Best Buy’s Failure in China Lea Pernet and Paulina Nunez-Candiani INTB4501/ Advanced Global Management Alvaro Cuervo-Cazurra April 25, 2012 Best Buy Co. is a “multinational retailer of consumer electronics, home office products, entertainment products and related services” 1. The group is the largest U. S consumer electronics retailer by revenue. In 2006, Best Buy made its first steps in China with the acquisition of a Jiangsu Five Star, a Chinese retailer and opened its first Chinese store under its name in Shanghai, soon followed by eight others.
With a consumer focused strategy, Best Buy was hoping to capture part of the electronics retailing market, so far dominated by the local retailers Gome and Suning. However, in 2008 the group’s net earnings had decreased by 77 percent from the previous year. No later than February 2011, the multinational announced it would close all nine of its branded stores. This report analyses the reasons of Best Buy’s failure in China and tries to assess recommendations for the company to approach the Chinese market. 1 SITUATION ANALYSIS Best Buy in the USA History of Best Buy
The company started in 1966 when Richard Schulze and James Wheeler opened a store called “Sound of Music” in Saint Paul, Minnesota. At the beginning, the company focused on home and car stereos. In early 80s Schulze realized that there was little potential selling audio components to a shrinking audience with little resources and began focusing on appliances and VCRs2. The company’s name was given when they had a special sale event they called “Best Buy”. After the success of this event, the board of directors approved the name for the company.
The design of the stores was introduced in 1989 and had spacious 44,000ft warehouse -like layout. The company overtook Circuit City as the leader in electronics retailer by revenue. In 1998 Best Buy entered e-commerce by launching a site that sold CDs and DVDs. Shortly after, the offering expanded into consumer electronics, computers, software and games. In 2002 Best Buy bought Geek Squad, a computer maintenance and repair company, and began to incorporate it into existing store locations. In more recent history Best Buy has been extremely successful in supplying demand for flat screen TVs and cell phones. Best Buy is recognized as a “big-box” store, which is defined as a physically large retail establishment being usually part of a chain. Best Buy was one of the first stores to implement the ‘big box’ model stocking mostly high technology/electronic items, and also home appliances sometimes. It’s important to mention that in 2011 after the company reported a $1. 7 billion loss and the closing of 50 big-box stores, “the opening of 100 smaller format mobile stores, and the culling of 400 employees”4 the company started thinking if this model was the best for them of not. A price competitive strategy threatened by online retailing
From its creation, Best Buy’s success relied on a price competitive strategy. However, the arrival of online retailers who do not have to bear as much overhead costs as Best Buy has significantly threatened America’s largest electronics retailer’s strategy. At the beginning the company’s competitive advantage was primarily the price. The company has had its share of ups and downs and endured many challenges that overwhelmed some of their competitors. In the late 80’s numerous competitors crowded the electronic retail space that resulted in price rivalry on popular consumer items.
Many companies took hits on profit margins by slashing prices to sell hot items such as VCRs. Best Buy’s sales had nearly doubled in 1988, but their net earnings fell 64%. 5 Although battered, Best Buy survived the price wars when some of their major competitors including Highland Superstores and Dixon’s Group’s Silo Holdings were forced to liquidate. Throughout the 1990s, Best Buy entered yet another intense battle with its main rival, Circuit City. The rapid expansion and intense competition caused the company’s stock to swing wildly in 1994.
Best Buy surpassed Circuit City in the late 1990s which eventually declared bankruptcy in 2008. 2 The company is now having problems competing with online retailers. Amazon’s example speaks for itself since its brand increased by 32% in 2011 while Best Buy declined by 11%. 6 Whilst Best Buy is now the largest electronics retailer in the US, Amazon has seen its revenues grow at a much faster rate and is expected to take the number one position by 2012. Best Buy’s net income is down 30% to 154 million for 2011 fiscal year. 7 The company’s CEO, Brian Dunn, has recently resigned because of inappropriate personal conduct allegations.
Best Buy’s stock price continues to set new 52 week lows. In order to improve its situation, the company plans to reduce store locations and sizes. 8 Moreover, Best Buy is struggling with an excess of overhead costs because it is a brick and mortar retailer and therefore it has large operational costs to run and maintain its locations. There are a lot of factors that contribute to the overhead costs. In addition to paying rent for the leased locations, Best Buy also incurs real estate taxes, insurance, and area maintenance fees, which the company has to incur to stock products on its sleeves.
