Best Buy is crazy, just not like a fox

By Michael Carney , written on January 25, 2013

From The News Desk

The suits at Best Buy are at it again. In the latest installment of “crazy like a fox, or just plain crazy,” the electronics retailer has decided to discount the MacBook Air by an absurd $200 for the next two days.

Why is this so ridiculous? Let me count the ways.

First, the company has seen an alarming drop in gross profit and operating income over each of the last four quarters. Gross Profit is down from $4.1 billion in the March 2012 quarter to $2.6 billion in the November 2012 quarter. Operating income is down from $1.31 billion to a mere $48 million over the same period. Net income, aka “earnings,” which considers non-operating expenses and is thus less of a direct proxy for sales, has been all over the board as well swinging wildly from -$1.7 billion to $158 million and back to -$10 million over the last four quarters.

The bottom line is Best Buy isn’t the most financially healthy company and can’t afford to lose money on hot devices. Amazon, it is not. (In more ways than one, but we’ll come back to that.)

Apple does not release wholesale pricing and margin data on its products, specifically the MacBook Air, but we can extrapolate from information known about its smartphone sales. Reuters previously reported that Best Buy earned $100 on each iPhone 4S sale, for a 16.7 percent margin – far smaller than the 30 to 40 percent Samsung reportedly allows retailers on sales of its mobile devices. According to Reuters, the retailer purchases $700 smartphones from Apple for $600 each, sells them to consumers for a heavily subsidized $300, then receives a $400 commission from mobile carriers AT&T, Verizon, or Sprint. The report called iPad margins similarly “thin,” regardless of whether they are Wi-Fi only, or 3G/4G enabled and thus carrier subsidized.

If the Macbook Air follows a comparable wholesale pricing model there would be approximately $143 of profit built into the sale of a $1,000 base model device and $214 on the $1,500 top of the line device. Even if Apple were uncharacteristically generous on the sale of its ultra-portable notebooks, it’s highly unlikely that Best Buy can turn a profit at a $200 discount. Moreover, this article from MacWorld suggests that the margins on Macs may actually be as low as single digits.

It’s not like Best Buy doesn’t know the impact that low-margin Apple sales can cause. The company reportedly lost $65,000 in profit over the holidays price matching an aggressively discounted iPhone 5 offer from Wal-Mart. Earlier in 2012, the Wall Street Journal pointed to competition from Apple’s retail stores, and Best Buy’s inability to gain sufficient share of the iPhone and iPad markets as a primary reason for its decision to close 50 Best Buy stores.

With this context, it’s not surprising that the retailer hopes to court Apple customers, but at what cost? Making a one-time sale at little to no profit does nothing to improve Best Buy’s business in the near or long term. Someone in some boardroom at Best Buy HQ likely made the argument that MacBook Air buyers are likely to purchase additional goods and services at the same time, such as cases, bags, software, and warranties. But the idea that this would happen at such scale to overcome losing as much as $57 per sale of base model MacBook Airs seems a stretch. That it would translate into future purchases and customer loyalty is a non-sequitur.

Maybe Best Buy is just glutton for punishment. Battered by showrooming in its stores, and proving it’s willing to price match online bad boy Amazon even with potential nine figure costs, this wouldn’t be the first radical move by new CEO Hubert Joly. Or maybe this comes down to something else.

Not only have Best Buy’s bottom line numbers fallen precipitously, but it’s quarterly revenue is down some 35.4 percent in the last four quarters from $16.6 billion to $10.6 billion. Maybe that’s what this is all about. Could Best Buy be hoping that a two-day sale of Macbook Airs may give the company a revenue bump in an otherwise slow post-holiday quarter? At this scale, such a move seems unlikely to have a material impact, but I wouldn’t put such a misguided strategy past it.

As I’ve said over and over, Best Buy can’t compete on price with Amazon on the low end or Apple on the high end. It simply doesn’t have the profit margin. Best Buy needs to compete, to the extent possible, on service and experience.

Amazon has convenience. Apple has support and service.

But what does Best Buy have?

[Image credit: Flickr, Lindebaum]