Best Buy's earnings disappoint, as price cuts lure shoppers, batter profits

Consumer products retail chain Best Buy reported disappointing quarterly earnings this week.

Best Buy said that its third quarter net income plummeted 29 percent as it slashed prices on scores of products in an attempt to lure customers to its stores. The retail chain has struggled over the past year to increase earnings amid mounting competition and a tepid economic climate, and the latest financial results underscored its strategy is not resulting in higher profits.

By significantly reducing prices on televisions, video games and smartphones, among other products, Best Buy mimicked a policy other retail chains are employing this holiday season as they work to entice prudent shoppers to spend more money. While such campaigns have helped drive an uptick in revenue at certain chains, they have also prompted many companies to implement business cost reduction campaigns, according to experts.

Such cost reduction initiatives are imperative to the success of the sales campaigns. While reducing item prices helps spur shoppers to visit stores, it also crimps profit margins, and that has prompted store executives to cut costs through improved strategic sourcing and by working with procurement consultants.

With consumers avoiding expensive electronics products, Best Buy suffered, The Associated Press reports. The company's adjusted earnings missed analysts' expectations, and its shares dropped by more than 15 percent following its quarterly financial announcement.

Best Buy chief executive Brian Dunn asserted the Minnesota-based firm had no choice but to increase marketing expenditures and reduce item prices, citing increased competition from Amazon, Target and other retailers.

"We took decisive actions to drive our business," Dunn said in a statement. "These actions, while negatively impacting gross margin, significantly resonated with customers and resulted in improved traffic."

The Wall Street Journal reports that while the sales strategy has worked for other retail chains, Best Buy's core product offerings are expensive electronics products. As a result, the company needed to significantly boost sales to offset the drop in profits from the price reductions.

"Consumers have been value-conscious," Dunn told investors on a conference call. "We purposely planned to take a leadership stance in the marketplace and stepped up our promotional efforts to do so."

Domestic gross margin dropped 1.3 percentage points as a result of its aggressive discounting, according to Dunn. Still, analysts said the sales tactics had successfully increased foot traffic at Best Buy stores. Compared to the same period in 2010, the company's revenue climbed 1.7 percent to $12.09 billion, illustrating how shoppers took advantage of cheaper mobile phones, computers and other electronic gadgets.

"While we think management is more focused on addressing competitive issues through better pricing and labor models, it is not producing enough top-line growth to convince investors that the longer-term challenges have changed all that much," Jefferies analyst Daniel Binder asserted in a note to investors.

Nevertheless, unlike its competitors Best Buy relies heavily on products such as Apple's iPad, which offer less profit potential than other kinds of consumer goods. Moreover, Best Buy does not have the ability to cut prices on goods including clothes, which are cheaper to produce and are often considered high-margin items.

On a positive note, Best Buy said its online revenue jumped 20 percent compared to the third quarter in 2010. Other retailers have also witnessed an uptick in sales through their ecommerce sites, and they have increasingly urged customers to take advantage of online-only deals. The company said sales of tablets and e-readers were robust.