These overhead costs have to be reflected in the price of the products offered, thus preventing Best Buy to compete on price alone with online retailers. Finally, another current and important disadvantage for Best Buy is tax regulations. Indeed, in most American states, the customer must pay a sales tax when purchasing an item at a store, which can often be avoided by purchasing from online retailers. These disadvantages that Best Buy has in comparison to its online competitors made the company to reevaluate its competitive advantage in the US. A consumer centric strategy
Such weaknesses amongst online retailers made Best Buy to reevaluate its competitive advantage in the US by putting the emphasis on services which competitors like Amazon cannot provide. Nowadays, Best Buy focuses its competitive advantage on a consumer -centric strategy by building a superior service to differentiate itself from online retailers. By extending its offers to warranties, in -home installation and configuration services, Best Buy hopes to position itself as a retailer who cares about its customers and provides them with the utmost services9.
Best Buy’s 2006 annual report synthesizes their positioning strategy as the company that “excels based on its fun, interactive store experience; broad product assortments; name brands; knowledgeable empl oyees; and ability to offer services. ” Best Buy is an ideal location for many new electronic product launches because customers can come into the stores and try out the product. The employees are typically dedicated to a specific section of the store to familiarize them with a product category, so they can best assist and educate customers.
In 2006 Best Buy decided that they had to “transform (their) company, and (their) transformation (had) moved beyond the tipping point. (They) believe (d) that the best way to boost returns (was) to invest in (their) customers and employees” (Best Buy’s 2006 Annual Report. ) An obvious element of this consumer-centric strategy is a focus on employees’ quality service. As Brian Dunn -Best Buy’s chief executive, explains in his interview with Marc Gunther: “We are leveraging our people as a competitive advantage.
We stand on the shoulders of all the people who have worked on the floor for the past 40 years at Best Buy. ” Indeed, the success of a consumer -centric strategy relies on the quality of the company’s service. “Several years ago, for example, Best Buy executives decided to save money — about $10 million a year — by cutting back on employee discounts. The reaction from workers was swift and 3 negative, and the company pulled back. ” 10. Such an example reveals the importance of the workers’ service to customers on the company’s profits and thus the appropriability of this competitive advantage to the company.
However, Best Buy’s competitive advantage of customer service is serving Amazon to generate more sales by being Amazon’s “showroom”. Indeed, a trend has started where people visit Best Buy to try a product and then purchase it online for a cheaper price. As an incentive to follow this trend, Amazon has facilitated the price comparison process by releasing Price Check. This mobile app, “available on Android and iOS, lets the user scan a barcode and instantly find the merchandise price on Amazon”11 Best Buy in China Entering the Chinese market
With such threats on their domestic market, Best Buy decided to double its efforts in foreign markets. With a two digit growth of its middle-class, China represented a promising potential market which the company saw as an opportunity to boost its sales globally. Having operated in China in the past, Best Buy decided to enter the Chinese market in 2006 through the acquisition of Five Star -China’s third largest electronics retailers. China represented a great opportunity for Best Buy to expand due to economic and social factors. China’s population of 1. billion people and an annual GDP (Gross Domestic Product) growth of 10. 7%, a strong middle class emerging and which rose from 6. 5 million to 80 million whose per capita income surged from RMB 21,739 per household in 2006, representing a “robust 50% increase over 2001 in real terms”12. By way of example, in 2004, Gome -the largest chain retailer of home electrical appliances in China, reported a 189% increase in profits due to increased customer demand. Most certainly, Best Buy saw a substantial market opportunity in China. Moreover, the company already had operated in China for purchasing purposes.
In 2006 Best Buy operated three global sourcing offices in China in order to purchase products directly from Asian manufacturers. These offices improved Best Buy’s product sourcing efficiency and provided them with the capability to offer private-label products, which complemented their existing product assortment, in order to achieve an increase on the total purchases and an improvement on the gross profit rate by lowering their overall product cost13. Having a first step in China most certainly made Best Buy confident they could start selling in the country.
Indeed, their 2006 annual report indicates that Best Buy had six priorities for fiscal year 2007, the sixth being the pursuing of an international growth strategy for which they had plans to embark on a controlled growth strategy in China opening their first store in Shanghai. In 2006, Best Buy entered into an acquisition of 75% of China’s third-largest retailer of appliances and consumer electronics, “Jiangsu Five Star Appliances”. This acquisition provided Best Buy with a strong management team that was familiar with local customers and business models.
Moreover, it was an opportunity for the American retailer to increase its knowledge of Chinese customers. Best Buy obtained 4 immediate retail presence in China and enhanced its expansion by opening its first Best Buy-branded store in Shanghai in December 28, 2006 (See Exhibit 1). By 2007 Best Buy and Five Star in China occupied 4. 3 million retail square feet in China, the equivalent of about 10% of the total retail square footage (See Exhibit 2), operating “135 Five Star stores in seven of China’s 34 provinces and one China Best Buy store in Shanghai”14.
