Discusion QS

The Battle for Best Buy, the Incredible Shrinking Big Box

By Bryan Gruley and Jeffrey McCracken on October 18, 2012

http://www.businessweek.com/articles/2012-10-18/the-battle-for-best-buy-the-incredible-

shrinking-big-box

Richard Schulze had a splendid summer of 2012 planned. He had made billions starting Best

Buy (BBY), the chain of electronics superstores, and at 71 was looking forward to relaxing with

his wife at their home on Florida’s Gulf Coast, taking a European cruise, and playing plenty of

golf. He would shoot up to Minnesota on his private jet for board meetings and to check on the

$500 million fundraising campaign he was co-chairing for the University of St. Thomas in St.

Paul.

It didn’t work out that way. In April, Schulze’s handpicked CEO, Brian Dunn, was forced out

over what the board described as an “extremely close personal relationship” with an employee.

Schulze, who knew about the relationship but failed to notify the rest of the board, gave up his

chairmanship and then quit entirely after 46 years at the company. But rather than work on his

golf game, Schulze did something that didn’t surprise anyone who knows him: He decided to try

to buy the company back.

Top: Scott Olson/Getty Images;

Bottom: Kristoffer Tripplaar/Sipa USA

Dick Schulze is a trim, kinetic man. He’s bald and maintains a red goatee. Since opening his first

store in 1966, he’s neared bankruptcy twice and confronted larger competitors, fickle suppliers,

and, more than once, the company’s own bureaucracy. Each time, he adapted. Since leaving Best

Buy in June, Schulze bounced around conference rooms in Minnesota and New York, meeting

with former colleagues and potential investment partners, some of whom thought he was nuts, as

he tried to raise as much as $10 billion to wrest control of Best Buy.

Schulze declined to be interviewed for this story, but associates say he’s certain he’ll succeed.

“He’s got as much energy and enthusiasm as I’ve ever seen,” says Elliot Kaplan, who was Best

Buy’s top lawyer and Schulze’s confidant for more than 40 years. “He absolutely gets turned on

by these challenges.” The Reverend Dennis Dease, president of St. Thomas and a longtime

friend, says: “He has a simple, childlike faith. It’s part of who he is.”

Best Buy is in trouble. In March it posted a $1.7 billion quarterly loss. Same-store sales

comparisons have been declining, and a Bloomberg analysis suggests revenue will fall this year.

Wall Street, at least as far as Best Buy’s stock price is concerned, does not seem excited by the

prospect of Schulze’s takeover. Shares have languished well below the $24 to $26 per share

Schulze offered on Aug. 6 to take Best Buy private. Its current management hasn’t shown much

enthusiasm for his return either, though new CEO Hubert Joly recently made his public-relations

handlers cringe by telling Bloomberg News, “In many ways, all of us work for Dick Schulze and

this great company.”

Schulze, who owns about 20 percent of the company, is still Best Buy’s largest shareholder.

Even if he can complete a deal, the resulting debt load might sink a rebuilding effort. “Honestly,

I think if Schulze takes on Best Buy, they’ll be out of business in a few years,” says analyst

Anthony Chukumba of BB&T Capital Markets. For Schulze, however, rescuing Best Buy is only

partly about business. “He oftentimes views the company as his child,” Kaplan says. “When your

child stumbles, you want to do all that you can to help the child get up.”

The battle for Best Buy is more than a Lear-like attempt to regain control. It’s also about the

future of stores in the age of digital goods, same-day delivery, and apps that’ll tell you in an

instant whether the 80-inch TV you covet is cheaper somewhere else, turning stores like Best

Buy into “showrooms” for online competitors. It’s an expensive way to go out of business: Best

Buy pays for the building, salespeople, and cash registers, and Amazon.com (AMZN) rings up

the sale. Showrooming hurt Borders bookstores, and chains that sell hardware, toys, clothing,

sporting goods, and groceries are vulnerable too.

Best Buy’s response to Amazon and other online threats has been inadequate. The company set

up bestbuy.com as early as 2000, when Schulze was still CEO as well as chairman, but years

later, as purchases of TVs, stereos, and microwave ovens shifted increasingly to the Web, the site

still lacked such basic features as customer reviews. An Internet unit didn’t get much financial

support and was kept walled off from store sales. While e-commerce now accounts for more than

20 percent of U.S. consumer-electronics sales, online is only 6 percent of Best Buy’s domestic

revenue.

Staples (SPLS), Williams-Sonoma (WSM), and other retailers have boosted online sales by

offering shopping experiences that rival Amazon’s for ease and selection. Analyst Colin

McGranahan of Sanford C. Bernstein (AB) goes so far as to suggest that Best Buy invent a time

machine “so they can go back 10 years and develop the online strategy they need today.”

