guaranteed price match for 30 days helps relieve the customer of this worry about price and allows them to focus on the benefits of the purchase and feeling good about the buying experience. By giving the customer these post-purchase benefits you build customer retention and return visits.

    At hhgregg, nearly 40% of their merchandise product is delivered to the home. This is an additional opportunity for the company to create a positive experience for the customer.

  4. Get them to return and tell their friends. In order to get more customers to do number one above, that is to come through the door to begin with, you have to also achieve number four here. Ken Blanchard popularized the term "raving fans" which means you have achieved the kind of service excellence that turns a customer into a lifetime customer. A raving fan is an advocate of your products or services in the marketplace. Raving fans will drive future sales by returning and by telling others and is the most valuable type of marketing there is. Raving fans sell for you.

The Road Ahead

The long-term economics of the businesses which hhgregg competes in will remain extraordinarily challenging as competition with direct and indirect competitors is fierce and unrelenting. The competition can observe what is working at hhgregg and emulate it themselves. The profit margins on most electronics merchandise are razor thin.

Long-term success will hinge upon hhgregg's ability to offer the right product mix and maintain satisfactory margins on those items where price is less of a determinant of sales, such as in appliances and other big-box items. The current strategy is working in the sense that they are surviving and growing, but the revenue growth picture is less than optimal.

As hhgregg expands its store footprint into new regions, it will take time for consumers to venture into the new stores and experience them. This will result in lower than favorable revenue growth by store in the early years of expansion. However, if they continue delivering a superior shopping experience, the long run has a good chance for satisfactory results. Quality management as is in place now will be critical to this success.

Investment Implications and Some Valuation Considerations

At current price levels, selling near book value, hhgregg is an attractive stock to buy. It has excellent management and a compelling growth story as it brings its superior customer service model nationwide.

Protecting the downside risk are two quantitative factors shown in the table below. Insider ownership is very high and CEO Dennis May owns over a million shares personally. Also, hhgregg has managed to grow stores without increasing long-term debt, as their debt to equity ratio is zero:

In the title of this article, I played upon the lyrics of a popular song by the Canadian indie-rock star Feist. The song continues, "Sleepless long nights, that is what my youth was for." I'm quite comfortable owning hhgregg at current price levels and won't be losing sleep over this position any time soon. With heavy ownership by management and other insiders, no debt, and an innovative shopping alternative to other electronics and appliance retailers today, especially Best Buy, hhgregg is a very interesting participant in the retail landscape to watch. If management continues to be focused on adapting to consumers' needs and behavior and providing better service and more value than the competition, hhgregg could prove to be an attractive investment over the longer run as they continue their nationwide expansion.

Disclosure: I am long HGG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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