By March 2008 the company operated 160 Five Star stores in China and one Best Buy store which represented 5. 9 million retail square feet. In 2009, Best Buy acquired the remaining 25% of Five Star and converted the Chinese retailer into a “wholly-owned foreign enterprise”, 100% owned by Best Buy. In 2009 the company expanded their Best Buy stores, they operated 169 total stores in China, 164 Five Star stores and 5 Best Buy China stores all located all in Shanghai (See Exhibit 3), and by the end of 2011 the company had a total of 8 Best Buy stores (See Exhibit 4).
From Five Star to Best Buy Management and operations of Best Buy in China were very similar to the ones in the U. S and Canada. In its 2007 annual report, Best Buy explains that its first store in China “employ(ed) an operating model similar to (their) U. S. Best Buy and Canada Best Buy stores. (Their) China Best Buy store (was) staffed with a general manager; assistant managers for operations, merchandising, inventory and sal es; and approximately 340 sales associates, including full-time and part-time sales associates.
Advertising, merchandise purchasing and pricing, and inventory policies for (their) China Best Buy store (were) centrally controlled by corporate management. Meetings involving store management and corporate management (were) held on a regular basis to review operating results and establish future objectives. ” Therefore, in terms of organization, Best Buy in China was managed in a similar way that their American or Canadian stores. One of the biggest challenges for the company when opening a Best Buy-branded store, was their lack of brand equity.
On the one hand, Five Star was the third biggest electronics retailer in China. But on the other hand, Best Buy had very little brand recognition in China while Gome and Suning -China’s number one and number two electronics retailers, were widely known of Chinese consumers. “One of the biggest contributing factors has been establishing brand identity amongst Chinese consumers. Whilst Best Buy is a global retail brand and a particularly formidable force in its domestic US market, it was relatively unheard of in China prior to its acquisition of Jiangsu Five Star.
In contrast, both Gome and Suning are household names in China. ” 15Consequently, Best Buy had to invest significantly in marketing in order to build brand recognition. As part of its brand strategy, Best Buy decided not to change its name in China but to convert it to its phonetic equivalent: Baisimai. However, the choice of name might have been a bad move as China Briefing Magazine explains: “Many consumers even commented that the Chinese name of Best Buy – Baisimai – as a bad one for marketing. Baisimai literally means ‘to buy after thinking 100 times16’. ” Best Buy’s business strategy in China
Boosted by their consumer-centric strategy in the US, Best Buy decided stay consistent and offer an utmost services range to its Chinese consumers in order to differentiate itself from domestic competition. The strategy mainly relied on qualified and objective salesperson, not biased by commission like most Chinese retailers’ are. 5 Contrary to its strategy in North America where stores are located in the suburbs with the convenience of parking lots, Best Buy opened its eight stores in urban environments of Shanghai, most of them in Pudong which is the historical center of Shanghai.
Perhaps they did so because this is where most Chinese retailers settle too since the number of cars per household in China is relatively low. However, most locations were not conveniently located. For instance, one of the Best Buy -branded store was situated in between two metro stops which customers complained about a lot on forums. In fact Best Buy decided to focus on building “large flagship stores, like in the U. S. , rather than smaller, conveniently located retail outlets.
China may have one of the highest car adoption rates in the world, but its perennial traffic congestions and lack of parking means consumers often prefer to shop closer to their homes. ”17 Best Buy’s store in China offered merchandise in three product groups, consumer electronics, home office and appliances. But the differentiation strategy of Best Buy did not rely on its product offer but on its services. With the objective of transferring its competitive advantage in China, Best Buy developed a consumer-centric strategy. Best Buy chose to take an alternative approach to the China market: it focused on a service-based business model. It sold the same installation, repair work and guarantees offered to customers at U. S. Best Buy stores and staffed its outlets with knowledgeable employees who did not push for sales. To prepare for its entrance into China, Best Buy handpicked customer service representatives from China and trained them at company headquarters in Minnesota to provide a higher level of service not typically found in China, much less in China’s bargain electronic retailers.
Best Buy would provide what they thought the China market needed: service with a smile. ” 18 Salaries of salespersons in the Chinese stores did not include commissions on sales since Best Buy wanted its sales force to work in total impartiality. “The U. S. -based appliance retailer is banking on a strategy adopted by its North American operations, under which its salespeople will work on a noncommission basis to guarantee unbiased advice, the company’s China chief said. Based on our understanding of Chinese consumers, we have an advantage of our model in China. It’s such a growing marketplace and retail chains only command a small part of the market,’ Best Buy China chairman Weimin Lu said in an interview. ‘The biggest thing for us is to learn about the Chinese consumer and the consumer electronics retail market in general. ’ Sales staff in Chinese retail chains such as market leader GOME Electrical Appliances Holding Ltd. and Number 2 Suning Appliance Co. Ltd. , generally work on commission for various brands. ”19 .
