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Why investors in retail should learn to love digital

The inside of a Best Buy store is seen in New York in this March 26, 2012 file photo.


The Best Buy/Future Shop consumer electronics retail chain recently announced that it was closing 15 stores in Canada. The big box stores are feeling the pressure from online electronics retailers such as Amazon and Tiger Direct with their discount pricing. Many home electronics shoppers are examining and testing the latest gadgets at the Best Buy physical stores before buying them from the cheaper online companies. This practice, known as show-rooming, has contributed to same-store sales at Best Buy declining by 4 per cent in the last nine months of 2012.

The Best Buy news, announced on the same day as similar cutbacks by Sears, exacerbated concerns from investors about the prospects for the retail sector in Canada. Best Buy shares have dropped by almost 50 per cent from its 52 week high.

But the Best Buy troubles don't spell the end of bricks-and mortar retailing in Canada. Colliers International Consulting forecasts that retail sales data for 2012 will show moderate, sustainable growth of about four per cent for the year. Target will be opening 123 stores in Canada and Walmart will soon expand to 388 stores across the country.

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Best Buy, and investors in the area, will have to look beyond the Consumer Discretionary sector to find models and comparables. It is a changing retail environment and yet another step in retail's evolution in this country.

In the beginning – the mid 1880s – were Eaton's and Simpson's. The Canadian population was drifting from the farm areas into urban centres like Toronto and developing a taste for factory-made goods that small town general stores didn't carry. The iconic Eaton's and the Simpson's, later Simpson-Sears, catalogues still allowed these department stores, which built their brands with low prices and large selection to reach out to the Eaton's family of shoppers in the smaller Canadian communities.

Then in the 1960s, lured by the wide open spaces of the suburbs and the automobile, Canadians started leaving the cities. Along came the discounters, Woolco and Kmart. Their large, brightly-lit stores dominated the vast suburban shopping centres and shoppers no longer had to head downtown to Eaton's and Simpsons for their shopping adventures.

By the 1990s, the American superstores, Costco and Walmart, and category killers, Toys 'R' Us and consumer electronics retailer Best Buy came to Canada anchoring power centres. The legacy discounters, not as specialized, found it increasingly difficult to compete.

Now it's Best Buy Canada's turn to suffer. It is not disappearing just yet, but as well as closing 15 mega-stores and laying off about five per cent of its employees, it is also downsizing by moving to smaller stores and moving its customers towards its own online outlet and away from its superstores.

This short tale of retailing in Canada seems to support Joseph Schumpeter's economic theory of creative destruction – that the old ways of doing things are destroyed and replaced by new ways. The lesson for investors seems to be to recognize and embrace the new before the old is destroyed.

In retail, however, the new doesn't necessarily come from within the sector. Best Buy should have been looking over their shoulder at Amazon as well as keeping their eyes on Staples and RadioShack.

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They might also have looked at Cineplex which has embraced technology to extend its brand beyond filling seats in movie theatres and selling popcorn. Revenues also come from the interminable advertisements that precede the shows, its partnership with Scotiabank in the SCENE entertainment rewards program and Visa card, and items from the store. Cineplex competes quite comfortably with Netflix, the Internet entertainment streaming service.

Best Buy might also look to Cineplex as a model for how to smooth out a cyclical business. Cineplex stock is trading at all time highs after its best year on record. But not every year is good. People spend money on movie tickets when there is something that they want to see, and this year the movies were popular.

It is the same for consumer electronics. When there is a product that is new and hot, sales at Best Buy, and similar stores, sizzle. It hasn't even been a warm year. The last big new home entertainment product to draw the crowds was high definition flat-screen television. When HDTVs first came out everybody wanted one, and people were willing to pay the price. As the market matured, prices came down along with the demand, even when there were performance enhancements.

The Next Big Thing in 2012 was the Apple iPhone and iPads. Here Best Buy is competing with the Apple Store, another company not listed in the Consumer Discretionary sector of the market. Last year Apple's retail stores in the U.S. made $6,050 in sales per square foot, the most of any American retailer, according to the latest data from RetailSails, which measures the productivity of major retailers each year. Apple's sales per square foot are twice that of Tiffany and Co., and significantly more than Best Buy.

It's because of the customer experience that people go to the Apple Store, not only to examine and test, but to buy as well. That's because the salespeople at the Apple Store are friendly, knowledgeable, patient and accommodating. The store is always bustling. At the Genius Bar, the customer gets help and support and training for all the Apple products, generally for free. Some Apple stores even have movie theatres for training sessions, special concerts and other events. Others stores set aside special areas for children to use educational software and play games on the Mac.

As well as looking over their shoulder, Best Buy might also take a look down the street across the mall to see its online competition. In November 2012, Microsoft opened its first Canadian bricks-and mortar store in the Yorkdale Shopping Centre in Toronto. It was Microsoft's 31st store and Microsoft has announced plans for 75 additional stores within the next three years. Amazon, the world's largest online retailer is quietly planning of an actual physical store in Seattle some time in 2013, call it a test to see if it makes sense to sell its books and Kindle e-readers in the "real" world.

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With these unconventional competitors to retail investment opportunities, you might want to look at the Information Technology sector.

READERS: Will the next big retail success story be all-digital, mostly brick and mortar, or a hybrid?

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