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Best Buy's Heartland location in Mississauga, December 2, 2010.

J.P. MOCZULSKI/j.p. moczulski The Globe and Mail

As a bellwether for the crucial holiday season, the financial performance of consumer electronics giant Best Buy Co. is discouraging.

U.S.-based Best Buy is struggling with lower profits after being forced to slash prices on items such as flat-screen televisions to lure financially fragile shoppers. At the same time, the retailer is counting on sales of popular mobile computers such as iPads even though they generate relatively low profit margins.

The heavy markdowns and other pressures underscore a tough business environment in the runup to the all-important shopping period. Fierce competition from savvy low-cost rivals, a growing number of them selling online, is beginning to re-shape shopping habits and drag down conventional operators.

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"It signals that we've entered an increasingly more competitive retail environment for the holiday season, especially in the consumer electronics category," said R. J. Hottovy, retail analyst at Morningstar. "These are a lot of the key traffic-driving items, tablet computers, e-readers … Retailers know this is what draws people into the stores. Ultimately they flock to who can do it with the lowest cost possible."

From clothing specialists to department stores, merchants are scrambling to attract shoppers by slashing prices or finding other creative ways to give them a break – including limited-time "flash" sales and buy-one-get-one-free offers – despite their profit-pinching potential. They're betting the tactics will build business in the face of rising competition from low-cost players, including online powerhouse Amazon.com and discount titan Wal-Mart Stores Inc.

In its third quarter, which included the intense U.S. Black Friday sales period at the end of November, Best Buy's profit tumbled 29 per cent to $154-million (U.S.) from a year earlier, missing analysts' forecasts, while revenue gained 1.8 per cent to $12.1-billion. After the results were released on Tuesday, the retailer's shares sank 15.5 per cent on the New York Stock Exchange.

In another early sign of a lacklustre holiday season, U.S. retail sales grew in November at their slowest pace in five months, according to a Commerce Department report. The sales increased a weaker-than-expected 0.2 per cent after gaining 0.6 per cent in October.

In Canada, where the competitive environment isn't quite as fierce, Best Buy's same-store sales in the third quarter were flat, while the U.S. operation booked a 1-per-cent gain for those key sales, the company said. While heavy discounting in the U.S. starts in the third quarter, leading to higher sales, Canadian discounts are more pronounced in the fourth quarter.

Annalisa King, chief financial officer at Best Buy Canada, said it managed to improve same-store sales and third-quarter margins in this country partly as a result of robust e-commerce. "We're taking a strong leadership position on the Web," she said in an interview. The division, which runs namesake and Future Shop stores, enjoyed solid sales growth in mobile, tablet and television categories, helped by bigger promotions, she said.

Even so, the competitive retail environment will soon intensify in Canada, Mr. Hottovy predicted. Amazon is pumping up its e-commerce offerings here, Wal-Mart is just starting to sell online in Canada and U.S. discounter Target Corp. will open stores in this country in 2013. "The themes that we're seeing in the U.S. in the consumer electronics retail market probably are applicable to Canada in the next couple of years," he said.

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In the third quarter, Best Buy reversed last year's strategy of limiting discounts and marking down only expensive items. This year, it touted deep discounts and pledged to match lower advertised prices, while offering free shipping. The change helped the retailer draw customers and boost sales: the company's overall same-store sales rose 0.3 per cent at stores open at least 14 months, reversing decreases in the past five quarters. But the moves hit the bottom line.

"These actions, while negatively impacting gross margin, significantly resonated with customers and resulted in improved traffic in [same-store] sales, including a significant increase in our online growth," chief executive officer Brian Dunn told analysts. "Retail has been very promotional and consumers have been value-conscious."

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