Unlike its Chinese competitors whose salespersons were encouraged to sell particular brands in order to obtain their commissions, Best Buy would offer a more ethical environment with reliable, objective and unbiased salespersons. An unprofitable expansion Nevertheless, Best Buy’s strategy in China proved to be unprofitable. In 2008 Best Buy’s international segment’s gross profit rate “decreased by 0. 9% of revenue to 20. 7% of revenue. Therefore, the company lowered its costs and by 2008, its international segment’s Selling, General & Administrative Expense (SG&A) rate “decreased by 1. % of revenue to 18. 3% of revenue. (Their) China operations, which carr(ied) a significantly lower SG&A rate than (their) Canada operations, reduced (their) International segment’s SG&A rate by approximately 0. 5% of revenue in fiscal 2008” (Best Buy’s 2008 Annual Report). 6 Although Best Buy cut significantly cut its expenses in China, results were still not satisfying. “(Their) China operations, which operate(d) at a significantly lower gross profit rate than (their) Canada operations, reduced (their) International segment’s gross profit rate by approximately 0. 7% of revenue in fiscal 2008.
The remainder of the decrease in (their) International segment’s gross profit rate was due primarily to the increased sales of lower-margin products in both (their) Canada and China operations, which was partially offset by rate improvements in certain product categories as well as l ower financing costs in Canada”20 In 2010, the company’s international segment operating income “resulted primarily from higher operating income in Europe and China”21. However, during 2010 the company faced a decrease of revenue of 0. 3% in China caused primarily by “cost-cutting measures to reduce overhead, payroll and arketing expenses”22 Despite these results, the company continued to expand its brand in China, and by the e nd of 2011 the company had a total of 8 Best Buy stores (See Exhibit 4). However, in the fourth quarter of fiscal year 2011, Best Buy announced plans to “restructure the Best Buy branded stores in China during fiscal 2012. Restructuring activities in China include closing all eight Best Buy branded stores. (They) also intend(ed) to explore other more profitable growth options for the Best Buy brand in China, including the option to reopen two of the closed stores at a later date” 23.
All of the eight branded stores were closed by the end of 2011. The Electronics Retail Market in China The rise of a cost-effective business model The Chinese appliances and electronics retail market has witnessed a determinant restructuring during the late 1990s. By building a strong logistics strategy, retailers have significantly lowered their overhead costs. “From 1993 to 2000 (before the rise of chain-store retailers), the average sales cost ratio (sales costs/revenue) of China’s major household appliance manufacturers rose from 2. 9% to 10. %. ”24. But by restructuring their whole business model, Gome and Suning rapidly took over the appliance and electronics retail market in China. The Chinese electronics retailers’ strategy and organization significantly differs from the typical American Big Box model. Indeed, Chinese retailer usually owns a large store and rent part of it to different brands. For instance, Gome, one of China’s biggest electronics retailers, owns retailing stores in which representatives of electronics brands such as Nokia or LG rent their selling area.
Therefore, the Chinese retailers’ revenue includes the rents from the brands as well as a commission on every brand’s profits (Ni, V. ) Therefore, Chinese retailers are extremely price competitive by passing costs directly to manufacturers. “Gome’s 2008 Annual Report revealed that its income from suppliers consisted mostly of such fees charged to suppliers for promotional activities, management services, and display space leasing. The total was RMB 2. 5 billion, which was nearly one billion more than the earnings before tax of the entire company.
Suning’s related income in 2008 was RMB 1. 4 billion, which contributed 48% of its earnings before tax. ”25 7 As a consequence to this Chinese business model, the sales strategy for Chinese electronics retailers relies highly on commissions “as a result sales personnel are keener to sell and meet their quotas in order to increase their personal incomes. This has resulted in higher sales per employee for domestic retailers. ” 26 As opposed to Chinese retailers, Best Buy’s non-commission strategy aimed at building impartiality as a differentiating aspect.
Such differences implied costs on Best Buy’s side which its Chinese competitors did not have to bear and thus prevented the multinational from being price competitive. An oligopolistic market On the one hand, the Chinese household appliances and electronics market is largely dominated by two retailers -Gome Electrical Appliance (Gome) and Suning who have been fighting for the first place. In 2006, Gome was China’s largest retailer in the industry with approximate sales of $10 billion, it ran 420 stores and employed about 300,000 people and Suning was very close behind Gome. 7 As a response to the arrival of foreign competition, both retailers initiated aggressive expansion strategies and started entering into acquisition with smaller retailers. As a result, in 2011, Suning ran 1,300 stores in China and took away the first place of Chinese electronics and appliances re tailer, leaving Gome with the second position with 700 outlets in China. On the other hand, independent convenience stores are still very present in the electronics retail market in China.
