Best Buy's Transformation - More Like Circuit City, Not At All Like Apple

Jul.10.12 | About: Best Buy (BBY)

Investors familiar with Best Buy (BBY) and who have been following the stock know how hard the company's public relations team has been trying to get investors to begin associating Best Buy's transformation plan with Apple's (AAPL) retail model. Sadly, the new "transformation" plan looks very little like Apple's strategy, and a lot more like the one that Circuit City tried to implement back in 2006 through 2008, right before that consumer electronics retailer shuttered its doors in 2009.

This article will not focus on a numbers comparison between the two companies. That analysis will be forthcoming in the coming weeks. Rather, this article outlines Circuit City's transformation plan and shows readers why Best Buy's transformation looks like it was ripped from the pages of Circuit City's failed playbook, which led to that company's ultimate demise.

Best Buy's New Retail Format Is No Different Than Circuit City's "The City"

In 2007, Circuit City unveiled a new smaller store format which was branded "The City." The new format was supposed to be a game changer for that company and Phillip J. Schoonover claimed that:

"It offers a different experience. Customers can touch and compare, and learn how to use the most complex products and services that we sell. It is a more efficient use of space. Typically our stores are 35,000 square feet, and less than 18,000 of that is selling space. The new prototype is 20,000 and has 17,000 of selling space. This fundamentally changes the economics. We can get higher revenue per square foot, higher-margin dollars per square foot, and we can find additional sites that weren't necessarily available for our old box."

The interview that quote came from can be found here. A synopsis of Circuit City's "The City" transformation program can be found here. While the exact square footage of the dimensions being proposed by Best Buy for its new store format may not be exactly the same, the defunct logic behind the proposal is. During Best Buy's Q1 earning call, which can be found here, George Lawrence Mikan stated:

"My goal is to continue to shrink the company's physical footprint and substantially reduce our cost structure. Total square footage will go down as we make decisions about the best use of space and resources. But as we assess opportunities, our total storefronts may stay the same or even grow somewhat, though with a smaller and more focused presence. We've had success with this model in some of our pilot markets, where we've been able to drive up revenue per square foot while reducing operating costs."

But it's not just the interim CEO that is trying to transform the company into the next Circuit City. It appears that Mike Vitelli, Best Buy's president of U.S. operations is also taking the company down the same path. In discussing the new retail store format, Mike Vitell was quoted as saying: "We don't see these as costs but investments that will lead to higher sales in less square footage." The article which published that quote can be found here.

Can Services Save the Day?

Circuit City's 2007 transformation plan did not just focus on reducing square footage, it also came with a plan to focus on increasing services. Circuit City's 2007 annual report devoted a full page of text touting how the "firedog" services brand would help to grow the company's bottom line by $20 billion. Specifically, the 2007 annual report stated:

"Consumers today are living a 'digital' life. The variety and complexity of consumer electronics enable us to create a theater experience or a fullservice office environment right in the comfort of our homes; but sometimes putting together the full experience can be difficult for consumers to achieve on their own. In fall 2006, Circuit City created a new brand, firedog, to enhance the full potential of our customers' 'digital' lives through helpful, knowledgeable, friendly and reliable experts who have a passion to serve. Firedog services include in-store and in-home PC services, available through Circuit City's more than 600 Superstores across the country; home-theater installations, available within 25 miles of Circuit City locations; and remote technical assistance for PCs through 24 hours a day, 7 days a week."

A link to Circuit City's 2007 annual report can be found here. A very similar sounding plan was announced by George Mikan during Best Buy's May 2012 Q1 earnings call. More specifically the interim CEO stated:

"Consumers have needs and preferences that are new and changing rapidly. Today, they need virtual products and services as much, if not more, than they need hardware. And businesses are under pressure to respond to those changes; to connect with consumers, whether they are online or in the store; and to meet these new needs and preferences. […] This new generation of consumers is empowered, educated and social. They have many options when browsing for tablets, smartphones and other devices that connect us. And they have a fast-growing need and appetite for services and accessories, both tangible and virtual, that help consumers take full ownership of their technology. […] We cannot be seen just as a hardware company. We must be relevant in the much larger and constantly evolving market of services that is driven by technology innovation and broader customer needs. And we must begin building those deeper relationships with customers. We must meet people where they are and not expect them to come to us."

