Best Buy's Amazon price match is a $400M all-in bet it can't win

By Michael Carney , written on November 12, 2012

From The News Desk

Desperate to compete with the abominable e-tailer snow beast, Best Buy recently announced that it will match Amazon on price this holiday season -- a move that will likely further depress its margins at a time it can least afford it.

How costly could this be for Best Buy? Hint: think nine-figures, break-the-bank, tank-the-stock kind of costly, according to price comparison engine and realtime price API company, InvisibleHand, which knows a thing or two about consumer product pricing.

Seeing the October 12 announcement of Best Buy’s price matching policy, the company decided to team up with Forward Venture Partners to analyze its likely financial impact on the retailer. The upshot: 75 percent of the items offered by Best Buy are cheaper on Amazon, on average by 17 percent. Based on Best Buy’s Q4 2012 earnings statement and InvisibleHand’s internal price data, Best Buy’s price-match promise could, conservatively, cost it more than $400 million of gross profit this quarter with an EPS (earnings per share) impact likely to exceed -$1.12.

With numbers like this, it’s amazing Best Buy is still in business. That Best Buy’s CEO Hubert Joly has been on the job less than 10 weeks and already feels the need to make a bet the farm type of move is telling. Not many companies have the leeway to make $400 million quarterly wagers. Of those who do, not many survive to try it again.

But let’s take a step back and understand where these numbers come from. First, they’re based on the assumption that 30 percent of Best Buy’s customers take them up on the price matching offer. If fewer do, the impact would be less. But, if the number is greater -- very possible -- the gross profit impact would rise by approximately $125 million to $150 million per 10 percent increase in adoption.

InvisibleHand isn’t the only one that believes these numbers. Wedbush Securities equity analyst Michael Pachter confirmed the company’s math, calling it “soundly reasoned,” and calculated that each 10 percent in price match uptake will likely cost Best Buy $0.37 in EPS.

Is there any scenario under which this works out for Best Buy?

Yes, but Best Buy would have to sell a whole lot of crappy headphones and digital cameras. According to InvisibleHand, the retailer needs to double sales this this holiday quarter compared to the same period in 2011 and must increase cross-sale value (the value of additional items sold, aka camera cases and memory card alongside digital cameras) to 100 percent. Maybe Best Buy should start selling Fairy Dust, too.

The impact of this price matching policy likely means that Best Buy will miss its adjusted FY 2013 EPS guidance of $3.50 to $3.80 provided to Wall Street by miles. The company posted an EPS of $0.92 for the first half of the financial year, meaning that it needs to generate $2.58 to $2.88 EPS in the last two quarters to meet projections. With the likely negative earnings resulting from the price match, this seems unlikely.

Best Buy is trying to play a game it can’t win in a sport it doesn’t participate in -- like a middling veteran basketball player suddenly switching to hockey. Amazon and Best Buy operate in two entirely different realms, their only similarity being that they both sell things. Amazon currently has more than $5.2 billion of cash and short term investments on hand, compared to Best Buy’s $680 million. The online-only giant is engaged in a decade long land grab that places customer loyalty ahead of short term profits. Plus Best Buy has significant overhead, with approximately 2,900 physical stores around the world. As a result, Best Buy is in the exact opposite position, gasping for air, desperately searching for a way to staunch the bleeding.

The land grab strategy seems to be working for Amazon, as its year-over-year revenues for the quarter increased from $10.9 billion to $13.8 billion (though this includes a variety of non-ecommerce business units), while Best Buy’s shrunk from $11.3 billion to $10.5 billion. Both companies operate on razor thin margins, with Best Buy eeking out $12 million of net profit (down from $177 million a year earlier) and Amazon losing $274.0 million (down from a gain of $64 million a year earlier), due largely to a write down of its Living Social investments.

Indicative of investor’s confidence in each business, Best Buy’s stock stock price of $15.99 is down 44 percent off its 52 week high and trending downward, while Amazon’s price of $227.63 is down only 13.8 percent off its high and generally trending upward. More tellingly Amazon’s price to earnings ratio is a stratospheric 3,045, while Best Buy’s is zero.

It seems that Amazon has tricked Best Buy into swallowing a poison pill, which the yellow tag retailer takes willingly. With the massive overhead of its physical stores, Best Buy must differentiate itself from the online-only crowd, and in turn justify slightly higher prices, based on service and experience. Personally, I’ve weighed in suggesting it tap into the connected consumer trend and even launch a captive consumer electronics crowdfunding platform, but these are just a few of the many options to consider.

What’s increasingly clear, however, based on InvisibleHand’s analysis, is that competing on price is a fool’s game for Best Buy. If the company does in fact go forward with the all in bet, it could be the hand that finally busts the company.