They have significant advantages over bigger retailers like Suning and Gome in terms of customer relationship “Independent local players, which account for more than 50 percent of the rural market, have advantages including being able to use their familiarity with local spending behavior to adjust their offerings and provide customized product advice to their customers. ”28 However, through their recent numerous acquisitions with small retailers, Suning and Gome have countered this disadvantage and widen their local, convenient presence and thus built a strong advantage on multinationals.
Indeed Chinese top retailers’ strong and fast supply chain management enables them to keep a large selection adapted to local needs throughout its fleet of stores. “Consider televisions. Rural consumers tend to prefer big screen TVs, which confer greater status in their villages while urban shoppers are more focused on quality and brand, according to Zhu. While national operators like Suning and GOME will struggle to compete with local chains, their wide selection of fast -selling electronics products may give them an edge over foreign players such as Wal-Mart and Carrefour.
When asked recently about flat-screen televisions, a salesman in the small electronics department of a newly opened Carrefour in the second-tier factory town of Dongguan suggested the reporter look elsewhere. ‘You can probably get a wider choice of products in the Suning just down the street,’ he said. ”29 The perceived value of Best Buy’s offer in China Many of Best Buy’s products were considered too expensive compared to the local market. Paradoxically, Best Buy’s prices were similar to its main competitors’ – Gome and Suning. However, Chinese consumers positioned Best Buy at a higher perceived price range. 0 8 Part of this misinterpretation might be due to the fact that the Best Buy was recognized as a multinational, considered to charge at a higher price. But the main reason why Best Buy’s prices were considered higher relies on the business model itself. Indeed, Best Buy’s non-commission strategy was accompanied by a fixed-price policy. Therefore, salespersons had no possibility to bargain products whereas Chinese retailers have a more adjustable and aggressive bargaining strategy by which they “lower prices within pre-defined limits if it ensures a sale.
This flexible approach allows retailers to price discriminate and maximize revenue from different income groups. Whilst consumer attitudes towards flexible pricing may be negative in North America or Western Europe, it is firmly embedded in the shopping experience in many Asia Pacific markets, especially China. ”31 Finally, the surplus in Best Buys’ perceived price was not accompanied by a higher value in their services and product range offer. Although American consumers might be willing to pay for a supplement in price for the services Best Buy offers, Chinese consumers’ buying behavior differs.
Chinese electronics retailers rarely provide warranty and installation services, mainly because repair services are available at a cheaper price at local convenience store. Typically, Chinese consumers would spend a lot of time comparing price and wait for the best deal on products, but services are rarely part of their buying decision process. “Best Buy’s service -oriented model seemed like a reasonable strategy given that China’s maturing consumer class is increasingly looking for product value. Though a better shopping experience would appear to be in line with those expectations, the price factor cannot be underestimated.
Chinese consumers are looking to upgrade their purchases, but the electronics market in China is known for being extremely price sensitive. ”32 Therefore, although Chinese consumers value and need the services, the price they are willing to pay for they were below Best Buy’s perceived price. Moreover, Best Buy’s higher perceived price was not followed by a different product range offer than what was already available on the Chinese market. “Customers could easily get the same product literally down the street. 33 Consequently, there was little incentive for Chinese consumers to purchase at Best Buy since the product offer was similar: “Why buy a Sony DVD player or Nokia phone at Best Buy when you can pay less for the exact same product at a local store? Consumers will only be willing to pay more, like at th e Apple stores, if they are buying something they cannot get elsewhere. ”34 While Best Buy did not differ from domestic competitors in its product catalogue, its differentiation strategy relied on its elevated services which Chinese consumers could find at a cheaper price at convenience stores.
Therefore Best Buy was left with only one differentiation point: the possibility for consumer to test products in the store but this advantage was quickly copied by competitors as Liu Buchen, an independent electronics retail analyst explains: “The company’s service style, whereby customers can test products, was quickly copied by others, and left them with no unique competitive strength”35 To conclude, the competitive advantage Best Buy was enjoying in the USA was not a source of advantage in China, its consumer-centric strategy offered services that were available elsewhere at a cheaper price.
Chinese retailers had competitive advantages among Best Buy: their convenient locations, low price and knowledge of the local market. Best Buy could not be competitive in terms of prices specifically because of its business model which was much less profitable than the Chinese rental system. “Ironically, its 9 business model, just as its Chinese name, tries too hard to educate co nsumers about high-end service value when lower price is typically the only value that motivates them to make quick decisions. ”36Best Buy in China quickly became a convenient window to more price competitive Chinese retailers.
