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Strategic Report for

BEST BUY CO., INC.

Ian Kwok

Rhett Dornbach-Bender

Rebecca Lange

April 20, 2009

Table of Contents

• Executive Summary
• Company Overview.............................................................................................................
  • History.............................................................................................................................
  • Products & Brands
  • Business Model
  • Market Overview...........................................................................................................
• Competitive Analysis
  • Internal Rivalry
  • Threat of New Entrants
  • Threat of Substitute Products
  • Bargaining Power of Buyers
  • Bargaining Power of Suppliers
• SWOT................................................................................................................................
  • Strengths........................................................................................................................
  • Weaknesses
  • Opportunities.................................................................................................................
  • Threats...........................................................................................................................
• Financial Analysis
  • Overview
  • Profitability and Growth................................................................................................
  • Solvency........................................................................................................................
  • Liquidity........................................................................................................................
  • Stock Chart....................................................................................................................
• Strategic Recommendations..............................................................................................
  • Challenges
  • Short-Term Solutions
  • Long-Term Solutions
• Appendix
• References

Company Overview

Best Buy Co., Inc. (NASDAQ: BBY) together with its subsidiaries is one of the world’s leading companies that operates as a retailer of consumer electronics, home office products, entertainment software, appliances and related services in the United States, Canada, China, Europe and Mexico. It controls retail stores and websites under 11 brand names: Best Buy, Five Star Appliances, Future Shop, Geek Squad, Magnolia Audio Video, The Carphone Warehouse, Best Buy Mobile, Audiovisions, Napster, Pacific Sales and Speakeasy. Best Buy currently has about 165,000 employees worldwide.

The company preliminarily recorded revenues of $45 billion during the fiscal year ended February 28, 2009, a 12.5% increase over 2008. The operating profit during the FY09 was $1.76 billion, an 18.6% decrease over 2008. The net income during the same period was $ billion, a 28.7% decrease from 2008.^1

History

Best Buy was originally founded as Sound of Music, Inc. by Richard Schulze and another partner in 1969. It operated as a single home and car audio specialty store in St. Paul, Minnesota. In 1971, he bought out his partner and began to expand the chain. By early 1980s, Schulze broadened the product line to include appliances and VCRs to target older and more affluent customers. Schulze would continue to expand the product line to suit the needs of his customers.

After almost 20 years of operations, Sound of Music officially changes its name to Best Buy and launches its first superstore in 1983. Best Buy grew rapidly between 1984 and 1987; it expanded from eight stores to 24 and its sales jumped from $29 million to $240 million.^2 In 1985, the company successfully raised $8 million in an IPO on NASDAQ.

To set Best Buy apart from its competitors, Schulze introduced the warehouse-like store format in 1989 and took sales staff off commission. The number of employees per store was reduced by about a third, resulting in significant cost savings. This concept was crucial to

Best Buy’s ascent to become the second largest consumer electronics retailer in the U.S. by

1993.^3

Best Buy continued to expand aggressively in the following years and found itself in a large amount of debt in 1995. In 1997, earnings plummeted and the company realized it had overextended itself with its expansion. The company initiated a massive makeover, scaled back operations and controlled inventory more tightly.

Since then, Best Buy has flourished once again under superior management (see Appendix 1 for biographies). The company implemented innovative concepts in its stores, expanded domestically and internationally, and quickly became the world’s leading consumer electronics retailer. As of February 28, 2009, Best Buy is the largest consumer electronics retailer in the U.S. with a domestic market share of 22%.^4 Table 1 details the company’s developments since 2000.

Table 1: Best Buy Historical Development since 2000^5 2000
Best Buy entered the online retailing business by launching www.bestbuy.com.
Fortune Magazine named Best Buy one of the top 10 performing stocks since 1990. (^2001)
The company acquired Magnolia Hi-Fi, Inc. for $87 million.
The company entered the international marketplace by acquiring Canada-based Future Shop, Inc. for $377 million. (^2003)
The company launched dual-branding strategy in Canada by opening Best Buy stores.
Best Buy acquired Geek Squad, Inc. for $3 million. 2004
Forbes Magazine named Best Buy “Company of the Year”.
Began testing the customer-centricity operating model in over 50 stores. 2005
Best Buy opened its first Magnolia Home Theatre store-in-store concept. The company later adopted this strategy for Geek Squad as well.
The customer-centricity operating model was a success and all stores will transition to this model.
Best Buy acquired Audiovisions, Inc. for $7 million. 2006
Best Buy acquired Pacific Sales, Inc. for $410 million.

