A Tale of Two Companies: The Innovator and the Follower

For some reason, I have been obsessed lately with Circuit City and Best Buy – a tale of two companies. Maybe because of all the holiday and Super Bowl promotions around Flat Screen TVs. Regardless of why, it makes me think back to my days as a retail executive with the now-defunct May Department Store Company, which merged with Federated Department Stores last year.

May Company grew dramatically during the 80’s and early 90’s under the leadership of David Farrell. It grew through the acquisition of a number of other traditional department stores – mainly regional players. Then May centralized a number of functions creating efficiencies and more central control. For a number of years, it held the title of the nation’s largest department store company (if you classify out discounters such as Sears, Wal-Mart, Target, and JC Penney’s).

May Company was a great investment during that time as well. Until a couple years before its demise, it had over 20 years of consecutive earnings growth. My profit sharing plan did quite nicely in my 8 years tenure there in the 90’s. The main innovation that May did develop was its private label business. It grew to a billion dollar plus part of the company in the late 90’s. When I left May in 1998 to venture into another career, it was a $14 billion company.

However – May grew primarily through acquisition and then operational efficiencies. When sales grew tighter due to the rise of the discounters (Wal-Mar, Target, Kohl’s and a revitalized JC Penney), the stock price was kept healthy by cutting costs. When Federated, May’s largest competitor acquired Macy’s & Bloomingdales in the late 90’s, they surpassed May Company in total sales revenue. May became #2. David Farrell, the legendary retail CEO who was at the helm of the company during this 20-year growth span retired.

Federated also had an established private label program (not sure if they preempted May on this one). And they aggressively began to build their brands in the late 90’s. Instead of doing designer label knock off’s and discounting them (as May did), they sought to make their own brand labels just as good as the designers and priced and positioned prominently as well. Their brands were promoted through marketing and in-store displays. And they grew. Profit margins on private label products are much higher than branded merchandise – no middleman. It also creates exclusivity, which they fully leveraged in their marketing. Federated built on this and their same-store revenue grew along with their profit margins. May Company’s sales were flat, and they kept cutting costs.

Last year, Federated acquired May. It went down as a merger but May was on a downward spiral. Federated won. Although Federated also grew through acquisition as well, they continued to innovate and be more progressive; they took risks. May Company was overly conservative. They were never first to market with a new innovation; always second. In the end, that’s what killed them. The growth through acquisition strategy can only take you so far. We’ll have to see if Federated continues to innovate or gets conservative now that their largest and most direct competitor is gone.

As I look at Best Buy and Circuit City, I wonder how that will play out over the next 10 years. Best Buy is the innovator and dominant leader. Based on what I saw as of today on Yahoo! Finance, Best Buy’s stock is around $50/share (52-week high was $59.50), with a market cap of $24.1 billion and revenues of $33.7 billion. They have 940 stores nationwide (plus more internationally) and each store does about double the sales volume of a Circuit City store.

By comparison Circuit City’s stock is around $20/share (off from the 52-week high of $31.54) with a market cap of $3.51 billion and revenues of $12.5 billion. Circuit City has about 625 stores nationwide and is just getting into international expansion.

As long as the market for electronics stays strong, and it appears as though it will for the foreseeable future, both companies can do well. But they both face increasing competition from discounters Wal-Mart and Target as well as Dell. Best Buy and Circuit City stole the electronics business from the more traditional department stores and now the discounters are a threat to them.

This is where Best Buy, the innovator, led by Geek Squad. Discounters won’t offer this kind of service and it’s a way to create better brand loyalty to Best Buy and play on their strength: service. It’s also a revenue-generating service that is expected to top a billion dollars for 2007. What is Circuit City’s answer? Firedog (which just launched in September about two years after Best Buy’s Geek Squad). They even have even stolen the concept of the branded vehicles that the Geek Squad uses. Geek Squad uses branded VW Bugs and Circuit City’s Firedog answers with branded Toyota Scions.

Even Circuit City’s CEO, Schoonover, came from Best Buy. As long as the market is strong for consumer electronics, both can do well. But as soon as the market tightens, it’s the innovator, not the follower, which comes out on top.

Let’s see how these companies do over the next decade, and if they are both still around. My money is on Best Buy.