Chinese consumers “had little incentive to buy immediately and were more inclined to wait for the right – and ostensibly cheaper – deal. The perceived price hike was a severe impediment to Best Buy’s success, and the additional service was not an attractive enough incentive to entice customers to buy exclusively at Best Buy. “Best Buy represented the shopping, not purchasing, stage of consumption,” sums up consumer researcher Mary Bergstrom. ”37 10 RECOMMENDATIONS The aforementioned situation analysis reveals a lack of understanding of the Chinese consumers for Best Buy in its attempt to mimic the American model in China.
The elements previously discussed raise two questions; was China a good location for Best Buy to offshore in the first place? And if so, what alternative strategy could have prevented the company from its obvious failure? While considering the possibility to offshore its activity to another country, it is important for companies to follow a thorough and systematic decision process. Indeed the expected profits assimilat ed with an offshoring strategy need to be weighed against significant costs and risks for the company. Farrell (2005) drew a helpful framework for companies to decide where to offshore.
We slightly reviewed this framework and added additional steps in order to optimize the decision process (See Exhibit 5). In this section, we assume a “back-to-the-future” scenario and use the aforementioned reviewed framework in order draw two possible recommendations for the company’s internationalization strategy. Option 1: Stay Out As clearly mentioned in its 2006 annual report, Best Buy’s objective in offshoring was to pursue an international growth strategy. Struggling in its domestic market, Best Buy’s main goal of offshoring was without a doubt trying to generate profit in foreign markets.
As a consequence, following the reviewed Farrell framework, we decided to establish decision criteria for Best Buy to consider while weighing different countries to offshore in. Firstly, the presence of a growing market with interest in electronics is crucial for Best Buy to generate substantial profit. The second criterion would be the presence of a weak competition or at least a competition on which Best Buy has a clear advantage on. Indeed, the decrease in profits Best Buy was experimenting in its domestic market did not allow it much breathing space for risks.
Considering these two criteria, China would have rank high as an offshoring location for the electronics retail market. Firstly, with 60. 5 million in 2006, China was a potentially profitable location for Best Buy. Moreover, the market was so far dominated by Gome and Suning, which did not provide such services as Best Buy offers, thus opening a clear differentiation strategy for Best Buy. Best Buy seems to have considered this promising data as a sufficient green light to expand its operations in China.
However, China did present some significant risks for the electronics retail market. While the sales revenue of foreign-retailers in China has been generally positive, it has not been so for the electronics and appliances retailers who have not seen any significant increase since 2005 (See Exhibit 6). In view of this threat, China was perhaps not the best location for Best Buy to offshore. Indeed, although the company had developed a differentiation strategy based on consumer service and reliable advice from its sales force, the risks perhaps outweighed the possible profits.
Indeed, as discussed earlier, Chinese consumers are known to be extremely price sensitive and might not have been ready to pay more for such services. Moreover, according to the global brand study of Douglas B. Holt, John A. Quelch and Earl L. Taylor, China has an interesting mix of global citizens and antiglobals. On the one hand, global citizens bu y global brands mainly because of it quality signal, that is to say, the assumption that global brands have better quality than local brands due to more funds. In this logic, if local brands had better quality, they would expand. 11
This type of customer would be ideal for a global brand. However Best Buy is a retailer and not a manufacturer, the quality of its products does not depend on the company but on its suppliers, most of which are already present in China. Therefore, China’s global citizens do not h ave any particular advantage in going to Best Buy. On the other hand, antiglobals are more skeptical on this quality signal and are not sensible to the global myth by which consumers buy global brands to feel part of a global community. On the contrary, antiglobal do not buy global brands because they “dislike brands that preach American values”.
Such customers were a significant threat to Best Buy’s implementation in China. Along with this idea of ant globalism, Best Buy had significant disadvantages of foreignness because of a strong consumer ethnocentrism. In addition, the retailing industry is difficult for multinationals to entry since its is long and requires and as Dawar, N. and Frost, T. ’s positioning for emerging market companies framework suggest s, local companies took a defender approach and continued to provide low price and corner store position which the local market preferred. Best Buy also made the mistake of focusing on building large flagship stores, like in the U. S. , rather than smaller, conveniently located retail outlets. China may have one of the highest car adoption rates in the world, but its perennial traffic congestions and lack of parking mean consumers often prefer to shop closer to their homes. ” 38 Best Buy could probably have acknowledged this strength of local competition before launching their over-sized stores in China. In view of these risks, our first possible recommendation for Best Buy in 2006 would be to stay out of China.
The company could have pursued the acquisition of Five Star and increase its presence in China. However, implementing Best Buy branded-stores might have been too risky an investment. Option 2: Stay in China and Define a New Positioning Strategy Despite the threats the Chinese market presents, we would like to consider an alternative strategy for Best Buy to implement its stores in China. Copy the Chinese business model First of all, Best Buy’s American business model is a weakness in China.
