Best Buy & J.C. Penney: Strategically Confronting Dislocation and Price Pressures with Relevancy

Declining profits and hammered by investors, Best Buy (BBY) and J.C. Penney (JCP) are having a tough go.  For the quarter ending May 5^th, profits at Best Buy dropped 25% to $158 million on sales of $11.5 billion. Worse, for the quarter ending April 28^th, J.C. Penney reported a loss of $163 million on revenue of $3.15 billion.  With reports like this, some seem to believe traditional brick-and-mortar retailers are circling the drain as US consumers switch to online channels.  But take a deeper look, and you will find that both Best Buy and J.C. Penney show promise.

Strong management from both of these brick-and-mortar retailers is leading these firms towards a potentially brighter future.

In this article, we will show that both Best Buy and J.C. Penney have acknowledged their common challenges, have developed strategies to address these challenges, and are taking action towards a more promising (profitable) future.

Common Challenges

The challenges Best Buy and J.C. Penney are both facing include dislocation and price competition.

In terms of dislocation, US consumers are continuing their switch from traditional brick -and-mortar retailers to online retailers.  In 2000, online retailers accounted for only 2% of US retail sales.  By 2011, the portion of retail sales online had grown fourfold to 8% of US retail sales.  This leaves traditional retailers like Best Buy and J.C. Penney facing increased competition for customers within a declining (though still large) channel segment.

In terms of price competition, online retailers have been found to be cheaper than traditional retailers in several categories.  In New York, where Amazon (AMZN) does collect sales tax, Amazon’s prices averaged 11% lower than Wal-Mart’s in-store prices and 8% lower than those at Best Buy.  The lower online retail prices are not only encouraging customers to switch channels, but they are also forcing traditional retailers like Best Buy and J.C. Penney to respond with lower prices.

These common challenges facing brick-and-mortar retailers are daunting enough.  Between a declining importance of their sales channel and the increased price pressures squeezing their profit margins, Best Buy’s and J.C. Penney’s demise would be expected by many an armchair business strategist.

But we aren’t done.  Consumers are also driving their costs up without contributing anything to the till through showrooming.

Showrooming is the consumer practice of visiting brick-and-mortar stores to select an item, then buying that item online.  Research by ClickIQ found that half of shoppers who buy products online first checked them out in traditional stores.  For traditional retailers like Best Buy and J.C. Penney, showrooming is a double whammy.  Not only do these retailers lose the sale, but they also incur the costs of holding inventory, maintaining sales staff, and managing property in the service of, ultimately, non-customers.

The End? NO.  Look at Strategy.

But Best Buy’s and J.C. Penney’s epitaphs need not be written yet.  Retail store format changes, price pressures, and customer cross-shopping are not new events.  These types of events have happened before and they will happen again.  Before Amazon came to market with lower prices and lower service, Wal-Mart came to market on the same premise.  This process is so common, its cousin even has a name:  the wheel of retailing.

Best Buy and J.C. Penney can survive – even profit and grow – if they take the right strategy.  Recent statements and actions by Best Buy and J.C. Penney indicate that they are each on the right track with slight variation.

The key to retailing, or any business for that matter, is to remain relevant to customers.  Best Buy and J.C. Penney have both developed strategies for ensuring continued market relevance.  Some of the elements of their strategies are common between them.  Other elements are unique and reflect the unique position and strengths of these firms.  Let us first examine the common strategic elements, and then consider their firm -specific strategies.

Common Elements of Best Buy’s and J.C. Penney’s Strategies

The strategies of both Best Buy and J.C. Penney share elements of, in order of increasing strategic importance, (1) competing online, (2) reducing costs, (3) improving price management, and (4) driving shopping theatre.

(1) The online channel is too important for any retailer to ignore, and both Best Buy and J.C. Penney are competing online.  In fact, Best Buy achieved a 21% gain in online sales for the latest reporting quarter.  While further improvement of online marketing is strategically critical for these firms, they are not alone in investing in the online channel.

(2) Strategic change requires maintaining cash flow while the change is underway.  To this end, we see cost savings as a part of the strategies of both Best Buy and J.C. Penney.  J.C. Penney has targeted a $900 million operational-cost reduction by the end of 2013.  Best Buy has announced closings of 50 out of 1100 big-box locations in 2012.  These costs savings will create some breathing room for executing their strategic transformations.

(3)  Neither Best Buy nor J.C. Penney will achieve a cost structure as lean as a pure online retailer, nor should we expect that as a reasonable goal.  As such, neither Best Buy nor J.C. Penney should engage their market in price wars.  Instead, they must improve their pricing management.

