How Best Buy gets better (Corporate Dealmaker)

How Best Buy gets better

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Next time you're cruising through a shopping zone in America's exurbs, spare a thought for the folks running that mammoth blue store with the big yellow sign reading "Best Buy." They're working in a dangerous place.

It's not the traffic that's perilous; it's Best Buy's business. This might sound slightly alarmist, considering that the 45,000-square-foot store you're looking at will probably sell $40 million worth of consumer electronics this year, and that Best Buy Co. can boast more than $27 billion in revenue, strong margins and a commanding lead in its category. But if you reflect on where Best Buy is operating - as the company's executives routinely do - the risks quickly come into focus. "There's a reality that we live at this intersection that is technology and retail," says Darren Jackson, Best Buy's chief financial officer and an executive vice president. "It's a very exciting intersection, but history suggests there are also a lot of accidents here."

Actually, history does more than suggest. Since chairman Richard Schulze founded it in 1966 as a St. Paul, Minn., hi-fi store called The Sound of Music, Best Buy has witnessed countless retail wrecks, casualties in a consumer electronics contest that has burgeoned from an analog buggy-race into a digital Grand Prix. Hundreds of billions of dollars are now at stake as consumers sort through a converging universe of personal computers, digital televisions, mobile phones, gaming hardware and the services and software that bring them all to life. But former category leader Highland Superstores Inc. is no longer around to claim a share; it went bankrupt in 1992 after taking on Best Buy in a price war. Circuit City Stores Inc. then held the No. 1 spot, but it's now a distant second. Best Buy itself has stumbled more than once. In 1996 a period of rapid growth culminated in financial distress. In 2000 Best Buy miscalculated when it paid $685 million for Musicland, an operator of mall-based CD retail chains, only to find its plans unworkable. Last year, it sold Musicland to a buyout firm in exchange for an assumption of liabilities.

But for the most part, Best Buy has done an impressive job of keeping pace with fickle shoppers and accelerating product cycles over the years. Along with a flair for promotion, the company has long exhibited a knack for nimbly changing its mix of merchandise and even its basic selling proposition when necessary. The stores of today contrast sharply with those of the early 1990s. Back then, the typical Best Buy was, in keeping with the name, a grab-and-go, warehouse-style superstore. Today, a Best Buy is a place to try out the latest video games, check out the new DVD movie releases or talk to a knowledgeable salesperson about music downloads or digital video. You can still buy a refrigerator - but you can also try out a home theater. The company has marched steadily upmarket, says Alan Wolf, who covers retailers for industry bible This Week in Consumer Electronics, better known as Twice. "They've got brands that used to be off limits to a national big-box store," he says.

And the changes continue. Indeed, under Bradbury Anderson - who joined Schulze as a stereo salesman in 1973 and succeeded him as CEO in 2002 - Best Buy is at work on its most ambitious transformation yet. The company is mounting a major initiative it calls "customer centricity," which involves customizing its offering for different segments of its huge and diverse collection of customers. It is aggressively expanding its service businesses and readying itself for growth outside North America. And it's doing all this while trying to become efficient enough to compete with the latest crop of competitors, which include the likes of Wal-Mart Stores Inc. and Dell Inc. Says Jackson, "We must be continually challenging ourselves as to what the next business model is."

How does a company of Best Buy's current size - 100,000 employees and 757 stores under two main brands - organize such a challenge? How does it test and implement its conclusions? This, too, is something that Best Buy has had to reinvent. Since buying Musicland and two other companies in 2000 and 2001, Best Buy has largely revamped its financial, strategy-forming and corporate development organizations. Current initiatives - from the national rollout of the Geek Squad, a small, brand-savvy computer service company acquired in late 2002, to a major outsourcing deal with Accenture, announced in July - are taking place in a very different framework from the one that was in place just a few years earlier.