The rental system Gome and Suning have developed is much more cost effective and enabled them to be more price competitive than Best Buy. We strongly believe Best Buy should have copied the Chinese business model in order to stay price competitive. On the one hand, this business model is unheard of in the US in the electronics and appliances industry. “The presence of a manufacturer’s store within a retailer’s store could suggest the weakness of the retailer or the dominance of the manufacturer, as the manufacturer has autonomy in the space owned by the retailer. ”39
On the other hand, in China studies show an opposite interpretation, where “the presence of stores-withina-store often indicates the strength of retailers, rather than manufacturers”, according to a detailed study titled “Store-Within-a-Store”, written by Kinshuk Jerath of the Tepper School of Business at Carnegie Mellon University, and Wharton marketing professor Z. John Zhang. Their analysis shows that “the storewithin-a-store arrangement can; in fact, be a sign of the retailer’s strength … one would expect to see the store-within-a-store arrangement only in the stores of power retailers, as is commonly the case. 40 Therefore, copying the Chinese business model would not only be a way for Best Buy to stay price competitive in a highly price sensitive market, but also to build credibility in the Chinese retail industry. 12 Reassess the competitive advantage in China Secondly, the company needed some point of differentiation from Gome and Suning. The main reason why electronics retailers have and keep failing in China might as simple as the fact that they do not bring anything new or more valuable to the consumers. Gome and Suning have a thorough knowledge of the Chinese market and already offer a wide variety of products.
While Best Buy could not differentiate with its product range, it decided to use its consumer-centric strategy in China. In the US, the services provided by Best Buy constitute a competitive advantage for the company, it is: – Valuable to the customer, such service is of great significance for electronic appliances which tend to become obsolete fast and which are often difficult to set up. – Rare, as Marc Gunther put it: “Just try getting help from Amazon or Wal-Mart if you can’t figure out why your TV or computer isn’t doing what you want it to. – Not difficult to Imitate, competitors could easily decide to provide extended services to their customers, though it might take some time to implement. – Difficult to Substitute, installation service can hardly be done in another way than by employees. However competitors could find a way to outsource the services. – Appropriable to Best Buy, “According to one analyst, such services, which can be highly profitable, could bring in 5 percent of the company’s $47 billion in sales in the fiscal year ending February 2010. (NewYork Times) But was this even a competitive advantage in China? While the warranties and installation services are valuable to Chinese consumers, it is far from being rare nor difficult to substitute. Indeed, as discussed in the situation analysis, Chinese consumers can easily find these services in their local convenience stores where they can get their electronics items repaired at a cheaper price. Therefore Best Buy needed to modify its competitive advantage in China, the company was neither price competitive, or had a product or service offer that the Chinese consumers were ready to pay extra money for. Find a gap in the Chinese electronics retail market While both Gome and Suning are extremely price-focused and offer an extremely wide selection of products, there is still place for Best Buy to effectively differentiate. Indeed, there is not any competitor in China which has positioned itself as a high-end retailer which has narrowed down the product offers to only what is best on the electronics market (See Exhibit 7).
This is specifically where we would recommend Best Buy to position itself in China because it would provide them the consistent and logical differentiation strategy. Best Buy cannot possibly offer a wider range of products than its Chinese competitors Gome and Suning. However, it can narrow down the options for the consumer and become the electronics retailer for the upper-middle class Chinese consumers who do not trust the biased salespersons in traditional retailers and who are tired of being lost amongst too many different products, making it hard for them to choose the best products on the market.
Best Buy would provide a higher environment, with a product selection narrowed down to the best options in the market. By copying the Chinese electronics retail business model, Best Buy would stay price competitive but simply serve a segment of the market that had not been by a particula r retailer served so far. 13 In addition, it is important to note that this target is actually the fastest growing segment in Chinese middle-class. Indeed, “when looking under the bonnet at China’s economic engine, it’s clear that a growing middle class with rising disposable income and consumption is missing.
Instead, there’s an economy that is still dominated by state owned firms and state-led investment, as well as by rapidly rising inequality. Instead of an enlarging urban middle class, China is increasingly splitting into a small upper class that spends freely on luxury goods, and a remaining population whose earnings and savings are eroded by inflation and state confiscation. ”41 Moreover, the spending power of this Chinese upper-middle class is expected to grow at a extremely fast rate in the future going from 9. 4% of the overall Chinese population in 2005 to 59. 4% in 2025 (See Exhibit 8).
