Bricks and Mortar Versus the Internet: The Battle for Consumer Dollars Continues
E-commerce is growing steadily more important to retailers, and is likely to remain so given consumers’ focus on value.
Once upon a time, the only way for consumers to shop for the latest consumer electronics goods and gadgets was to visit a showroom, where they could check out the latest features and options for themselves. Before buying, they would have to do their own due diligence; educate themselves about the product and hunt around for consumer reports. When Best Buy (BBY.N) opened its first retail showrooms, it became a novelty – and a hit. Consumers could do much of their comparison shopping in a single location, and the company’s stores became a place where they could check out what was new and cutting-edge in the fast-moving world of consumer electronics.
Today, however, some of those innovations appear to have turned Best Buy from market leader to market laggard. The advent of the Internet and smart phone technology has transformed the company into a victim of a phenomenon referred to as “showrooming”, in which customers check out the merchandise in person at a Best Buy showroom, then go to Amazon.com (AMZN.N) or some other online store to buy it at a lower price – often paying no sales tax in the process. Many retailers also offer discounts on shipping, or even free shipping.
E-commerce transactions still make up only a fraction of total retail sales – 5.1% as of the end of the second quarter, compared to 4.2% in early 2010 – but they have changed the shopping patterns of consumers, and likely will only increase with the passage of time. The weak economy is reinforcing this trend: the last thing a consumer wants to do is pay full price, plus tax, and possibly shipping expenses for larger items, at Best Buy. And these days, the power lies in the hands of those consumers. Whereas in the past, manufacturers and retailers controlled the consumer electronics market and in particular pricing, these days, online retailers like Amazon are putting more power in the hands of consumers themselves. Amazon’s “Price Check” application, for instance, enables shoppers to find the best deal, whether it is at Amazon itself or offered by one of the merchants it partners with. Standing in Best Buy and checking prices on Amazon? If you buy it right then and there on your iPhone or Android device, you’ll save an extra $5. (Oh, and Amazon is enlisting your help to keep track of its rivals’ pricing.)
Amazon’s platform has proved enticing – even if you just go there to buy a book or some dog food, all it takes is a single click with your mouse to check out what is being offered in the electronics marketplace. But Amazon will need to continue walking a careful line between offering enough value to keep aggressive bargain-hunters (aka its customers) happy, while not cutting prices so much as to eat into its profits or margins. As we discussed earlier this year on AlphaNow, however, Amazon’s managers seem happy to continue sacrificing profits for growth. For now, investors are prepared to accept that, but the strategy of growth for growth’s sake may not resonate much longer if it comes at the expense of profits.
It is now up to conventional “bricks and mortar” retailers like Best Buy and Wal-Mart Stores (WMT.N) to ensure that they are just as savvy as Amazon is in fighting for market share. Online retailing offers those traditional retailers some advantages as well as challenges: it’s a way to manage inventory levels and control costs in the midst of the constant battle to keep up with technology and with consumers’ wants and needs. Both Best Buy and Wal-Mart have emulated many of the strongest features of the Amazon shopping experience, from offering consumer reviews and comparison shopping to providing suggestions based on the customer’s online behavior for other products in which they might be interested. The downside? There is no sales person there to close the deal. Still, Best Buy’s attempt to blend the best of both shopping experiences – letting consumers shop for the item they want and pick it up in their nearest stores, saving them the shipping costs, is an interesting example of a retailer trying to compete more effectively with Amazon. (For its part, Amazon is rolling out a locker system that will reduce the anxiety of having an expensive electronic device delivered to your front door and left there when you’re not around to sign for it; have the item delivered to a locker and pick it up at your convenience.)
Apple (AAPL.N) is, of course, a unique case. Its product range, from the Mac suite of computers the latest iPhones and iPads, are iconic and put the company in a class of its own, transforming Apple’s retail outlets and its website into more than just another retailer of consumer electronic products. Both in-store and on the site, a key part of the Apple experience is education; you don’t just shop for your new Apple device online, but sign up for an online tutorial on how to get the most for it.
There are a number of uncertainties lying ahead for all online retailers of consumer electronics. Firstly, there is the looming threat of the expiry of special sales tax treatment for online shoppers; bricks and mortar retailers are lobbying states like California to end what they see as the unfair fact that online retailers don’t need to collect sales taxes. This may well continue to pit online players against their bricks and mortar counterparts in the coming months.
Then, as always, there are company-specific considerations to bear in mind. As we have discussed, Amazon’s stated intention is to reinvest its cash in expanding its business – a decision that investors so far have accepted but that may well continue to produce losses to the company’s bottom line. Meanwhile, Best Buy’s future remains murky as the company’s founder and former CEO, Richard Schulze tries to launch a bid to acquire the entire company, backed by private equity firms. That news comes as Best Buy’s management team is still struggling to reinvent itself to compete more effectively with both Apple and Amazon; so far, investors remain wary of the proposal and the stock continues to trade well below the price of $25 or so that Schulze has said he is prepared to offer, subject to due diligence. That may explain why some 12% of the company’s shares have been sold short – a rather high level – according to data from the StarMine Short Interest Model. (See Exhibit 2, below.)
The clock stops for no one. There is no question that the global macroeconomic climate and technology evolution together have affected the way consumers shop, creating in them a desire for instant gratification. To remain competitive in the industry, retailers will have to adapt or be left behind to a grapple with a painful deceleration of profits. Still, Best Buy may offer some potential upside; there is a glimmer of sunshine in its high score on the StarMine Earnings Quality (EQ) model – it earns a rank of 97 – and the fact that analysts’ outlook for the company’s earnings over the coming two quarters has become notably more optimistic.
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