3. Geek Squad – provides residential and commercial computer repair, support, installation and related services in U.S., Canada, China, and U.K. It operates both within Best Buy stores as well as several standalone stores.
4. Magnolia Audio Video – a Seattle-based, high-end retailer of audio and video products. It operates both within Best Buy stores as well as several standalone stores.
5. Jiangsu Five Star Appliances – the fourth-largest appliance and consumer electronics retailer in China and sell similar a product line as Best Buy.
6. The Carphone Warehouse – Europe’s leading independent retailer of mobile phones and services.
7. Best Buy Mobile – a U.S.-based retailer that sells similar products as The Carphone Warehouse. It operates within Best Buy stores as well as several standalone stores.
8. Pacific Sales – offers kitchen, bath and home improvement products in Southern California.
9. Speakeasy – a U.S.-based provider of broadband, voice, data and information technology services.
10. Audiovisions – a U.S.-based commercial and residential video/audio systems integration firm.
11. Napster – a leading online provider of digital music.

Business Model

Best Buy’s current business strategy has two primary goals: offering customers the widest range of products at the lowest prices and expanding into new international markets. The company’s recent acquisitions and new business ventures have been in these two directions. The management is positive that these two strategies will allow Best Buy to be in a favorable position to grow domestically and internationally.

Customer-Centricity Operating Model Best Buy’s success thus far is a testament to its commitment to “treat customer as unique individuals [and] meeting their needs with end-to-end solutions.”^6 Since 1989, Best Buy prides itself as one of the earliest retailers to adopt the strategy of non-commissioned

employees to give customers more control during the purchasing experience. In 2004, Best Buy began implementing an innovative strategy it calls customer-centricity in its stores. Through these strategies, Best Buy has differentiated itself as a store that provides mid- to high-end electronics and entertainment systems and excellent customer service.

The customer-centricity operating model views Best Buy as a portfolio of customers rather than products. It forces the company to understand its customer base at a deeper level and better target its needs. In 2004, Best Buy tracked its customers’ behaviors and identified five initial customer segments that represented significant new growth opportunities. The segments were each given a name^7 :

1. Jill, the busy suburban mom who wants to enrich her children’s lives with technology and entertainment.
2. Buzz, the focused, active, younger male customer who wants the latest technology and entertainment.
3. Ray, the family man who wants technology that improves his life – the practical adopter of technology and entertainment.
4. Barry, the affluent professional who wants the best technology and entertainment experience and who demands excellent service.
5. BB4B (Best Buy for Business), the small business customer who can use Best Buy’s product solutions and services to enhance the profitability of his or her business. Best Buy tested out these segments at 32 U.S. stores by training and empowering employees to better meet these customer segments’ needs. It allowed employees large discretion in making the store more appealing to their particular customer segment. The results were astounding. The lab stores sales were an average of 7% higher than other U.S. Best Buy stores. Close rates (the percentage of shoppers who make a purchase) also rose by approximately 6%.^8 SG&A for the stores were expectedly higher, but the model helped lower employee turnover from 81% in 2005 to 69% in 2006.^9 The company decided to adopt this strategy with all of their stores and the transition was fully completed in 2007. To this day, Best Buy continually revises the customer segments in order to capture new growth opportunities.

Figure 1: Best Buy Global Store Count (as of February 28, 2009)^12

500

1,

1,

2,

2,

3,

3,

4,

4,

Q205 Q405 Q206 Q406 Q206 Q406 Q206 Q406 Q206 Q Fiscal Year-end Domestic Stores International Stores

Table 2: Best Buy Global Store Breakdown (as of February 28, 2009)^13

Store Type U.S. Canada China Mexico Europe

Acquire Year

Best Buy 1023 58 5 1 0 N/A

Future Shop 0 139 0 0 0 2001

Magnolia AV 6 (standalone) 0 0 0 0 2001

Geek Squad 6 (standalone) 0 0 0 0 2003

Pacific Sales 34 0 0 0 0 2007

Five Star Appliances 0 0 164 0 0 2007

The Carphone Warehouse 0 0 0 0 2465 2008

Best Buy Mobile 38 (standalone) 3 0 0 0 2008

Distribution The distribution system is crucial to Best Buy’s operations in order to meet its customer needs. Generally, U.S. Best Buy stores’ merchandise, except for major appliances and large- screen televisions, is shipped directly from manufacturers to the distribution centers located in California, Georgia, Indiana, Minnesota, New York, Ohio, Oklahoma and Virginia. Major appliances and large-screen televisions are shipped to satellite warehouses in each major market. The distribution system in the international segment operates similarly. The Canada stores’ merchandise is shipped directly from the suppliers to the distribution centers in British Columbia and Ontario. Five Star Appliances stores’ merchandise are received and warehoused at more than 50 distribution centers and warehouses. The China Best Buy store’s merchandise is shipped directly from the suppliers to the distribution center in Shanghai. In order to meet release dates for selected products and to improve inventory management, certain merchandise is shipped directly to the stores from manufacturers and distributors.