The central players in strategy and corporate development have changed as well. Along with Anderson and Jackson, they are Kal Patel, senior vice president for strategy and international, and Ryan Robinson, vice president of finance and treasurer. Jackson, Patel and Robinson are young - none is yet 40 - but bring substantial experience to the company. Jackson previously helped turn around Milwaukee-based retailer Carson Pirie Scott, then served as CFO of Seattle-based Nordstrom Stores.; he arrived at Best Buy in late 2000 and became CFO and executive vice president shortly thereafter. Robinson spent 15 years doing corporate finance work out of Chicago for Dutch universal bank ABN Amro Bank NV, joining Best Buy in 2002. Patel's background is in consulting, first with KPMG in Europe and then with a firm called Strategos, where he had Best Buy as a client; he joined the retailer in 2003.

It isn't that the previous setup was entirely unsuccessful. Two other sizable acquisitions are working out well: Magnolia Hi-Fi Inc., a high-end Seattle-based audio and video chain, for which Best Buy paid $88 million in 2000, and Future Shop Ltd., Canada's largest consumer electronics chain, acquired for $368 million in 2001. Strategic stakes in small, leading-edge vendors such as TiVo Inc. and Netflix Inc. have served their purpose. But Musicland was a blow, not least to Best Buy's share price, and in 2002 the company reassured shareholders (who were nervous that a large European deal was imminent) by promising to put material acquisitions on hold. "We needed to take a time-out and understand: What went awry in this transaction? Why is that transaction so good?" says Jackson, who joined the company 10 days before the Musicland deal was announced.

Best Buy's current strategy and corporate development framework is less centralized, yet also more tightly tied into the corporate finance organization. George Lopuch, the executive vice president for strategic planning who led the charge on Musicland, Future Shop and other deals, ran a combined strategy and corporate development department and reported to then-CEO Schulze. Lopuch left the company (along with many of his team) as Anderson ascended to the CEO slot in 2002 and, together with chief operating officer Allen Lenzmeier, inaugurated a new strategy. Nowadays, a downsized corporate development team works under Robinson, who reports to CFO Jackson. Strategy chief Patel reports to Anderson, but he brings a very different approach to the job. "The existing model was very much top-down," he says. "We had lots of experts determining a point of view, with very good intent, thinking about it very sequentially." The goal now, he says, "is to move away from that - to strategy as a capability, as a network, as a continual experimentation inside the business."

Robinson, for his part, is charged with bringing a financially rigorous approach to development initiatives. "It's about taking a more proactive assessment of how we can use our size, our market presence and our capital to better serve our customers and accelerate our growth into new areas," he says. Acquisitions, strategic investments, and the company's more complex alliances are all supported by Robinson and a five-member corporate development team, as are some new retail concepts (using brands other than Best Buy) that the company has begun testing. Robinson also managed the Musicland sale. Meanwhile, as treasurer, he remains deeply involved in basic balance-sheet issues such as dividend and share repurchase activity and cash management.

Robinson's responsibility for vital but rather technical treasury functions contrasts with some of the splashy transactions he's worked on - such as the move this year to take a stake in Roxio Inc. and promote its Napster service as a brand for digital music downloads. Similarly, a cerebral-sounding strategy such as customer centricity doesn't seem (at first blush, anyway) to quite fit the scene inside a Best Buy store, where giant TVs show quarterback sacks and Star Wars battles, and the in-house radio channel puts its promotional muscle behind hits like KillRadio's "Do You Know (Knife In Your Back)." Even at the company's shiny new headquarters, which rises beside I-494 in the Minneapolis suburb of Richfield, Minn., the mood on the expansive ground floor is all bustle and hustle. One day this summer an ear-pierced Napster executive demonstrated the new download service not far from a trendy latte shop and an exhibit on Best Buy history where visitors can view some of the company's low-budget, high-impact TV commercials from the 1980s.

But Best Buy's is a culture that has long mixed showmanship with calculation. This is a company that turned some bad luck with the Minnesota weather into a 1981 "Tornado Madness Sale," giving rise to the superstore concept as well as the name Best Buy. A free Lenny Kravitz concert marked Best Buy's arrival in Boston in 1998. Meanwhile, it's also North America's biggest retailer of personal computers and accessories ($7.65 billion worth last year, according to Twice) and a major supplier of information technology to small businesses. The mix may have something to do with the partnership between Schulze and Anderson, who have worked together for more than 30 years now. Anderson is a former Lutheran seminary student who is "passionate about learning," according to Elizabeth Gibson of RHR International, a psychologist and change management consultant who worked with Best Buy in the 1990s. Schulze's formal education, by contrast, ended with high school, but he is widely recognized as a master entrepreneur. "We used to call them the odd couple," Gibson says.

