Financial Clarity for Entrepreneurs

Hope Is Not a Strategy

This article in Businessweek discusses the impact that Walmart’s infamous sub-$1,000 plasma TV promotion for Christmas 2006 had on both suppliers and competitors. With its scale and its low cost structure Walmart forced its competitors to adjust prices with disastrous effects.

The fallout is evident: After closing 70 stores in February, Circuit City Stores (CC) on Mar. 28 laid off 3,400 employees and put its 800 Canadian stores on the block. Tweeter Home Entertainment Group (TWTR), the high-end home entertainment store, is shuttering 49 of its 153 stores and dismissed 650 workers. Dallas-based CompUSA is closing 126 of its 229 stores, and regional retailer Rex Stores (RSC) is boarding up dozens of outlets, as well as selling 94 of its 211 stores. “The tube business and big-screen business just dropped off a cliff,” says Stuart Rose, chief executive officer of Dayton-based Rex Stores. “We expected a dropoff, but nowhere near the decline that we had.” Clearly, these retailers are taking such drastic measures because they don’t see any respite in sight.

Walmart also took advantage of suppliers in an industry with heavy competition and a rapid increase in manufacturing capacity.

Also, manufacturers like Samsung, Sony (SNE), Panasonic, and Westinghouse had ramped up production last year with new factories in Asia and the U.S. They began flooding the market with new TVs in the latter half of 2006. All these forces combined to make a commodity of what just six months earlier had been a solidly high-end, high-margin entertainment product. “It’s Econ 101: Best Buy and Circuit City had seen fat margins from flat-panel TVs for a while, and as it happens with any product, eventually the margins come down and the music stops,” says David Abella, a portfolio manager at New York-based Rochdale Investment Management, with assets of $2 billion.

So, what lessons can we learn from the TV business?

Whether you’re a supplier or retailer, if you’re in a commodity business you will either have to adjust or live with small margins. Adjusting could mean using commodity products to act as a foundation for the infrastructure associated with scale and using this as a jumping off point for selling smaller volumes of value-added products or services. This is what Circuit City is attempting to do with its Firedog installation service. Or, it could mean getting out of the commodity business altogether, reducing scale and moving up the value chain.

Living with small margins means a relentless focus on costs in an attempt to squeeze out a couple more points of gross profit – if you’re lucky. If your strategy is to compete with Walmart on price, you’ve probably already lost the ball game.

Flat panel TV manufacturers are between an rock and a hard place. They need the scale that Walmart, Circuit City, Best Buy, et al provide in order to amortize their large investments in manufacturing capacity. Reducing size and moving to higher value products with less volume may not be an option for them.

The small business, however, has the ability to both take a longer-term view and adjust more quickly.

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