For J.C. Penney, we see a huge shift from discount- and coupon-dependent store traffic to full-price revenue with their “fair and square” pricing strategy.  Last year, only 1 out of 500 items sold at Penney wasn’t discounted.  In the most recent quarter, 67 out of 100 items sold at Penney were sold at full price.  Many pundits have derided Penney’s “fair and square” strategy as misguided, but that is poor thinking.  Simply put, Penney’s can’t profit selling commodities at commodity prices.  Heavy discounting and couponing disproportionally attracts price-sensitive – and therefore unprofitable – customers.  The discounting and couponing customer-engagement model wasn’t working for Penney’s anymore, and strategically spelled a looming disaster.  J.C. Penney had to realign their pricing strategy.  As a part of their merchandising strategy (to be discussed later), the “fair and square” approach to price management is a better fit than any promotion-led pricing strategy.

For Best Buy, we see some price-compression relief being provided through their price guarantee and by their suppliers.  Best Buy practices a 60-day price match of online prices.  Price guarantees enable Best Buy to capture customers with competitive prices while simultaneously discouraging competitors from poaching customers based on price alone.  Furthermore, both Sony and Samsung have announced plans to enforce minimum price clauses on televisions with online and brick-and-mortar retailers.   For Sony and Samsung, the sale of high quality items often benefits from minimum price clauses through financially rewarding retailers for teaching consumers the value of the benefits delivered by the item.  For Best Buy, minimum price guarantees from their branded-good manufacturers reduce their pricing pressure.

(4) Shopping theatre as a strategy for enhancing the buying experience has been best demonstrated by outlets such as American Girl Doll Store, FAO Schwarz, and Starbucks.  The concept has been copied by many manufacturers through the establishment of flagship stores by M&Ms, Hershey’s, and Nike Town.  Even Krispy Kreme was known for “donut theatre” prior to their ill-conceived strategy of entering the grocery channel.

Best Buy is experimenting with a form of shopping theatre with their “connected store” format, a take on the Apple Genius Bar.  This new format will emphasize service through technical support and hubs to assist shoppers in making the right selection for their individualized needs.  Tangentially, Best Buy is experimenting with small stores focused on selling mobile phones.

J.C. Penney’s Ron Johnson, himself a former Apple executive, is likewise improving the shopping experience at his stores.  J.C. Penney is re-conceptualizing the store layout to deliver shops within a shop.  Brands and products will be organized into stores, shops, and boutiques within the new J.C. Penney.  “The Street” will be deliberately designed to encourage customers to stroll from boutique to boutique. “The Square” in the center of a J.C. Penney store will be developed into a destination for services and product demonstrations.  Overall, the planned enhancements are planned to deliver a shopping theatre which improves the engagement between customers and the products and brands offered by J.C. Penney.

Best Buy and Value-Added Sales Process

Best Buy’s strategy places increased importance on delivering a value-added sales process through increased worker training and team incentives.

In a value-added sales process, customer engagement is not simply focused on moving product, but rather is focused on uncovering the needs of customers and delivering solutions which fit the constraints of the customer.  In this approach, the sale force itself adds value by facilitating customer choice and helping customers make tradeoffs to better fit their needs.   Academic research and business practice has shown that a value-added process enables the firm to create more customers, engender stronger customer loyalty, and capture stronger prices.

In their engagement with customers, Best Buy is known for having a highly knowledgeable and highly trained sales force that focuses on aligning customer needs with products and solutions.  In congruence with this approach, Best Buy replaces the standard commissioned sales force with team incentives that reinforce customer satisfaction and traffic.

With the “connected store” format, Best Buy is relying upon a highly competent and trained sales force to help customers buy, buy the right product for them, and then return for more.  In effect, Best Buy is leveraging their core competency in value-added retail sales to enhance the strategic fit with the store format to deliver a business process which others may find inimitable – that is, a real competitive advantage.

J.C. Penney and Differentiation

J.C. Penney’s strategy places increase importance on sourcing unique merchandise.

Unique merchandise is necessary for a retailer to position itself within customer’s minds as a “go-to” place for a distinct set of needs.  With broadly sold merchandise, a retailer will find itself in competition for the same set of customers.  Price pressures are greater when selling “me too” commodities than when positioned as a unique and differentiated retailer that serves a well-focused market segment.

In keeping with differentiation, J.C. Penney will be unveiling new offerings from Betseyville, Lulu Guinness, Vivienne Tam, Buffalo, DC, Dream Pop, Royal Velvet, Georgina Chapman, William Rast, Watchgear, Martha Home, Happy Chic,  Design by Conran , and Bodum.  Furthermore, they will launch their own private label, JCP,this year across several categories.

Along with their “Street” and “Square” shopping theatre format, J.C. Penney is developing a unique and differentiated shopping experience that may be compelling to customers.

Outlook

Will Best Buy and J.C. Penney succeed in executing their strategy? It is perhaps a smaller step for Best Buy than for J.C. Penney, but with good management, we should expect they are able.  Will their transformations bring customers and profits? Hard predictions are tricky, but it looks promising that Best Buy and J.C. Penney will maintain or improve their relevancy to the market.  While their outlook isn’t as assured as Neiman Marcus’, it is also not as dour as Sears’.

Note of Interest and Holdings: At the time of writing, the author is not currently a direct consultant to nor investor in any of the firms listed in this article.