Best Buy Co., Inc.

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Best Buy Co., Inc.

7075 Flying Cloud Drive
P.O. Box 9312
Eden Prairie, Minnesota 55437
U.S.A.
(612) 947-2200
Fax: (612) 947-2422

Public Company
Incorporated: 1966 as Sound of Music Inc.
Employees: 16,000
Sales: $2.1 billion
Stock Exchanges: New York
SICs: 5722 Household Appliance Stores; 5731 Radio, TV & Electronics Stores; 5734 Computer & Software Stores; 5735 Record & Prerecorded Tape Stores; 5946 Camera & Photographic Supply Stores

One of two powerhouses among consumer electronics retailers, Minnesota-based Best Buy Co., Inc., dominates the central U.S. market through a network of more than 150 stores in 18 states. The company’s arch-rival is Virginia-based Circuit City, with $3.6 billion in sales and strongholds on both the east and west coasts. By 1993 both superstore titans had virtually vanquished the remaining competition, which included such former number two retailers as Highland Superstores (forced to liquidate) and Dixons Group’s Silo Holdings (forced to downsize and sell to Fretter Inc.). Best Buy’s recent growth has been nothing short of spectacular. From 1989 to 1992 corporate sales rose annually by 23 percent, while the industry as a whole expanded by a yearly average of just 3 percent. From 1992 to 1993 revenues catapulted for the first time beyond the $1 billion mark, from $929 million to $1.6 billion, for an increase of 74 percent. During this same period, net earnings soared 107 percent to just under $20 million. Although Circuit City is a significantly larger and more stable company in the eyes of investors, with a history of wider profit margins and negligible debt, it is Best Buy that has generated the most excitement on Wall Street. For the first half of 1991, Best Buy outshone all other New York Stock Exchange stocks in percentage appreciation. However, with excitement comes volatility: in 1993 the stock nearly doubled within a three-month period but then dropped by 10 percent in a single day in mid-November. Part of this roller coaster pattern is due to Best Buy’s increasingly heated battle with Circuit City, which has many analysts wary. In the notoriously competitive industry of consumer electronics, Best Buy has proven itself an expert player. The only question that remains is whether two giants can remain healthy at the top of the heap, as each tries to usurp market share within the other’s established domain.

Best Buy is the brainchild of the company’s founder, chairman, and CEO, Richard M. Schulze. In 1966 Schulze and a partner opened Sound of Music Inc. in an attempt to capture a share of the Twin Cities’ home and car stereo retail market. First year sales reached $173,000. Four years later Schulze bought out his partner and proceeded to expand his retail chain; his product line, however, was limited to audio components until the early 1980s. Then, according to an Executive of the Year cover story for Corporate Report Minnesota, Schulze said, “the lights began to turn on.” Writer S. C. Biemesderfer explained: “Schulze had come to realize that there wasn’t much of a future in a market glutted with vendors, serving a shrinking audience of 15- to 18-year-olds with limited resources.” His ability to alter the course of his company was enhanced by a week-long management seminar he attended in 1981. Departing the seminar as a “reformed controller,” Schulze saw the dynamic possibilities that lay ahead and turned them into reality.

His first step was to expand Sound of Music’s offerings to include appliances and VCRs. Schulze saw sales quickly climb. In 1982 revenues reached $9.3 million; the following year the company renamed itself Best Buy and firmly oriented itself toward an older, broader, and more affluent customer base. Then, in 1984, Schulze took another major step by introducing the superstore format and quickly capturing 42 percent of the local market. At the time the company operated just eight stores in the Midwest, but by 1987 this number had tripled, while sales and earnings had spiraled upward to $239 million and $7.7 million, respectively. In addition to greatly expanded warehouse size and product offerings, the superstore format meant significantly smaller margins in order to maintain its good service-low prices image.

Of course Best Buy was not alone among upstart chains during the 1980s in capitalizing on the superstore format and such hot-ticket consumer items as VCRs. “But after a raft of these chains went public,” wrote Mary J. Pitzer in 1987, “they expanded rapidly and began colliding head-on. As a result, many companies took a beating on profit margins and are now gravely wounded.” It was, in a very real sense, the best of times and the worst of times for Best Buy. Although sales had practically doubled to $439 million in fiscal 1988, net earnings had declined by 64 percent. Price wars were the chief culprit, and they were still escalating to a frenzied pitch in Best Buy’s core Twin Cities market, which Highland had boldly entered in early 1987.