Instead of figuring out the Internet, Best Buy focused on acquisitions and foreign expansions. It

also kept adding giant stores—more than 30 of at least 36,000 square feet since 2008. Today

most of the company’s 1,062 big-box stores are as clean, stocked, and well-organized as ever.

But they can seem outdated. Until recently, one of the first sales displays visitors saw in the store

in Burnsville, south of Minneapolis—the first Best Buy Schulze built—was for car stereos, not

smartphones or tablets. A few steps away stood racks of CDs, including $4.99 albums by Kiss

and James Taylor. Best Buy just closed the store to make it a training center.

There’s little point in visiting these stores when you can find a better selection at lower prices on

your smartphone or tablet, says Love Goel, CEO of GVG Capital Group, a Minnetonka (Minn.)

private equity firm that invests heavily in retail. “When I was a teenager, Best Buy was the place

that had all the cool stuff,” says Goel. “For gadget freaks, it was amazing. There was nothing like

it.” Today, there isn’t much that sets Best Buy apart from Amazon or even Wal-Mart Stores

(WMT), he says. “There’s no word-of-mouth like with Apple (AAPL), or with Whole Foods

(WFM), like when I go back to the office talking about my pasta salad.”

Schulze grew up in St. Paul. He didn’t attend college and was selling audio equipment for his

father, a manufacturer’s rep, by age 18. When he asked for a raise in his $1,200-a-month salary,

Dad said no. Schulze told his wife he was quitting to start his own business. “I need to be in

control of my own destiny,” he said, according to his self-published 2011 autobiography,

Becoming the Best.

In 1966, Schulze opened his first stereo store, Sound of Music, in St. Paul. Seven years later he

hired Bradbury Anderson, a music buff and former seminary student. Anderson would become

Schulze’s closest business partner. By the late 1970s, though, the stereo business was changing.

Mom-and-pop stores such as Sound of Music were already vanishing as bigger outlets pushed

prices down. In 1979, Schulze’s lawyer, Kaplan, drew up liquidation papers. “I really don’t like

to lose,” Schulze writes in his autobiography (available on Amazon). He told Kaplan to hold off,

packed a double-breasted suit, and flew to Las Vegas, where many of his suppliers were

attending a consumer-electronics convention. Two days of begging and a family loan later,

Schulze was back in business.

By 1981, the Sound of Music chain was bringing in about $5 million a year. One Sunday

afternoon, a tornado sheared the roof off of one of his stores. Schulze arrived to find dangling

wires and scraps of ceiling scattered among rain-soaked boxes. No one was hurt, but Schulze

figured profits would suffer. Then he had an idea: He put up a circus tent next to the store and

parked a trailer out front. He filled both with damaged products and other excess stock, trundled

in cash registers and portable toilets, and advertised a Tornado Sale, promising “best buys” on

everything. Traffic backed up for miles. Sales went through the blown-off roof. “We knew

something pretty amazing had happened,” Schulze wrote, “but we weren’t entirely sure what it

was.”

He and Anderson wondered if they could re-create the carnival-like atmosphere every day in a

real store. By January 1983 there were seven Sound of Music stores, and combined they were

taking in $10 million annually, but Schulze had almost no money left over and owed suppliers

tens of thousands of dollars. Kaplan again prepared liquidation papers and told Schulze to sign.

Instead, Schulze went back to Vegas.

At the same consumer-electronics show, Schulze shuttled from booth to booth making an

unusual pitch to credit managers for Pioneer, Sharp, and other vendors. He showed them a floor

plan for a “superstore” that would be at least triple the size of any store he had and vowed to

stock it not merely with stereos and TVs but also VCRs, dishwashers, camcorders, computers—

just about anything that plugged into a wall—and sell it all at the lowest prices anywhere. Of

course, he’d need the vendors to extend him even more credit until the new stores started making

money. As the meetings ended, Schulze would mention his “Plan B.” Out came those bankruptcy

papers. “If you don’t extend our credit,” he’d say, “we’ll have no choice but to file at the end of

the week.”

Nine months later, Schulze opened a boxy, high-ceilinged store on a hill overlooking a highway

in Burnsville. An enormous striped balloon tethered outside proclaimed the store’s name: Best

Buy. In its first year, the Burnsville Best Buy took in $14 million.

That early success attracted the attention of competitors. Bigger, more established retailers such

as Sears (SHLD) and Montgomery Ward began selling Sony (SNE) and other famous brands.

Anderson spent weeks spying incognito on a rival chain’s store in Chicago, posing as a

customer, interviewing for a job, and digging in the trash for receipts and internal memos.

