Sunday, March 11, 2007

Where's the Power in Circuit City

It’s the weekend again, so we are going to step back and look at a specific retailer. This weekend, we are going to examine Circuit City.

Past Glory
Circuit City used to be a highly successful organization. In my mind, it’s success was based on three factors:

1) They had a core competency in knowing how to sell big-ticket items to customers. It was such a core competency that they decided to point it in a new direction when they started Carmax.

2) Circuit City understood the power of densing up a market with lots of stores (building to capacity).

3) Circuit City had a low cost structure due to economies of scale and cheap real estate. Circuit City realized that for big ticket purchases, people are willing to travel to more out-of-the way locations to save some money, and they took advantage of that.

This was a highly successful formula, which allowed Circuit City to survive the industry consolidation and become one of the final two players, along with Best Buy.

The Rules Change
Unfortunately for Circuit City, Best Buy then changed the rules for success, making the success factors of Circuit City almost irrelevant.

1) Best Buy decided to sell the big ticket items in a self-service environment at a loss and make its money on accessories. Suddenly, Circuit City’s powerful commissioned salesmen were rendered unpowerful, for they could not make a profit matching Best Buy’s prices on the big ticket items and still pay the high commissions. Compared to Best Buy, Circuit City’s stores were not designed well for self service or for accessories.

2) Best Buy also understood the importance of densing up markets. But Best Buy built larger stores in better, higher traffic locations. It could afford the higher rent because it did a better job in selling items that brought in more frequent traffic, such as music and movies. This made the out-of-the-way locations of Circuit City less desirable.

3) Eventually, Best Buy built enough stores that it had superior economies of scale. This left Circuit City had a higher cost structure than Best Buy, with inferior locations and less traffic, specializing in selling the things that were no longer profitable by themselves.

Circuit City Adapts
When it became obvious that Circuit City’s old success model no longer worked, they decided to change their business model. This was a wise idea, but their choice for a new strategy became their downfall. In essence, they decided to imitate Best Buy’s strategy. They got rid of the commissioned sales people and put more self-service traffic items in the store. They added computers to their product mix. To make room for all of this, they got out of the major appliance business. Eventually, they hired a former Best Buy executive to run the company, who accelerated the process of imitating Best Buy, bringing in things like Firedog to go against the Geek Squad.

At first, you can understand why Circuit City went this way. Best Buy was the winner with the winning strategy. Therefore, let’s copy the winner. It works for them, so it should work for us.

The problem was that the market already had Best Buy executing that strategy well. They did not need another Best Buy. All that this strategic change had accomplished was to make Circuit City appear to the average customer as an inferior Best Buy in inferior locations. The only reason, then, to shop Circuit City was if it was cheaper than Best Buy.

According to a presentation sponsored by Deloitte, Circuit City’s own research has shown it that most of the people entering Circuit City would prefer to buy their products elsewhere, but were in the Circuit City store just to make sure that Circuit City wasn’t cheaper. The razor thin margins in consumer electronics did not provide enough room for Circuit City to consistently underprice Best Buy (and now Wal-Mart, who had decided to get big in consumer electronics). And since Best Buy had found a superior way to attach high margin accessories to the purchases, Best Buy could actually afford to more consistently underprice Circuit City. That is why even though Circuit City is selling some of the most in-demand products in the US, it is still struggling to provide a decent return on investment.

Need A New Prescription
Circuit City needs a new strategy. Being an inferior Best Buy is not working. Just as Best Buy rewrote the rules to gain an advantage, Circuit City needs to rewrite the rules in a manner that gives them an advantage. Here are some suggestions:

1) Best Buy stores tend to be noisy places full of crowds of young men. This is a turn-off to some customers, particularly women and older people. Circuit City could use this to their advantage and position themselves as the quiet, sane place where women and/or older people are treated with respect and allowed to make a decision without feeling rushed or uncomfortable. This would particularly work at the higher end of the merchandise mix.

2) Studies have shown that children abandon traditional toys at an ever younger age. Now the age of seven or eight is when the shift is made from playing with traditional toys to consumer electronic toys. Circuit City has the opportunity to become the modern era’s version of Toys R Us, the electronics toyland. This again, would appeal more to women. And some of the young men who love Best Buy might feel less comfortable in a store full of little kids. Hence, Circuit City could stand out with a differentiation against Best Buy in owning “the coolest electronic toys for kids.”

3) The internet is not exactly ideally suited to Best Buy’s strategy. It is much harder to sell the accessories on-line as part of the purchase. Instead, it is often just a means to get the loss leader items at a lower price than in the store. There is a reason why the Connecticut Attorney General is investigating a practice at Best Buy stores where they try to steer people in the store away from a comparison to the site. It is less profitable for them. Circuit City has a better reputation for its on-line ordering to pick up in the store than does Best Buy. Perhaps there is a way that Circuit City can more fully embrace the on-line world in a way that causes more grief to the Best Buy business plan.

These are just a few ideas of how Circuit City could set itself apart. These show that there is more than one way to sell consumer electronics. However, as long as Circuit City is bent on abandoning creativity and content to just copy Best Buy, it will be a perennial marginal player.

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