The plan to grow the business by increasing the sale of services is a great concept but much harder to execute. It requires excellent service technicians on the ground, and a strong brand to help give consumers the confidence that they are spending their dollars wisely. The firedog brand failed for Circuit City because the company mistreated the very workforce who was supposed to be providing the services that the company was touting. Best Buy's recent move to lay off employees will likely have the same effect, as described by the article here.

Best Buy Mobile = Circuit City Express

Just in case a copy of the Circuit City 2007 transformation plan was too obvious, it appears that Best Buy reached back even deeper into Circuit City's old playbook by trying to re-create the "Circuit City Express" brand. For those investors too young to remember, the "Circuit City Express" brand was a chain of "mall-based Circuit City stores with over 55 locations at its peak." Cell phones "were a major focus of the business" and allowed the big box retailer to operate in a smaller format mall environment so it could sell "small electronic products for personal use." Most of the "Circuit City Express" stores were eventually closed in the early 2000s. More information about "Circuit City Express" can be found here.

Best Buy's current management team has made it no secret that they want to build out the company's small-box Best Buy Mobile concept and publicly announced plans to open 43 additional Best Buy Mobile locations in Q1 of this year, many of which are (or will be located in malls). These Best Buy Mobile locations sell cellular phones/plans and also carry a subset of electronics products that are normally carried at the larger stores, as described here.

While the mobile/cell phone industry has changed significantly since the early 2000s, many would argue that the competition in this space has gotten significantly tougher. Carrier branded stores, Radio Shack (RSH), and mobile phone locations in Costo (COST), Wall-Mart (WMT), and Target (TGT), make Best Buy's decision to spend significant amounts of money to expand in this space a questionable move at best. It also makes Best Buy start to look and feel not just like Circuit City, but also like Radio Shack as well (as described here).


Comparisons between Best Buy and Circuit City which were previously dismissed as ridiculous and unreasonable are now increasingly becoming more and more accurate. In 2006, as a show of strength to investors, Circuit City decided to increase its dividend (which was subsequently cancelled in its entirety a number of months later) while also increasing the company's stock share buy back program (as described here). This move likely accelerated Circuit City's eventual bankruptcy. This is probably why pundits recently questioned Best Buy's decisions to raise its dividend and buy back stock (as described here). Even today's Best Buy buyout rumors are reminiscent of those that were constantly swirling as Circuit City was floundering. To make matters even more ironic, reports indicate that Best Buy would likely hire the same investment bank that defended Circuit City from a buyout (i.e. Goldman Sachs (GS)) should a hostile buyout attempt ever materialize (as described here).

This article could continue on for pages based on the growing number of similarities between the two companies. Best Buy's headlines today read like the Circuit City annual reports that were issued between 2004 though 2007. Rather than bore readers with more analysis, those reports are all available publicly online. In summary, investors should be very concerned about the path that Best Buy is currently headed down. There has been plenty of recent debate over whether the new transformation strategy Best Buy is currently implementing can turn the company around. While past performance is never an indicator of future results, Circuit City's fate after implementation of a very similar plan has been well documented, and is well known to all investors who are familiar with the consumer electronics retail industry.

At a minimum, hopefully Best Buy's management team purchased the "obsolescence protection plan" from whichever consulting firm helped them to develop the company's new transformation strategy. It appears that the transformation plan that Best Buy purchased is a little over five years old, and already out of date.

Disclosure: I am short BBY and RSH.

Additional disclosure: I have no positions in any of the other stocks mentioned in this article.