Suppliers In fiscal year ended March 2008, the 20 largest suppliers accounted for just over 60% of the merchandise purchased, with five suppliers — Sony, Hewlett-Packard, Samsung, Apple, and Toshiba — representing just over one-third of total merchandise purchased.^14 Best Buy generally does not have long-term written contracts with the major suppliers. The company, however, has not experienced significant difficulty in maintaining satisfactory levels of supply.

Best Buy operates global sourcing offices in China in order to purchase products directly from manufacturers in Asia. These offices have improved the product sourcing efficiency and provided the company with the capability to offer private-label products that complement the existing product line. In the future, the company expects purchases from the global sourcing offices to increase as a percentage of total purchases.^15

Figure 2: Real Disposable Personal Income (Percent change from preceding quarter)^16

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

Q102 Q302 Q103 Q303 Q104 Q304 Q105 Q305 Q106 Q306 Q107 Q307 Q108 Q

Figure 3: Year-on-Year Growth of Retail Store Sales^17

-10.00%

-5.00%

0.00%

5.00%

10.00%

15.00%

Q102 Q302 Q103 Q303 Q104 Q304 Q105 Q305 Q106 Q306 Q107 Q307 Q108 Q308 Q

Electronics and Appliance Retail Stores All Retail Stores (excl. Motor Vehicles and Parts)

Competitive Landscape For many years, Best Buy’s most direct competition comes from Circuit City, the second largest consumer electronics retailer behind Best Buy. Circuit City’s business has been struggling since 2006 and filed for bankruptcy protection in November 2008. Circuit City was forced into liquidation by March 2009. The company stands to gain lot from Circuit City’s demise. According to one research report, Best Buy would be able to capture as much as 40% of Circuit City’s market share.^18

With $45 billion in revenue for the fiscal year ended February 28, 2009, Best Buy is the largest consumer electronics retailer in the world. No other pure consumer electronics retailer comes even close to Best Buy’s size and performance. RadioShack, currently the second largest consumer electronics retailer recorded $4.2 billion in revenue for the fiscal year ended December 31, 2008.^19 Despite the lack of immediate comparable rivals, Best Buy still faces a wide array of indirect competitors:

1. Unspecialized discount retailers such as Wal-Mart, Target and Costco.
2. Online retailers such as Dell, Amazon.com, and eBay.
3. Entertainment software stores such as GameStop.
4. Office supply stores such as Staples, OfficeMax, and Office Depot.
5. Home improvement retailers such as Home Depot and Lowe’s.
6. Small retailers with little overhead (including internet vendors). While Best Buy has no direct competition, but has a many rivals in each of its product categories.

(3.80%). This implies that competition is quite fierce, and profitability and survival is depended on inventory turnover. Circuit City had to liquidate its assets because it was not able drive sales as effectively as other competitors over the past several years. Combine the level of competition with the current economic conditions, many companies in the industry must find it more difficult to continue operations as they did in the past several years.

Threat of New Entrants

The threat of potential new entrants into the consumer electronics retail industry is relatively low. The market capital of the industry, according to Yahoo Finance, is currently at $23. billion. This figure is substantially lower than other industries such as Apparel Stores ($37. billion), Home Improvement Stores ($53.0 billion) or Discount Variety Stores ($240. billion). The low market capitalization implies that it would not be difficult to enter the industry based solely on the capital required. However, a potential entrant would have to overcome the superior brand reputation that Best Buy has established. Best Buy has built a reputation for selling mid- to high-end product and excellent customer service. It would be difficult for an entrant to challenge the company. Furthermore, it would be difficult to undercut incumbent firms who have already established relationships with suppliers to purchase merchandize at the lowest prices.

Although the threat of entry is low, the potential pool of entrant is actually quite large as it consists of numerous online electronics retailers. These online retailers are the most likely candidate to enter the consumer electronics retail market because they already have large existing inventories and extensive experience dealing with customers – two key factors that give them a potential edge. The fact that they are currently only online retailers suggests that acquiring real estate is a significant entry barrier. However, once an online retailer is able to establish a strong reputation with customers, it is likely to enter the industry to captures additional sales through non-web customers. As mentioned, the NPM of the industry is low (3.80%). This means that a key component to be successful in this industry is to drive sales and have high inventory turnover. High inventory turnover implies that large inventories are

required in warehouses. Together, these two factors make a very significant barrier to entry for potential entrants.

