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Best Buy: Deflation Is the New Normal for Consumer Electronics

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Best Buy had a rough holiday season.

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I thought my holiday season was bad.

I was sick for over a week two separate times, I got dumped via text message, and the Christmas turkey was undercooked.

But boy, Best Buy (NYSE:BBY) got sliced and diced up by what we can comfortably call the new normal of deflation in consumer electronics.

The company said that holiday season (defined as the nine weeks ending January 4) sales fell 2.6%, with a domestic same-store-sales decline of 0.9%.

But the real kicker was Best Buy's announcement that its fourth-quarter operating margin would fall 175-185 basis points from last year due to what it called an "intensely promotional holiday season."

This required what Best Buy CEO called an "investment in pricing."

I'm not crazy about that choice of words because the word investment implies some long-term benefit while it increasingly looks like prices have nowhere to go but down.

The market flat out hated it, sending Best Buy shares down as much as 33% in pre-market trading.

From a macro perspective, the biggest culprit is Amazon (NASDAQ:AMZN), whose business model revolves around giving customers rock-bottom prices and great customer service in an effort to build scale over the long term.

And it's working. Barring some unforeseen disaster, Amazon will cross the $100 billion/year revenue mark in 2015, and it has a good chance of beating Wal-Mart (NYSE:WMT) to the $1 trillion/year mark.

Investors certainly have a lot of confidence in its long-term growth prospects:



Now, there's always been some level of price pressure within the mostly commodity consumer-electronics industry.

Competing with Wal-Mart was bad enough, but Amazon changed the game completely by giving up on margins to build market share. It lowered the bar, and now everyone's forced to play the discount game because people naturally gravitate to cheaper prices, aided by the transparent price-discovery process made possible by the Internet.

The big brick-and-mortar sellers really are stuck between a rock and a hard place. They don't have much room left to expand geographically and they all sell the same stuff, so they're left with two lousy choices: 1) hold the line on price and lose revenues and market share, or 2) compete on price and sacrifice profitability.

Smells like deflation to me.

Now let's look at things from a micro perspective.

We're going to fire up the time machine and fly back to Best Buy's 10-K from fiscal 2006, the last full year before the company's stock hit its all-time high of $59.50 in April 2006.

What was driving the business then?

Products having the largest impact on our fiscal 2006 comparable store sales gain included flat-panel televisions, MP3 players and accessories, notebook computers, digital cameras and accessories, and video gaming hardware. Flat-panel television sales were very strong as unit-volume growth and increased screen size more than offset declines in the average selling prices of these products. MP3 products also generated strong comparable store sales gains as customers continue to adopt, upgrade and add accessories to digital music players.

And what's happening now?

The mp3 player category has all but disappeared. Due to the introduction of the Apple (NASDAQ:AAPL) iPad as well as other structural issues, the Microsoft (NASDAQ:MSFT) Windows 8 upgrade cycle never happened. Digital-camera sales are collapsing. Everyone's got a flat-panel TV nowadays, and the market then was boosted by the craziest housing market in history. Demand for next-generation video game hardware like the Microsoft Xbox One and Sony (NYSE:SNE) PlayStation is strong for now, but there's no Nintendo (OTCMKTS:NTDOY) Wii-like phenomenon expanding the size of the market.

But wait, there's mobile! The iPhone and iPad and an army of Google (NASDAQ:GOOG) Android devices are ready to save the day, right?

Not so fast.

One piece of information that's getting ignored is the fact that Best Buy cited a "disappointing mobile phone market" as a key factor in its weak performance.

Additionally, have you been paying attention to what smartphone carriers are doing? Our pals at Reuters put out a great story last weekend recounting how T-Mobile (NYSE:PCS), AT&T (NYSE:T), and Sprint (NYSE:S) are effectively trying to buy customers from each other. That's awesome if you're about to go shopping, but it supports the idea that the domestic smartphone market is saturated. In November 2013, ComScore (NASDAQ:COR) said that 148 million people in the US owned smartphones.

There's still growth in smartphones ahead, but we're clearly past the glory days -- especially if you consider the fact that virtually every smartphone maker is hurting.

See also:

Live From CES: Cisco, Clover and Bank of America Rethink the Connected Store

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No positions in stocks mentioned.
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