Best Buy's China Challenge

Best Buy is used to pushing higher-end fare. It drew 43% of sales in fiscal first quarter 2007 from consumer electronics, including flat-panel TVs and MP3 players. Only 7% of revenues were from appliances.

No wonder, then, that Best Buy's profit margins far surpass those of the top Chinese retailer. Last year, Gome's listed arm managed a profit of only 9.2% of revenues, compared with gross margins of 25% at Best Buy.

To win customers in China, Best Buy would likely have to flip its business model on its head, downplaying its carefully honed brand of customer service (which Best Buy calls "customer centricity") and tolerating much lower margins. It would have to do the exact opposite, in fact, of what pleases Wall Street.

It's precisely Best Buy's strengths in customer service and its position as a go-to spot for high-tech goods that have won it praise from analysts. Best Buy should see a continued benefit as digital TV "enters the sweet spot in terms of household penetration," writes Pali Capital analyst Stacy Widlitz.

The biggest factor in the American retailer's favor is its massive purchasing power with Chinese manufacturers, which has increased with its recent acquisition of Five Star. That buying heft should help Best Buy extract more favorable terms with suppliers, which it could in turn pass on to consumers, possibly helping it take market share.

Still, with prime real estate in the rich cities already taken, Best Buy will probably need to rely on acquisitions to secure the storefronts it needs. It remains to be seen whether a brilliant M&A strategy could help the company overcome its late entry into China.

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