Retailers are on a roll, with July sales data released by the Commerce Department earlier this month suggesting that consumer confidence remained relatively robust early in the third quarter, despite volatility in stock and bond markets. Among the specialty retailers, however, few have had a better year than Best Buy. In what may go down in the annals as one of the best turnaround stories of 2013, the electronics retailer has seen its share price soar more than 190 percent.
A big part of the allure is the fact that Best Buy is a turnaround story, offering investors the chance to play not just a broader economic recovery, but the revival of a particular company. A recent report from Credit Suisse analyst Gary Balter argued that what appears to be taking place is exactly what he has seen occur at other specialty retailers he has covered: a bona fide turnaround.
Given the headwinds confronting retailers – including fierce competition from Amazon on both price and service and consumer demand for value-priced products and great customer service – counting on a turnaround may feel a bit risky. After all, history is full of examples of companies that have failed miserably at reinventing their business model. In today’s retail world, you don’t have to look further than the fierce battle between JC Penney’s board and recently departed board member Bill Ackman, the company’s largest shareholder and architect of its failed recent strategy to halt customer discounts and redesign stores, to see just how badly a turnaround can go wrong. Shortly after JC Penney announced the departure of CEO Ron Johnson, who led the company through the strategy shift, the company reported it had lost $348 million in the first quarter of this year, more than double its losses in the same quarter of the previous year.
But if JC Penney is a case study for what not to do when trying to stage a retail industry comeback, what does work? It all begins with a change in management, Balter explained in a discussion of turnarounds with The Financialist. “The people who get you into the problems tend not to be the people who will get you out of them,” he said. The characteristic common to the successful turnarounds he has witnessed, Balter said in a recent report about Best Buy entitled, “This is Not the End, It Is Barely the Beginning,” is the presence of a visionary management team that is “willing to break down the old silos, to question what would seem like basic ways of bringing product to market and interacting with customers.” In other words, there can’t be any tried-and-true way of doing business that is so sacred it can’t be questioned or changed in the name of helping the business recover lost ground or get an edge on its rivals.
PetSmart, for example, did some things that analysts might have expected, such as cutting spending and making its stores more appealing. But it also found new ways to connect with customers, such as launching a range of “Smart with Heart” specialty foods and introducing pet health campaigns. Moreover, the company purposely strayed from strategies its peers were pursuing. As JC Penney showed, however, it’s not enough to quit following the pack. Turnaround architects also have to think deeply about the company’s customer base. A relative latecomer to the customer rewards card program, PetSmart modeled its version of the popular retailing device on the customer loyalty program offered by gaming company Harrah’s Entertainment, rather than other retail store programs. Just as the casino operator wanted to get more business from high rollers, PetSmart decided to focus on convincing its own big spenders to upgrade further. Segmenting customer data made it possible for the company to offer a customer buying premium dog food a coupon for a free bath – a low-cost strategy that could make the customer a regular user of PetSmart services.
A successful turnaround, then, hinges on the company’s ability not only to understand who its customers are and what they want, but also to identify what they might want down the road. Another element: understanding and correcting something retail customers never want: poor customer service. Balter recalled talking to an employee who moved from a struggling retailer that he covered to a rival that was in the midst of a strategy shakeup. At the employee’s new company, the message he received daily was, “Tell us what we can do to help you sell more.” By contrast, his previous job had seemed to revolve around paperwork and following the chain of command. That’s the same kind of issue that haunted Home Depot in the early 2000s. At first, CEO Robert Nardelli’s strategy of centralizing operations and cutting jobs to make Home Depot’s operations more efficient caused earnings to soar. Nardelli approached growth by expanding wholesale distribution, believing that same-store sales growth was less important.
What Nardelli overlooked or discounted, Balter said, was that the customer experience is critical for any retailer. When shoppers walked into a Home Depot, they found their experiences so frustrating that they decamped to its arch-rival, Lowe’s, where they could find a sales associate who was motivated enough to help them find the right kind of paint or pick out a new set of kitchen cabinets. “Nardelli had turned the company into a machine, forgetting that satisfying customers and employee empowerment is at the heart of any successful retail story,” Balter said. “Now, senior management at Home Depot is there only to solve problems; the company’s headquarters is essentially a store support center. The message to employees is that they are the customer relationship managers.” It’s up to them, in other words, to tell management what they need in order to deliver.
Balter said that kind of culture change lies at the heart of any successful retail turnaround. “You can’t change a business if you don’t change the people,” he explained. In some cases, that may require replacing employees who cannot reconceive the way they think about their roles. In other instances, it may be enough to provide training and support and use compensation structures to drive home the message that there is a new way of doing business. That’s exactly what Best Buy is doing. Going forward, an associate’s pay will reflect not only absolute sales, but also how much merchandise gets returned. Given the ease with which a Best Buy customer can turn to an online retailer like Amazon, “it is more important to satisfy the customer (the first time) than to make the extra dollar on a sale,” Balter said. Returns have been a major problem for Best Buy, amounting to more than 10 percent of sales and costing the company about $400 million, he noted. If the company can solve that problem with better service by more informed associates, they stand to gain $1-per-share in earnings annually, Balter estimated.
Just don’t expect it all to happen overnight. Balter cautioned that not every store branch will buy into a new strategy at first, something Home Depot discovered when it tried to change course post-Nardelli. Also, quarterly financial results are likely to be uneven at any retailer in mid-turnaround, meaning that Wall Street will get frustrated at times. Nor will all the headwinds a retailer faces simply vanish. For instance, like many other specialty retailers, Best Buy has been battling a phenomenon known as “showrooming,” in which shoppers take advantage of the store displays to examine and even test electronic equipment, but then order it online. New partnerships with vendors will help create better-informed and better-trained sales associates; a redesigned website also would help. “A successful turnaround is about whatever makes the customer experience easy, satisfying and enjoyable,” Balter said.
The rewards for changing culture can be enormous. There are examples of companies seeing their stocks trade as much as 10 times higher post-turnaround, Balter noted in his report, citing companies such as Home Depot, PetSmart and Pier 1 Imports. For now, Best Buy is sending out all the right signals. But only time will tell whether the company’s new leaders are able to deliver on their strategy’s early promise.