Best Buy hired Gibson in early 1997 to help fix the organizational and logistical problems brought on by adding 212 stores in a five-year period. As she recounts in her book, "Big Change at Best Buy" (foreword by Anderson), the company needed to foster more collaboration in its hypercompetitive sales culture and implement a common operating platform for its stores. The retailer succeeded in righting itself, and that year gross margins began an impressive climb. But by the end of the decade, Best Buy had begun thinking about a new challenge: How to grow when it ran out of places to put new stores.

This was the backdrop to the acquisitions of Magnolia, Future Shop and Musicland - made to extend Best Buy's reach into, respectively, the high-end entertainment hardware market, the world outside the U.S., and shopping malls. Adding a new mall channel by buying crosstown competitor Musicland at a good price seemed especially promising. Itself a major retailer of music CDs and movies in DVD format, Best Buy knew its target was suffering in the age of digital downloads - but it still underestimated the weakness of brands such as the Sam Goody chain and overestimated the receptiveness of consumers to a new pitch that would add electronic gear to the offering.

Today, nearly two years after declaring a moratorium on material acquisitions, Best Buy still faces many of the same challenges. The company will add 70 Best Buy and Future Shop stores this year, but many of those are smaller, so-called fill-in stores, and, anyway, it's approaching the 1,000 total stores it thinks North America can support. Wal-Mart and Dell continue to exert pressure on prices, with the latter now big in LCD televisions as well as computers. And the digital transformation of the music and movie industries continues, giving the members of Best Buy's digital entertainment team (who championed the Roxio-Napster deal) plenty of work to do as they try to manage the company's evolution from a seller of packaged media to a market-maker in entertainment services, many of them subscription-based. "Best Buy has a real issue," treasurer Robinson says. "We sell a lot of shiny disks. Ten years from now there may not be a market for shiny disks."

What has changed in the past two years is the way the company is responding to these challenges. Start with the new approach to strategy. Patel explains that his role isn't to invent it but to give executives and managers the tools and networks they need to create it and put it into practice. One important setting is the strategy leadership forum, where 40 top executives and store managers gather monthly to consider an important topic, often with a presentation from an outside consultant or academic thinker. One meeting helped lay the groundwork for the two big outsourcing agreements Best Buy reached with Accenture this year.

Another such group is the general managers' forum - 30 of Best Buy's top store managers. "I get them to work an issue and recommend change to the executives," Patel says. The managers get access to Anderson, to chief operating officer Lenzmeier and to other company leaders. Sometimes they choose their own issues - labor allocation, for example, or entry into new markets. The forum can also spawn subgroups. "I have a group of Hispanic general managers who are giving me a point of view about what we might want to do in Mexico," Patel says. "They're from some of the border states, where the customer insights reside."

Patel has big plans for the store managers' forum: He wants to connect it with the network of venture capitalists that Robinson is cultivating. The goal: "To have some of them sending me entrepreneurs to get an input from our general managers - to see, 'Is this a good idea?' 'Is this going to help your customers?' That's going to be a major channel of input for us." Such a process, Patel believes, will be far more effective than internal innovation teams, "which become stale and kind of irrelevant pretty quickly."

The emphasis on customers is constant - not a big surprise at a company steering by a concept called customer centricity. Drawing on the work of former Columbia Business School professor Larry Selden, co-author of "Angel Customers & Demon Customers," the strategy is aimed at moving Best Buy away from a mass sale and into a custom one that identifies and deepens the company's most valuable customer relationships. To Best Buy's traditional base of male tech enthusiasts have been added four other core customer types with easy-to-remember names - such as "Barry," a well-heeled guy who might want a home theater installed in time for the Super Bowl next week, and "Jill," a time-starved suburban mom shopping for her kids.