Stores’ locations One of Best Buy’s most questionable strategies in China was the location of its stores which wa s not considered convenient enough for middle class consumers who do not always own a car. However, targeting the upper-middle class opens wider location possibilities for Best Buy. Since the majority of upper-middle class households in China own a car, Best Buy could settle its high-end stores close to neighborhoods with upper-middle class standard of living. In Shanghai, Pudong New Area and Changning District downtown gather most of the upper-middle class.
Another advantage for targeting this segment class is that foreign expatriates tend to live in areas where upper-middle class is settled. Opening its stores in the area they leave will enable Best Buy to reach its target market while attracting expatriates who are already familiar with the chain. The product and service mix The presence of antiglobal consumers in China might have been underestimated by Best Buy in China. “With regard to product mix, Chinese consumers are increasingly turning to Chinese brands.
This is in part due to a resurgence of national identity, the increasing quality of Chinese products and the fact that Chinese brands are often priced considerably lower than foreign brands. This is particularly true of consumer appliances and Best Buy China has been accused of not stocking enou gh Chinese SKUs. ”42 Therefore, and along with the aforementioned differentiation strategy, we strongly believe that Best Buy should narrow down its product range to the most up-to-date products with all brands, but highlight the Chinese brands in its stores.
In terms of services, Best Buy should keep its extended warranties as optional services but it is not what the company should rely on to differentiate itself. Instead, Best Buy should provide an enhanced and more pleasant shopping experience for the upper-middle class. Delivery services, easy parking spots, luxurious retail space, restaurant options… Everything at Best Buy should facilitate the consumers’ visit in a way that is consistent with Best Buy’s consumer-centric vision, but in a high-end positioning. 4 China’s fast growing middle class is without a doubt a tremendous opportunity for Best buy to generate profits abroad, especially in times where it struggles in its domestic market. However, China has proven to be a very hostile environment for foreign electronics retailers in the past, and Best Buy was no exception, the closure of its eight branded-stores in China in 2011 is a striking symbol of the failure of the American electronics retailer’s strategy in this particularly complex country.
While Best Buy defined an effective competitive advantage in the US, its American business model was not a source of profitable advantage in China. Perhaps the company should have stuck to its acquisition of Five Star and simply expanded its stores. However, if Best buy did decide to play a significant role in China, we strongly believe it should have copied the Chinese rental system in order to stay price competitive. Moreover, by observing the demographic trends in China, it appears that the upper -middle class is the most promising segment of Chinese population.
Therefore, Best Buy could have opted for a very different positioning strategy and approach this upper-middle class with a higher-end retail experience. Thanks to this strategy, Best Buy would have stayed consistent with its consumer-centric vision while effectively differentiating itself from the two giant retailers in China -Gome and Suning. Best Buy operations nowadays in China are based on “stand-alone” stores, described as “small stores located in strip and similar retail locations”, because as mentioned above in China “the presence of stores within-a-store often indicates the strength of retailers, rather than manufacturers”43.
This indicate that Best Buy is following the Chinese model instead of focusing on their competitive advantage before implemented wasn’t the best idea to enter China. 15 APPENDIX Exhibit 1: Best Buy – Financial Hilights – 2007 Source: Best Buy’s 2007 Annual Report. 16 Exhibit 2: 2007 Best Buy China Total retail square footage Source: Best Buy’s 2007 Annual Report. 17 Exhibit 3: Total stores 2009 International segment Source: Best Buy’s 2009 Annual Report. Exhibit 4: Total stores at the end of fiscal 2011 Source: Best Buy’s 2011 Annual Report. 18 Exhibit 5: Updated Farrell Framework/ Where to Offshore? 1. Define the goal of offshoring (in comparison to existing locations) –2. Establish the decision criteria and the weights that matter most to your company –3. Draw up a long list of possible locations –4. Collect data for each potential location, and forecast labor and other factors –5. Rank locations in order of their attractiveness to your company –6. Gather qualitative data (from experts, consultants, bankers, visits) on a short list and revisit the quantitative analysis (add factors, change weights) –7. Select the location (city and where in the city) Source: Farrell, 2005
Exhibit 6: Sales revenue generated by foreign-owned retailers Source: Euromonitor International, Retailing. 2010. 19 Exhibit 7: Determinant gap map of the Chinese electronics and appliances retail market 20 Exhibit 8: China’s Spending Power Forecast Source: The McKinsey Quarterly 21 Exhibit 9: Map of Urban Districts in Shanghai Source: Housing Choice in Affluent Shanghai 22 END NOTES / SOURCES 1. Best Buy Co Inc (BBY). Reuters. Retrieved from: www. reuters. com 2. Best Buy Co. , Inc. Funding Universe. Retrieved from: www. fundinguniverse. com 3. Best Buy Co. , Inc. Funding Universe.
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