Schulze cut costs and prices in the Twin Cities, but it wasn’t enough. “We either had to invent a

new strategy or face extinction,” he later told the Harvard Business Review.

From top: Chris

Goodenow/Reuters/Landov; Craig Lassig/Getty Images; Courtesy Best Buy

A visit to a Sam’s Club moved Schulze to consider a step verging on heresy: eliminating sales

commissions. He figured customers would prefer not to be pressured by salespeople who stood

to get a nicer cut on particular items. Best Buy’s board balked. Schulze’s sales force didn’t like

the idea. Neither did his suppliers, some of whom yanked their products. Schulze pushed on,

rearranging store layouts to make it easier for customers to grab what they wanted and leave

without saying a word to a salesperson. Sales and profits grew, and the suppliers returned.

Riding the 1990s surge in personal-computer sales, Best Buy overtook Circuit City as the

nation’s largest electronics chain. But crisis loomed again. Profits plummeted from $48 million

in fiscal 1996 to $1.75 million—essentially breakeven—in 1997. Revenues were growing

because the company kept opening stores, but operating costs, which never much interested

Schulze, were out of control. He offered a $1 million cash bonus to the executive willing to dive

into the mess; there were no takers. Shareholders began to question his leadership. His wife

asked him if he should move on.

Instead, Schulze agreed to pay Andersen Consulting (now Accenture (ACN)) $44 million to look

at his company. The decision was painful, partly because he disliked consultants (“Nobody pays

$44 million to anybody for anything,” he told deputies), and partly because he always believed

Best Buy’s own people were best at solving its problems. With Andersen’s help, Best Buy made

sweeping changes in how it ordered, shipped, warehoused, priced, and advertised goods, and

hired dozens of new managers to make it work.

Within two years profit rose past $200 million, and shares increased more than twentyfold. In

February 2000, the Minneapolis Star Tribune named Schulze the state’s wealthiest person, with

an estimated net worth of $2.2 billion. Later that year, the company celebrated the opening of its

first stores near New York City with a Central Park concert by Sting. In 2002, Schulze stepped

down as CEO, handed the day-to-day reins to his partner Anderson, and kept the chairman title.

For a few years, everything seemed to go right. The value of the company reached $26 billion as

customers snapped up digital devices. Best Buy bought Musicland, a 1,300-store chain;

Canadian electronics retailer Future Shop; and the onetime nemesis of the recording industry,

Napster. It expanded in China, Turkey, and the U.K. In the meantime, one of its largest

competitors, Circuit City, liquidated in 2009.

As the decade wore on, Amazon and other online retailers poached more and more sales from

stores. Frank Trestman, a Minnesota businessman and Schulze ally who was on Best Buy’s

board from 1984 to 2010, says the company was aware of the Internet threat, but “the strategy to

counteract it wasn’t in place or executed in time. It’s a management failing. It’s a board failing.”

Those failures became abundantly clear under Brian Dunn, who succeeded Anderson as CEO in

June 2009. Dunn was a burly salesman who started with the company in 1985 and became a

legendary leader of its blue-shirted sales force. In 2003, Best Buy had dumped Musicland at a

loss, and Dunn continued trimming. He sold Napster and closed underperforming big-box stores

in China and Turkey. As sales comparisons and the stock fell over the past year, the board

pressed him to move faster on a digital strategy.

In March, according to the company, the board’s audit committee learned from a Best Buy

human resources official that Dunn had a relationship with a female employee. A subsequent

investigation found that the CEO gave the woman tickets to concerts and sporting events, loaned

her $600, and met her for drinks and lunches on weekdays and weekends. During trips abroad in

2011, Dunn called the woman 33 times and sent her 191 text, photo, and video messages. Dunn,

who couldn’t be reached for comment, resigned in April.

The board also determined that Schulze had confronted Dunn about the relationship last

December without telling the board. It’s unclear how far Dunn’s relationship with the employee

went, or whether the board saw it as a convenient excuse to dump a CEO it didn’t like.

No black-tie dinner commemorated Schulze’s departure after 46 years. He initially agreed to step

down as chairman at the June 21 annual meeting and stay on the board into next year. Instead, he

filed papers on June 7 with the Securities and Exchange Commission, saying he was quitting the

board to assess his options, citing “urgent need” for change at Best Buy. He recruited Anderson

and other Best Buy veterans and began visiting KKR (KKR), TPG Capital, and other private

equity firms.

Relations with his old company went publicly sour. Best Buy learned of his Aug. 6 offer to buy

the company not from Schulze but from a Bloomberg News reporter. The company dismissed

Schulze’s bid as “highly conditional.” Schulze warned: “I am not going away.”

