Best Buy is a multinational firm with operations in the United States, Belgium, Bermuda, Canada, China, France, Germany, Ireland, Luxembourg, Mexico, the Republic of Mauritius, the Netherlands, Portugal, Spain, Sweden, Turkey, Turks and Caicos, and the United Kingdom. Sales are split 75%/25% domestic (US) and international. Asset investment approximates this with a rough 60/40 spread between domestic and international. Profits are a different story. Operating profits domestically were 5.6% in 2009 while international operations were at 1.5%. That means 93% of profits are driven by domestic operations and only 7% internationally. On a return on investment basis, international then uses 2.7x more investment to generate a dollar of sales and each international sales dollar generates about 70% less profits than a domestic sales dollar.
An illustrative example can help us understand these underlying numbers. A domestic investment of $250 should generate an increase of $1000 in sales, which will generate $56 in profits and a 22.4% return on investment. The same investment internationally will cost $680 to generate $1000 in sales. This investment will return $15 and generate a 2.2% return on investment. To generate the same profits internationally as our $250 investment did domestically we’d have to invest $2.500.
A possible reason for Best Buy to invest so much in the international business is the eventual returns they will generate. The evidence doesn’t support that conclusion. When the domestic business had the same level of investment as does the current international operations it was 2007 and the operating profit rate was 6%, approximately 4x where the international segment is now. When the BBY domestic segment was at $9b annual in sales (1998) the operating income rate was 3.5%. So neither investment size nor additional sales will give investors comfort that the BBY international segment returns are likely to increase.
US based retailers have a long history of wasting capital in international expansions. Starbucks, Wal-mart, Borders amongst others have pulled out of overseas operations in the past few years. There are some very good reasons for these investments failing.
First, the US is a very large relatively heterogeneous market. Although the world is getting smaller, it isn’t small enough so there aren’t some product and business model issues that have to be changed by country. Those changes require extra merchandising support, local distribution and local management. The size of the US market creates low overhead costs. That is not true internationally. The management team you hire in Canada cannot manage Mexico also.
Secondly, the US is wealthy and doing business here is relatively efficient. Consequently retailers here generate strong returns. Moving away from a high return market is always going to be unattractive, every incremental dollar looks less effective. Comparing capital investment in the US with capital investment in the international segment is a bit misleading. Reaching a similar capital investment for the opportunity might require 2-3x more capital internationally than in the US. Although Best Buy has invested $6b in their international operations, they have only achieved a very small international market share vs their US share.
Thirdly, retailers in the US live on low paid workers which have relatively high levels of turnover. This is not the employment model that Europe follows. Although Best Buy does not have very high employment turnover, their number for this last year was 36%.
Fourth, international growth is rarely organic. If you have to buy your way into a market you end up paying market price. Organic growth is about adding value by putting together parts (merchandise, systems, processes, people and real estate), not through acquisitions. Adding value to an acquired asset is more difficult. Incremental sales are harder to generate, incremental profit opportunities are usually have lower gross margins or higher inventory requirements.
Finally, real estate costs are higher internationally. This is due to land use decisions and issues related to ownership and development of property. Landlords internationally take more of the profit equation than landlords in the US, usually because the competition for space is greater. When landlords have multiple bidders for the same space, they will end up with higher rents and a higher portion of the value added created by the retailer.
So why does a management team continue to invest in growth when the returns are so poor? Best Buy’s management team has a web-site that speaks to why they want to continue to grow. Sometimes growth becomes such a part of a firm’s self-image that they continue to do so well after the investments make sense. I don’t know if that is the case at Best Buy, but the return on investment results don’t look good.