Customer centricity is being rolled out slowly (there were 30-plus laboratory stores as of September, with 70 more stores undergoing conversion) and adjusted along the way. It calls for action on many fronts: adding more personalization capabilities to Best Buy's Web site; reconfiguring individual stores to match the local customer mix; and further training for the gung-ho, noncommissioned sales force on which so much depends for Best Buy. "I can't think of another retailer that's gone to this extreme," says Stacey Widlitz, an analyst who follows specialty retailers for Fulcrum Global Partners LLC in New York and is impressed with the company's direction. Together with a related buildup in services - for example, working with homebuilders to install networks in new homes - customer centricity holds the promise of taking Best Buy someplace where Wal-Mart, the great commoditizer, can't follow.

No wonder, then, that customer centricity also underlies so many of the projects that Robinson and his team take on. Consider, for example, Best Buy's relationship with small businesses, another of the five core customer segments. Many companies with fewer than 10 employees use Best Buy as their primary technology supplier, but until recently, the company hadn't purposefully targeted them. "It makes us realize that we've been underserving them," Robinson says. "And we can serve them better, either with internal development or with investments or acquisitions of other companies." Case in point: The acquisition and buildup of the Geek Squad, done partly with small-business customers in mind (see box).

Of course, Best Buy also has new customers in mind. And it remains the case that many of the best places to look for them are outside the U.S. The Future Shop acquisition was done partly as a first step across the border, and the expansion into Canada (using both Future Shop and Best Buy stores) has gone well. But the Musicland experience remains fresh in the minds of investors, who are sure to scrutinize whatever Best Buy does. "An international acquisition would not be received well," analyst Widlitz says.

For now at least, the company is moving cautiously. A sourcing operation in Shanghai (key to Best Buy's growing practice of selling gear under its own labels) is also helping the retailer gain insights into Chinese consumers. And it is in booming China that Patel (who earlier this year took on responsibility for driving expansion beyond North America) sees the most opportunity. "We're exploring partnerships, we're exploring greenfield," says Patel, who grew up in Africa and England. "Mostly partnerships, because we're a Minneapolis-based company and it's going to take us a lot to learn about Asia."

Still, this is a company that thinks big. CFO Jackson says that one of the big motivations for Best Buy's deepening relationship with Accenture is the need to position the retailer for global growth. In a deal last winter, Accenture took over Best Buy's human resources and payroll functions, and in July the computer services and development giant began a seven-year commitment to run all of Best Buy's information technology operations. Customer centricity has big implications for supply-chain and customer relationship management applications. Accenture's ability to manage them - and also HR functions - in multiple countries around the world was a big factor in the decision to outsource. "Do I want to figure out how to integrate all those payroll and human resource capabilities around the world?" Jackson says. "No. I want to spend my time figuring out how I drive the best value proposition."

The IT deal involved transferring some 600 Best Buy employees over to Accenture. But international growth may also result in some additions to head count - specifically, on Robinson's corporate development team. "As we think about the world scale, we'll probably have to go back and reinvest some dollars in corporate development," Jackson says.

No word yet on what skills Best Buy will be looking for in its new hires. But a knack for learning is likely to be one of them. - Kenneth Klee

Best Buy
Revenue, earnings, stock price and store count, 1994-2004
Year	Revenue ($mill.)	Net earnings ($mill.)	Stock price			No. of stores
Year	Revenue ($mill.)	Net earnings ($mill.)	High	Low	Year end	No. of stores
2004	$24,547	$705	$62.70	$43.87	$53.25	757
2003	20,946	99	53.75	16.99	29.07	679
2002	17,711	570	51.47	22.42	45.35	589 *
2001	15,189	396	59.25	14.00	26.73	432
2000	12,494	347	53.67	27.00	32.00	357
1999	10,065	216	32.67	9.83	30.92	311
1998	8,338	82	10.20	1.44	9.93	284
1997	7,758	-6	4.37	1.31	1.54	272
1996	7,215	46	4.94	2.13	2.79	251
1995	5,080	58	7.54	3.69	3.92	204
1994	3,007	41	5.24	1.81	4.50	151

Revenue mix, 2004
Consumer electronics			37%
Home office			35
Entertainment software			22
Appliances			6
* Reflects acquisition of Future Shop Sources: Best Buy, Yahoo Finance