Best Buy has time to right itself. The company still has $50 billion in revenue, a dominant share

of its market, and a strong balance sheet. Showrooming isn’t as pervasive—yet—as it’s

portrayed in media coverage. A recent study by Stevenson Co.’s TraQline Report shows that

people who shop at a Best Buy but then buy online elsewhere account for only 5.4 percent of the

company’s shoppers. Still, the company has given its blue shirts the power to match some

Amazon prices during the holidays, partly to offset showrooming.

Online retailers could lose some of their pricing edge as more states force them to levy sales

taxes. Sony and other manufacturers have begun to demand that Amazon set some prices no

lower than at stores. Where price gaps narrow, in-store shoppers may be more inclined to collect

their stuff immediately rather than wait for UPS (UPS). “It looks like there’s a big opportunity to

get consumers outside the store inside the store,” says Guy Rosen, CEO of data firm Onavo.

Sonda Dawes/The Image WorksSmall box retail

According to Goel and others, the company needs a differentiator: some offering or experience

you can’t get online or at another store. Schulze and the new CEO, Joly, both seem to think

customer service is a big answer. The company has plowed tens of millions of dollars into

training employees so that they become “an undisputed point of reference” for shoppers, as Joly

recently put it. (He declined to be interviewed for this story.)

A newly refurbished outlet near Best Buy headquarters suggests how a customer service push

could help. With its low shelves, broad sightlines, and smaller footprint, the store feels more

Apple than Best Buy, down to the prominent Apple logo hanging over the displays of iPads and

iPhones. In one corner is a counter for picking up goods ordered online. Opposite that is a warren

of cubicles where customers can get one-on-one technical assistance from Geek Squad agents.

A bank of counters in the middle of the store is “Solution Central”—Best Buy’s version of

Apple’s Genius Bar, where Geek Squad members help customers figure out how to get their

iPads to work with their laptops, iPhones, and TVs, so they leave the store with working gear

instead of “a box of problems,” says Best Buy Vice President Josh Will. The bet is that most

people, even young ones, are baffled as to how to make their assorted gadgets function

together—and Best Buy, with no particular allegiance to Apple or Android or any other brand of

technology, is in the best position to help. “We don’t just speak iOS—we speak it all,” Will says.

Best Buy plans to have 50 such “connected” stores by yearend and could add more depending on

sales performance. Analyst McGranahan says these outlets are still a mishmash, but “making the

service more ingrained into the customer experience will help.” Planning for the stores began

while Schulze was chairman.

In theory, the emphasis on strong service would draw customers to stores and persuade them to

buy there. That in turn could enable Best Buy to price products a bit higher and avoid

unwinnable price wars. Higher prices would bring bigger profits. Over time, smaller store

footprints would cut costs and widen profit margins, giving the chain more flexibility on prices.

Joly, who started as CEO on Labor Day, hasn’t said much publicly about his plans for the

company. A 53-year-old Frenchman with a full head of salt-and-pepper hair and rimless glasses,

he has never run a retail business. But he showed turnaround mettle in previous stints at

entertainment giant Vivendi (VIV) and Carlson, the hotel, restaurant, and travel chain. He’s

already putting distance between his regime and Schulze’s. Best Buy recently announced the

departure of its chief financial officer. The company has said it will close at least 50 big-box

stores while opening hundreds more of its smaller Best Buy Mobiles—a smaller format, typically

located in malls, that focuses on smartphones, e-readers, and tablets. On Oct. 16, word got out

that Best Buy will soon sell Android-powered tablets of its own.

People familiar with Schulze’s thinking say he believes closing lots of the bigger stores would

shortchange customers by offering less selection and convenience. In pitches to prospective

investors, he’s stressed better relationships with suppliers and a “growth strategy” that will be as

cost-effective as Amazon’s. He’s also selling himself and Anderson as the ones who’ve

repeatedly faced down calamity. Sentimental as it might sound, McGranahan and other observers

say that only a leader with Schulze’s passion can fire up Best Buy’s troops.

As part of his deal to see internal Best Buy finances, Schulze has until late this year to make a

fully financed offer. But is he really the best guy to fix Best Buy? He’s teaming up with people

who were around when the company was heading south. People who’ve listened to his

turnaround pitch say they’ve heard nothing to suggest radical change.

Outside Schulze’s vacated office at Best Buy headquarters, thousands of employees pass daily

through a shrine to the founder. A winding corridor is festooned with photos of the 1981 tornado

sale, a framed newspaper ad promoting a rival’s liquidation sale, and picture after picture of the

bald, smiling man who spent his life building a company he refuses to give up.