Best Buy turning to private labels to raise margins

  • Article by: JACKIE CROSBY , Star Tribune
  • Updated: June 17, 2009 - 4:59 PM

As shoppers hunt bargains, the retailer is turning to private labels to raise profit while upholding its image.

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Best Buy team member Ricky Didaravong helped Harry Winters select a flat-screen television. Insignia and Dynex are both Best Buy house brands and Winters selected the 32-inch Dynex.

Photo: Glen Stubbe, Star Tribune

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Harry Winters is the kind of shopper who likes to know his options. So when he set out to buy a new television for his den, he went to Wal-Mart, Target and Ultimate Electronics.

In the end, he decided on a 32-inch Dynex flat-screen from Best Buy, one of the retail chain's increasingly popular store brands.

"I was looking at Sharp and Samsung, but prices haven't come down much," said Winters, of Victoria, who was shopping in Eden Prairie with his wife, Shirley. "The picture on this one looked as good as the others, and it was less expensive."

Winters is part of the reason Best Buy's private-label business is soaring. Revenue from the Richfield-based retailers' house brands jumped 40 percent last year, according to CEO Brad Anderson, even as overall sales in existing stores fell 1.3 percent. Analysts suspect in-store brands will remain a big part of the story when the company releases first-quarter results Tuesday.

With recession-ravaged consumers hunting for lower-priced goods, Best Buy believes its growing commitment to private labels gives it a chance to capture more profit without hurting its image as a seller of high-quality goods. As the retailer tries to gain market share from the demise of the Circuit City chain -- while facing serious competition from Wal-Mart, Costco and Amazon -- the company can't afford to stumble.

Becoming an own-brand manufacturer comes with risks: It's more complicated to manage and could tarnish a company's reputation if products malfunction. And while the grocery industry has used store brands to pump up profit and build shopper loyalty in recent years, it's less clear whether the same model will work for pricier, complex electronics.

Best Buy's own experience with its VPR Matrix computers may be a case in point. It launched the house brand in 2001 but abandoned it two years later.

"Maybe the timing was wrong," said David Brennan of the Center for Retailing Excellence at the University of St. Thomas. "On the other hand, it shows some difficulties you can have in terms of launching your own brand. It's a different situation with Target's Archer Farms versus trying to convince someone to [spend] $1,000 or $500 for a computer."

For retailers looking for an edge, it's hard to ignore the steady growth of house brands. Store brands accounted for more than 17 percent of total dollars spent at U.S. food, drug and mass merchandise stores last year, according to the Nielsen research firm. Overall, the private-label segment grew about 10 percent to $84 billion last year -- more than four times the growth rate of national brands.

Best Buy won't reveal how much of its $45 billion in annual sales comes from private labels, but a Banc of America Securities analyst projected two years ago that store brands could make up as much as 25 percent of the company's revenue by 2011. Best Buy has five brands: Insignia, Dynex, Geek Squad, Init and Rocketfish.

Morningstar analyst Brady Lemos doesn't see house brands making quite so big a splash on company sales, given today's economy, but believes the strategy is sound, particularly as the recession lingers.

"Exclusive brands are just one more way it can improve its margins and separate itself from the competition, especially with Circuit City's customers up for grabs," Lemos said. "Best Buy already has differentiated itself with better customer service and hotter products than Wal-Mart and Costco."

Going in-house

Even as they tout the private-label strategy to Wall Street, Best Buy refuses to disclose the most basic data about it, including sales and number of employees.

In the early days, the division focused on sourcing and cutting out third parties. Today, it continues to bring more of the design and research in-house. About half of the current team has a background in manufacturing, including design engineers and technology experts from Xerox, Apple, Imation, Gateway and 3M.

"We have a team that is experienced and integrated into the manufacturing base who can speak the language of product development," said Fernando Silva, vice president of exclusive brands and global sourcing, who put in 27 years at Kodak before coming to Best Buy in 2005. That experience in R&D, he said, gives the company "the ability to quickly turn ideas into reality."

Rather than trying to break new ground, Best Buy's strategy focuses on improving existing products, such as connecting Google searches to GPS devices. It also is tapping into what the company considers its mother lode of idea generation: 140,000 sales associates with a million hours of customer contact each day. Two or three times a quarter the company holds "ideation" events at a dozen stores where employees take on a specific problem -- such as poor sound quality with ever-slimmer televisions and computers.

Information gleaned from the events helped lead to a new Insignia TV series that will hit stores in July, which uses advanced speaker technology developed by Audyssey, a California start-up. Best Buy also used customer feedback in developing a wireless surround-sound system with Avnera of Washington state, which sells for less than $100.

After customers complained they kept losing the caps to their flash drives, Best Buy launched an award-winning Geek Squad brand drive whose caps didn't separate from the unit.

Listening to moms

When Best Buy realized moms were major purchasers of portable DVD players for their kids, it redesigned its Insignia brand with softer edges, spill-resistant controls, stronger hinges and rubberized skin (so grimy fingers could hold onto them better.) The changes propelled the DVD players to the No. 1 market share position in 2007 without any advertising, Silva said.

"I have a fundamental belief that successful innovation only happens when you listen," Silva said. "So we're trying really hard to listen to our employees and to our customers."

Like other large retailers with a stake in building exclusive brands, Best Buy can exert plenty of influence on the supply chain to keep costs down and its own margins up. It already is the No. 1 buyer of products in all of its major categories and does its own sourcing.

The company said it has stopped selling some national lines to reduce competition with its own products.

And the company must walk a fine line between supporting national brands and competing against them, particularly as manufacturers such as Apple, Dell and Hewlett-Packard also sell directly to customers.

"Both of these worlds can coexist," Anderson told analysts in a March earnings call.

Analysts note that Best Buy is ratcheting up private labels just as Wal-Mart is scaling back. Wal-Mart, instead, is revamping its electronics sections to showcase mobile phones, portable computers and brands such as Apple and Nintendo as it works to reel in former Circuit City loyalists.

Best Buy's Silva seems to shrug off the downsides. He said the company will focus on its five brands in the short run but will bring more brands to the market.

"We believe we know a lot about technology, and we are trying to find ways to give our customers more choices, more simplicity and more value," Silva said. "This is just another pillar driving us toward a better shopping experience and a better product experience."

Jackie Crosby • 612-673-7335

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