Thursday, February 10, 2011

Learning from a bad acquisition leads to success at Best Buy

There's a great mistake story at Strategy & Innovation told by Brad Anderson, former CEO at Best Buy. He discusses how they messed up a significant acquisition of mall record store Musicland, but applied those lessons to its subsequent market segmentation strategies, which helped the company emerge from the financial crisis as the leader in electronics retailing:

By 2000, Best Buy was reaching the limits of a growth strategy it had pioneered in 1989 with great success: selling consumer electronics -- computers, TVs, stereo equipment, and the like -- through noncommissioned sales staff in brightly lit, low-cost, free-standing “grab-and-go” stores. It was a simple idea, borrowed from the big-box general retailers, enabling Best Buy to radically undercut the leading competitors like Circuit City, which were operating according to the industry-standard business model: advertise loss leaders to get people into the stores and then use the talents of commissioned sales people to upsell to something far more profitable. 
Looking for avenues of growth, Best Buy could see potential in malls. Musicland, which sold CDs in malls, looked like a smart entry point. “We sold CDs; Musicland sold CDs,” Anderson explained. “We knew CDs were going to disappear; we weren’t that stupid. But we also knew an awful lot of product was being sold in malls.” 
The strategy wasn’t nearly that simple, of course. In 2000, Musicland was a $1.7 billion company generating about $100 million in cash. Since everyone knew CD technology was terminal, Best Buy was able to buy the mall retailer for a bargain price of $600 million. At the time, Musicland, like all the other music retailers, turned over its inventory twice a year. But Best Buy had learned to double that rate in its own stores, and sales had gone up. “So we thought, ‘Wow, how much cash could we create if we go buy the guy that sells it in the malls and move his turns, which were two, to four?’ ” If Best Buy could apply its merchandizing skills to Musicland to double its turnover, the theory went, revenue gains would pay back the investment quickly, and as CD demand declined, Best Buy could bring in its other products, which it could sell for far less than they were currently being sold in other mall stores. It looked like a no-brainer. 
But, as Anderson put it bluntly: “We misread totally what was going on.” Best Buy had increased turnover by decreasing selection, something its customers were apparently tolerating but Musicland customers would not. When the selection declined in the Musicland stores, sales dropped. What’s more, Best Buy initially maintained Musicland’s CD prices, which were $5 higher than at Best Buy stores. Customers assumed that if they were paying mall prices for CDs, they were overpaying for all the other merchandize Best Buy brought in, even though in reality the company was selling its other goods for the exact same low prices it was offering in its stores outside the mall. Dropping Musicland’s CD prices way down to Best Buy levels didn’t shake that impression, nor did rebranding stores under the Best Buy name.
Eventually Best Buy realized that it didn't understand deeply who its current customers were, and who its non-customers were. When they studied that issue, they learned that women, who shopped in mall stores, recoiled from Best Buy's selling proposition. With that knowledge in hand, the company retooled, and focused on female shoppers as a key buying segment. It was too late to save Musicland, which was shut down in 2002, but soon enough to re-energize Best Buy, the success of which drove its nearest competitor, Circuit City, into bankruptcy in 2008.

(Hat tip Rita Gunther McGrath)

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