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Online retailers pose stiff competition for Best Buy

Electronics chain Best Buy, whose Heartland location in Mississauga is seen here Dec. 2, 2010, offers a barometer on the state of the U.S. economy.

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

As the world's largest electronics chain, Best Buy Inc. is a window into the mind of the consumer and a barometer on the state of the U.S. economy.

But when the company posts third-quarter results on Tuesday, investors will also get a peek at the havoc being inflicted by the Internet on traditional retailers.

Best Buy is forecast to post revenue growth from a year earlier of only 2 per cent, to $12.1-billion (U.S.). Worse still, same-store sales in the U.S. are expected to have decreased for the sixth consecutive quarter and profit is thought to have fallen 20 per cent, to $173.3-million.

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Best Buy chief executive officer Brian Dunn has insisted that the company offers shoppers a superior formula in comparison to online competitors such as Amazon Inc. , because it blends both ecommerce and bricks-and-mortar outlets in an industry where consumers still want to touch and feel the merchandise.

But the market is not buying this argument, and it's hard to argue with the numbers. Amazon posted a 44-per-cent rise in revenue last month. Its shares, up 7 per cent this year, trade at a price-to-earnings multiple of 101. Best Buy shares, in contrast, have fallen 18 per cent in the same period and trade at a multiple of 8, in line with RadioShack Corp. and OfficeMax Inc.

Best Buy rose to prominence in the 1990s with big box stores that carried an enormous variety of products. But these days it cannot match the selection that is sold online through mass merchants and from massive distribution centres run by the likes of Amazon.

Aggravating the situation, the product development cycles in consumer electronics have become so short that it's hard for Best Buy to maintain price premiums, allowing big discount retailers such as Wal-Mart Inc. to capture market share. In addition, Best Buy's lengthy aisles of videos and CDs represent an increasingly antiquated way to buy entertainment.

In the hot market for tablets and smartphones, Best Buy finds itself competing not just against Apple , but also powerful wireless carriers that sell the devices directly to consumers.

In response to these challenges, Best Buy has been expanding its online offerings and reducing the size of its physical stores as leases come up for renewal. It has also been looking for ways to differentiate itself again and to develop new sources of revenue. The company offers in-store Geek Squad technical support services, high-end home theatre departments and at-home technical support and installation services. It is testing the waters internationally, following the success of its expansion into Canada, and through a partnership with Carphone Warehouse – Europe's largest mobile phone retailer – it is looking for a stronger foothold in the explosive smartphone sector.

None of these efforts appear to be offsetting the decline in Best Buy's traditional business. Gross margin slippage is likely to have continued last quarter as the company fought back by cutting prices.

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"Although Best Buy's customer-centric shopping environment and service offerings provide some differentiation, we're not convinced that the firm has an economic moat to fend off its encroaching rivals," said R. J. Hottovy, an analyst with Morningstar Inc. "At the end of the day, we question whether these moves are sufficient enough to address Best Buy's most pressing long-term challenges."

Best Buy still generates enviable amounts of cash and has committed to buying back billions of dollars worth of shares, while offering an annual dividend in excess of 2 per cent. But without a stronger plan to adapt to the new retail environment, the company will have a tough time winning back investors.

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