Threat of Substitute Products

The substitute products that may take a portion of the market share away from the consumer electronics retail industry do no pose a huge or direct threat. Today’s society and culture places a lot of emphasis on technology and is highly dependent on electronics. As a result, there are few substitutes for electronics that will directly take their place, such as books, magazines and other non-electronic hobbies to occupy people’s time. Some of the main retailers of books are Barnes and Noble, Borders and the online retailer Amazon.com.

Bargaining Power of Buyers

The bargaining power of buyers for electronic products is extremely low because the buyers primarily consist of a weak and fragmented group of individuals. There are several reasons for this:

1. The purchase volume is very low. Most people do not go to Best Buy and purchase 10 HD TVs or 10 DVD players, for example. The typical individual will purchase one item of a specific product. So the buyers often do have any influence on prices.
2. The cost of buying electronic products is not a huge percent of a buyer’s budget, unlike purchasing a house or car. Also, there is no intense competition between buyers for any one brand (i.e. Sony, Panasonic, Samsung, and etc.).
3. Because electronic products are often a luxury than a necessity, buyers do not generally have a say in what products get produced and at what price.
4. Most importantly, buyers do not have the ability to integrate backwards because it is not feasible for individuals to build their own electronic products or establish their own retail shops. As a result, the buyers in the consumer electronics retail market do not have any substantial bargaining power over the companies in the market and do not have any substantial influence on the products or prices.

SWOT

Strengths

Demonstrated financial strength Best Buy has consistently recorded strong growth. The company’s revenue grew at a CAGR of 9.90% during FY05-08, from $27 billion to $40 billion. Operating profit grew tremendously at a CAGR of 10.64% during FY05-08 from $1.4 billion to $2.1 billion. Also net income increased by a CAGR of 9.35% during the same period, from $980 million to $1.4 billion. The increase in net earnings was driven by revenue growth and a decrease in selling, general and administrative expense rate, offset by a decrease in gross profit rate and a higher effective income tax rate. With the huge increase in its operating and net profits over the years, the company strengthened its financial position in the market.^21

Reputable Brand Name Best Buy is recognized as one of the best companies in the world because of its sound management. In 1993, the company became the second largest consumer electronics retailer and in 2000, Fortune magazine named it one of the top 10 performing stocks. Best Buy was named company of the Year by Forbes magazine in 2004, Specialty Retailer of the Decade by Discount Store News in 2001, ranked one among the Top 10 America's Most Generous Corporations by Forbes magazine and made Fortune Magazine's List of Most Admired Companies in 2006.

Expansive Store Coverage Over the years, Best Buy has built a name for itself through offering a wide selection of products and excellent services. This has allowed Best Buy to opened many stores both domestically and internationally during the past several years. At the end of FY09, the company operated approximately 1,100 domestic retail stores. On the international front, the company operated approximately 3,000 stores. Going forward, the company plans to open more stores in new countries such as Turkey and Mexico.

Weaknesses

Dependence on United States market Although Best Buy has international operations in China, Europe and Canada, the company mainly derives its revenues from the U.S. market. About 83% of the company’s total revenue comes from the U.S. Furthermore, the company relies heavily on the sales of consumer electronic products. Therefore, this high market concentration in the U.S. can result as a big disadvantage for the company in the long-run as consumer electronic products decrease from 42% in 2007 to 41% in 2008 in the revenue mix. It could significantly affect the revenues of the company and also its expansion opportunities if it continues to focus only in the U.S. market. Best Buy needs to further diversify its revenue generating sources.

Dependence on select number of vendors for its merchandise Best Buy mainly depends on a handful of vendors for the supply of their products. Best Buy’s 20 largest suppliers account for just over 60% of the merchandise it purchases. If any of key vendors fails to supply products or if there is any disruption and loss from any vendors the company may not be able to meet the demands of the customers which can result in the decline of revenues.

Opportunities

New ventures The recent joint venture between Best Buy and The Carphone Warehouse is an exciting opportunity for the company to expand into new geographic locations in Europe. The consumer electronics market has been one of the fastest-growing industries in the European market over the past five years.^22 The management will have to be careful in this expansion and try not to overextend its resources.

Bankruptcies Best Buy’s largest competitor, Circuit City, filed for bankruptcy at the end of 2008 and is closing 155 stores. This will prove to be tremendous opportunity for Best Buy to gain market share as competitors scramble to fill the void left by Circuit City. Many other