For a while, both companies benefited from market share increases, if not profit gains, by the battle. Then, finally, a saturation point was reached, with too many stores in the same area competing for the same dollars. According to Biemesderfer, “Rumor had it that, as Best Buy limped into the fall of 1988 Schulze tried to sell his company to Sears and failed because of his demands for certain perks.” Biemesderfer went on to write that “Schulze denies the allegation, but to this day, even his backers question his version of the story.” Schulze’s own explanation was that “At no point in time were there ever any concerns or fears about the future of the company.... Our discussion with Sears Roebuck was simply an attempt to understand the interest they would have in supplying capital necessary to grow the company independently.”

Despite the earnings downturn in fiscal 1989 (net profits for the year ending March 31 slumped 26 percent, to just $2 million), and the looming presence of Highland, revenues were still climbing, albeit more slowly. In Schulze’s mind, the key to regaining the momentum of the mid-1980s was to stand out from the competition, for the average customer recognized little difference among superstores, with their discount prices, multiple-step purchase processes, commissioned salespeople, and ubiquitous service plan and extended warranty packages. Schulze’s answer? Concept II stores.

The unveiling of Best Buy’s first Concept II stores in 1989 was the culmination of a daring new advance by Schulze. The idea behind Concept II was that the traditional superstore format was largely out of sync with the needs or preferences of most shoppers. Shoppers were entering electronics discount stores with only a limited need for sales help and a desire for hassle-free buying (no service plan contracts, no waiting for merchandise from the back room, no switching from counter to counter). Thus the revamped Best Buy stores would feature well-stocked showrooms averaging around 36,000 square feet; fewer salespeople; more self-help product information; Answer Centers, for those requiring personal assistance; and one-stop purchasing. As a veteran Best Buy analyst, quoted by Biemesderfer, has proclaimed: “Concept II is the most innovative thing to happen in this industry—ever.” The revenue Best Buy sacrificed in de-emphasizing service plans was compensated for by lowered employee costs. Stores without commissioned sales help were now able to operate at two-thirds of the work force required in the past.

In April 1991, even before Best Buy had gotten around to converting its 10 Twin Cities stores, loss-ravaged Highland exited the metropolitan area, conceding defeat and closing all six of its stores there. Best Buy itself reported a loss of $9.4 million for fiscal 1991, but this was due to a $14 million change in its method of accounting for extended service plans. From fiscal 1992 to fiscal 1993, Best Buy reported “the best financial performance in the company’s 27-year history.” In addition to its stunning increases in revenues and earnings, the fast-growing retailer opened 38 new stores and saw comparable store sales (sales from stores open at least 14 months) increase by 19.4 percent.

During the calendar year 1993, Best Buy opened 9 more stores in Chicago, for a total of 23, to solidify its leadership position in the Midwest and also entered the key Circuit City markets of Atlanta and Phoenix with an additional 13 stores. Numerous other openings, including a small number of megastores (40,000- to 50,000-square-foot self-service warehouses emphasizing the emerging growth lines of prerecorded music and computers), brought Best Buy’s tally to 151 stores by year-end 1993. At that point, the only internal factor seriously saddling the company was a hefty 43 percent debt-to-capital ratio. However, Best Buy’s “push” distribution system, in which products are automatically shipped to outlets based on computer analysis of past sales trends; its rapid turnover time; and its expectation of rising sales per store indicated that the company could hold its costs while continuing to expand.

Its greatest concern for the future was the bottom line impact of Circuit City’s latest moves. Just as Best Buy had looked to the outer corridors of the country, Circuit City had looked inward. It, too, had embraced Chicago, where price wars began anew. The Virginia company also had plans to enter Kansas City, Missouri, and the Twin Cities in 1994. Whether the two would be able to operate side-by-side for long was unknown. Whatever the case, the stakes were high, not only for the companies but for related retailers and manufacturers. Such high-image manufacturers as Mitsubishi had already retreated from both store chains, complaining of poor price and sales support. And, wrote Berss, “the last thing retailers need this Christmas—the biggest selling period of the year—is a price war. But that’s what they’re getting.” The obvious winner in all of this? The consumer, by sheer happenstance. Then again, maybe it’s by design.