Best Buy May Mean Goodbye to Record Stores

Ok, so your teenager is begging for a copy of “Sparkle and Fade,” the new album by the hot rock trio Everclear.

Do you drive to the local mall, where popular releases often run as high as $17, or try your luck at Best Buy, which is blowing out the Everclear CD this week for under $10?

If you’re anything like millions of other price-conscious buyers, it won’t be long before you set foot into one of Best Buy’s 251 outlets.

Indeed, the fast-growing Minneapolis-based discount chain--which often sells CDs below cost to bring shoppers into the store to buy electronic goods--has already captured about 10% of the U.S. retail music market.

Competitors blame Best Buy’s price-slashing practices for ruining the business, but whether they are or aren’t, analysts believe the firm is radically altering the way music is marketed and sold in the U.S.

“Best Buy is more than just a record store. It’s a brand-new kind of retail environment aimed at consumers who just happen to be music fans,” says Gary Gersh, chairman of Capitol Records, which releases Everclear’s album. “The people who put this place together are very hip.”

Best Buy, which has opened 19 stores in the Los Angeles area since 1994, stocks more than 60,000 alternative rock, rap, punk, jazz, country and R&B; CDs--all priced between $7 and $12. The chain grossed nearly $7.3 billion last year, most of which was derived from sales of computers and electronic gear, not music.

Unlike other retailers that rely on record companies for advertising revenues, Best Buy spends about $200 million of its own money each year to market music on MTV, broadcast TV and in major newspapers.

In addition, record company chiefs credit the firm’s savvy music marketing team with helping to break a number of the industry’s hottest new acts, including Everclear, Bush and Live. There’s little doubt that low-balled CDs purchased at Best Buy contributed handsomely to boosting the domestic market shares of the Capitol, Interscope/Trauma and MCA/Radioactive labels.

Record retail chains, however, wonder whether the record industry isn’t sacrificing the long-term health of its traditional sales channels simply to cash in on short-term profits generated by Best Buy.

Best Buy purchases superstar CDs from manufacturers for about $10.80--the same price paid by other retailers--but often sells them for as low as $10. Thus the manufacturer is making the same profit regardless of whether the retailer makes a dime.

Critics say Best Buy is destroying the perceived value of the compact disc, which until last year was supposed to be around $18, according to the average manufacturer’s suggested list price. According to this theory, once a consumer pays $10 for a CD, it becomes virtually impossible to get him or her to pony up $18 the next time around. (Indeed, consumers probably assume they’re being gouged by retailers who charge more than Best Buy.)

But competitors have had to match Best Buy prices or come close. With CDs selling for $10 and $11, profit margins have dropped so low for record store owners that several retail chains, including Torrance-based Wherehouse Entertainment, recently filed for bankruptcy protection.

Even giant retail chains such as Minneapolis-based Musicland and Albany, N.Y.-based Trans World Music Corp. have begun to feel the pinch. Musicland lost $136 million last year and closed 64 stores. Trans World plans to close 150 stores over the next two years, in addition to the 180 it shut down in 1995.

“This may be the beginning of the end of the traditional record store as we know it,” says Harold Vogel, entertainment analyst for Cowen & Co. “I believe that the retailers left standing after the industry shakes out may ultimately have to adopt the Best Buy loss-leader formula and add higher profit-margin products to their inventories to survive.”

The relationship between record companies and traditional retail chains that sell their products has been deteriorating for decades, with each side accusing the other of being greedy and inflexible.

Responding to the concerns of music retailers about Best Buy-instigated price wars, Time Warner, Sony, Bertelsmann and other manufacturers have implemented policies that suspend cooperative advertising for retailers advertising music below certain minimums. This can be a powerful tool, because cooperative advertising, paid for by the music companies, can form the backbone of a retailer’s marketing campaign.

So far, Best Buy has avoided any penalty, in some cases advertising higher prices to meet the manufacturer’s rules.

Best Buy, however, criticizes such penalty policies as hypocritical because, in many cases, they are being enforced by corporations that operate direct-mail record clubs that sell compact discs for even lower prices.

“Who do these guys think they’re kidding?” says Gary Arnold, merchandise manager at Best Buy. “We spend millions of dollars helping to break new acts, and 90 days later their record clubs give 11 CDs away of the same act for the price of one.”

Even Best Buy encountered cash flow problems in January and asked vendors for more time to pay its holiday bills. Other retail chains have also delayed payment of bills and have begun shipping millions of unsold albums back to the manufacturers.

As the shakeout in the retail community deepens, analysts say it could eventually force manufacturers to lower the wholesale price of the CD and accept smaller profit margins.

Music retailers have long contended that the corporations that run the booming $12-billion record business could afford to drop their prices. Indeed, manufacturers currently charge retailers almost $4 more for compact discs than for cassettes, even though it costs about the same to produce each format.

“At some point, the issue is going to come back to the record companies,” Vogel said. “It may not happen today, but in three to five years, if the retail community bleeds enough, pressure will develop for the labels to drop their price.”

But if the record corporations can hold out for another five years, new technologies could allow them to bypass the traditional retail distribution system entirely.

“Music isn’t like Barbie dolls or teddy bears or something that can’t be downloaded,” Vogel added. “In the future, record companies won’t have to worry about middlemen taking up real estate. They’ll just deliver their products directly to your home computer over the Internet.”