Static Ahead for Electronics Retailers

Best Buy missed earnings forecasts for the most recent quarter—and there are more difficulties ahead for electronics stores

by Pallavi Gogoi

Last month, as Thanksgiving approached, an intense price war on flat-panel TVs broke out. Two weeks before the holiday, Wal-Mart's (WMT) newspaper insert for Black Friday, the big shopping day after Thanksgiving, was leaked on the Internet, touting 42-inch flat-panel high-definition TVs for $998 a pop. It was the first time a 42-inch HDTV had crossed below the $1,000 threshold.

Within days, retailers Best Buy (BBY), Amazon.com (AMZN), and Circuit City (CC) also dropped their prices on brand-name, 42-inch HDTVs, to around $1,200. In one month, TVs that were going for more than $2,000 were marked down a staggering 40% or more (see BusinessWeek.com, 11/14/06, "Holiday Hysteria").

The degree of discounting lured flocks of people into stores, and TVs flew off the shelves. But those sales came at a price. On Dec. 12, Best Buy, the largest electronics store chain, missed Wall Street analysts' profit estimates for the third quarter ended Nov. 25. The Minneapolis-based retailer reported a lower-than-expected 8.7% increase in net income, to $150 million, as sales rose 16%, to $8.47 billion. Best Buy said an increase in its average sales ticket boosted same-store sales 4.8%, but gross profit margin declined more than expected, to 23.5% from 24.4%. "A very competitive climate put pressure on our margins, resulting in earnings below our original expectations," says Brad Anderson, vice-chairman and CEO of Best Buy.

Gadgets Needed

Executives at Best Buy were at pains to stress that they expected to meet sales and earnings expectations for the rest of the year. "The third quarter ended with very strong top-line growth, and we see solid customer interest continuing into the early part of the fourth quarter," says Darren Jackson, Best Buy's chief financial officer. But that didn't allay investor concerns about future prospects for consumer electronics retailers. Best Buy's shares fell $2.645, or 4.5%, to close at $51.47 (see BusinessWeek.com, 12/12/06, "Best Buy Feels the Squeeze"). Rival Circuit City, which reports earnings on Dec. 19, saw its shares tumble $1.37, or 5.5%, to $23.55.

The trouble for electronics retailers is that the HDTV party appears to be over—and there isn't a next big thing to take its place. Over the past two years, the high prices and rich profit margins of the sleek televisions fueled triple-digit sales increases in some quarters at both Best Buy and Circuit City. Neither retailer forecast such a swift and steep drop in prices. And prices aren't going to go back up—currently Circuit City lists a Polaroid 42-inch HDTV on sale for $999. "The TV product cycle is maturing," says Danielle Fox, retail analyst at Merrill Lynch (MER), who expects both Best Buy and Circuit City to be under pressure from heightened promotions.

As HDTVs approach commodity status, no product on the horizon seems capable of taking its place. While digital SLR cameras and digital music players like Apple Computer's iPod continue to be big sellers, neither of them have the scale or profits of HDTVs. HDTV sales are projected to be about $25 billion this year, while SLR sales will run about $1.5 billion. "The new gadget isn't there yet," says Robert Passikoff, CEO of brand consultant Brand Keys in New York.