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ELECTRONIC WARFARE

After major real estate gaffes, Circuit City playing catch-up to Best Buy

BY GREGORY J. GILLIGAN

Consumer electronics chain Circuit City has a long road ahead to catch up to muscular rival Best Buy.

Circuit City spent most of the 1980s and ’90s building stores in the wrong spots, acknowledges John Froman, the Richmond, Va.-based chain’s executive vice president and COO. Now the pressure is on to keep pace as Best Buy thrives, and store relocations are only a part of the plan.

“They are making a turnaround,” said David Campbell, a retail analyst at Thompson Davis & Co., a boutique brokerage based in Circuit City’s hometown. “It is not something that is going to happen overnight. But they are doing what they need to do, and they have been fairly aggressive in pursuing their objectives.”

In the past two years Circuit City has tried every way and then some to boost sales and profits: opening dozens of new stores, updating older ones, offering hundreds of private-label products, exiting the credit card business, spinning off its CarMax automotive business, hiring new executives — even buying a Canadian retailer.

But so far nothing has produced the desired results, though Circuit City did make some progress in its fiscal second quarter ended Aug. 31, drastically narrowing its losses and beating Wall Street estimates. The chain reported a loss from continuing operations of $11.4 million, or 6 cents a share, compared with a net loss from continuing operations of $39.3 million, or 19 cents, in the year-ago period. But it continues to lose market share to Best Buy and to other retailers that sell consumer electronics, such as Wal-Mart Stores and Target Corp.

Market shape-up and shake-up
The U.S. consumer electronics retail industry is a roughly $100 billion business, the Arlington, Va.-based Consumer Electronics Association says. Of that, Best Buy’s share is about 13 percent, compared to Circuit City’s 6 percent to 7 percent, according to Campbell. Wal-Mart controls roughly 10 percent, he says.

Best Buy first overtook Circuit City in sales terms in the fiscal year ended February 1996. Best Buy posted $7.2 billion that year, against Circuit City’s $7.03 billion. Since then, Best Buy has dramatically boosted sales each year, while Circuit City has remained relatively stagnant. Circuit City recorded $9.95 billion in sales last fiscal year, down from $10.59 billion for fiscal 2000. Best Buy posted $19.23 billion at its domestic Best Buy stores ($22.7 billion for the entire company, which includes its Canadian chain). Five years ago, Best Buy’s sales were $12.5 billion.

Circuit City also lags behind Best Buy in sales per square foot. Circuit City posted $484 in sales per square foot last fiscal year, down from $491 the year before, while Best Buy’s $871 per square foot were up better than 4 percent from the previous year’s $836.

Aging stores and poor locations are big reasons Circuit City has slipped against Best Buy, Froman says. “Our strategy then was not to get the best real estate . . . but we got reasonable real estate,” he said. “We were a destination location. We often were the biggest player in town. We had customers coming to us.”

Indeed, at the time, Circuit City frequently picked store sites on the fringe of growing trade areas. The location wasn’t always the best, Froman says, but Circuit City got there first. “We consistently chose ‘B’ real estate sites and not ‘A’ real estate when we first moved into a market,” he said. “You can do that when you don’t have a lot of competition.”

But the good times didn’t last for long. “Slowly but surely, other retailers came into markets, and their strategy was to get the best real estate at the time,” said Froman. “We have struggled to keep up with them as they have come in with a new box and a better consumer offer.”

Yup, it’s location
Starting in the mid-1990s, Best Buy was among those retailers snagging the better sites. And by the time it had opened a store in one of those markets, the trade area had usually shifted, giving Best Buy a location on the edge of a growing area and leaving Circuit City in a more mature part of town. “Had we reacted in the ’90s and opened a new store where the trade area shifted, we would be much better off today,” Froman said. “But we have struggled to keep up with them.”

Circuit City is now implementing an aggressive real estate program. It calls for the addition of 30 new stores by February and the relocation of an additional 30 to sites in more-robust trade areas. The chain plans to open and relocate a similar number of stores through the remainder of 2005. It hasn’t opened that many new stores in one year since the mid-1990s.

Those new stores, along with about 140 others that have been either remodeled or relocated in recent years, have an updated, more contemporary look with brighter lighting. The shopping process, too, has improved at most of the chain’s 600-plus stores, with most of the products stocked on shelves for customers to take to a central checkout. In the past, customers had to wait for a commissioned sales employee to ring it up.

The chain appears to be finally making some progress on the financial front at those stores it has relocated. At the 27 open more than six months as of July, sales average about 27 percent higher than the remainder of the chain, Froman says.

“We’re very happy with the rate of returns we are getting,” Froman said. “It is not just the better real estate but better real estate with a more contemporary-looking store and, in some cases, a bigger footprint than before.”

But analyst Campbell says the relocated stores’ results should be higher, because the stores are bigger. What is not known yet is whether those stores are driving more traffic on a sales-per-square-foot basis versus the rest of the chain. “That is their biggest challenge,” he said. “They need to drive more traffic into their stores.”

Other fronts
Real estate strategy is not all that Circuit City is revisiting. The chain took a bold step in February 2003 by eliminating its decades-long tradition of paying a sales commission to its employees. That move saved the company nearly $30 million in annual payroll expenses.

The company also decided to sell its finance subsidiary in November 2003 and its private-label credit card business early this year. Earlier, in the fall of 2002, it spun off its CarMax chain of used-auto superstores.

International expansion is yet another potential avenue for growth, the company says. Early this year Circuit City ventured into Canada through its purchase of InterTAN, which operates more than 1,000 stores and dealer outlets in that country under the RadioShack, Battery Plus and Rogers Plus names. There are no plans to change those names to Circuit City. (But Texas-based RadioShack Corp. filed suit in April to stop Circuit City from using the RadioShack name in Canada. The lawsuit was still pending at press time.)

The InterTAN deal gave Circuit City a boost into the lucrative private-label merchandise business, which carries higher profit margins. InterTAN’s gross profit margins last fiscal year were 41.2 percent of sales, compared with Circuit City’s 22.9 percent. Sales of private-label products accounted for roughly 29 percent of InterTAN’s revenue that year.

Beginning this fall Circuit City’s stores will be stocked with as many as 300 private-label products from InterTAN’s lineup. Some of the edgier-looking items include a power cork screw, a recording/playback photo frame and a talking jump rope that announces the number of jumps, eslapsed time and calories burned. These are the types of products consumers might find at Sharper Image or Brookstone. For about a year before the InterTAN purchase, Circuit City was selling a handful of electronic items under three private-label names it had developed. The purchase sped that process, and more private-label merchandise will be available at Circuit City in the coming year.

In an effort to gain customers and tap into the highly fragmented computer-tech services industry, in October Circuit City began testing a customer-assistance program, called the IQ Crew. The pilot, which operates about two dozen selected stores in four markets, is similar to Best Buy’s Geek Squad. For a fee, the crew fixes computers problems inside the store or at a customer’s home. If the program works, Circuit City says it may expand it to other stores.

There have been some executive changes too. The company named Michael E. Foss as its new CFO in June and in early October hired former Best Buy executive Philip J. Schoonover as executive vice president and chief merchandising officer. Schoonover had been an executive vice president at Best Buy since February 2001 overseeing new business development and customer segments. Before that he spent five years as Best Buy’s senior vice president of merchandising.

But company spokesman Bill Cimino says management recognizes that the majority of the chain’s stores are still not what they could be. “This year has been a year of hard work and changes, but by no means are we saying we are done,” Cimino said. “There is still a lot more we can and will do in the future. It will take time.”