When innovation disappears: Five lessons from Circuit City

Circuit City global strategyBy Dan Benton, Dave Davidson, Kyle Larsen, Dan Olver and Jong Chul Park

Innovation is a buzzword thrown into corporate missions as evidence of how a company creates and differentiates; it’s a keystone for any business, a prerequisite for any manager, and a selling point for any investor.  But what is innovation? And why do we desperately seek it? The way we look at it, innovation is the creativity of a few put into action by many, offering quantitative and qualitative advantages over the competition.  However, any single act of corporate innovation is not enough to create sustainable value; legacies are created through continual value creation.

Imagine a company that created an industry, pioneering enormous growth and innovation in a consumer demand market that had never before existed.  Picture the company riding decades of success into the preeminent spot of its industry, rising to 160th in Fortune 500’s most successful companies, peaking at $10 billion in sales.  Now, envision this giant lying in ruins only two years later.  Circuit City is a case study in how not to run a business.

Relying on decades of success, it became complacent and ultimately failed to truly innovate.  Lacking the foresight to evolve with changing consumer preferences, Circuit City eventually eliminated what it should have raised and relied on imitation over creation, ultimately managing its way to liquidation.

In the 1990s, there were three main retailers where consumers bought electronic goods: Circuit City, Best Buy, and Radio Shack.  However, within the past decade, the Consumer Electronics Retail Outlet landscape completely changed.  Increased competition from new rivals forced companies to adapt to an evolving consumer base, and some did it better than others.  The most significant game-changer to the traditional Consumer Electronics Retail Outlet industry was the emergence of internet technology – 74.1% of electronics are now purchased online.

Lesson #1: Recognize your consumer base.

Through the internet, consumers now have instant access to information. The masses are now empowered with real-time price comparison tools which can rank dozens of stores at a time irrespective of geography. This knowledge of price discrepancies bestows tremendous power upon consumers and drains profits out of the industry as people exercise their arbitrage options.  Also, online retailers have eliminated the awkwardness of dealing with overly-eager or aggressive salespeople, relieving added purchase pressure unnecessarily placed on consumers.  Circuit City, unfortunately, had a hard time letting go of its in-store traditional sales strategies in order to fully adapt to the changing market space.

The internet also connects potential buyers with previous buyers, who now have significant influence on sales.  The 2004 book The Wisdom of Crowds documents the internet-facilitated shift of consumer buying trends; now consumers trust amateur customer reviews over expert opinions.  The idea that the collective wisdom of crowds is a more accurate depiction of a product’s worth is the driving force behind collecting and publishing customer opinions online, to which Amazon owes much of its success.  While Circuit City did eventually move into this space, its database of customer reviews was relatively small, which pushed potential buyers to other websites.  Surprisingly, much of Circuit City’s online strategy focused on enticing online shoppers to come into their stores, as seen with their 24/24 policy, which promised customers a $24 gift card if their item was not ready for pick up in-store 24 minutes later.  Though the idea did get the attention of a number of online shoppers, the strategy reveals a subtle stubbornness to move away from their old sales techniques and fully embrace a changing industry.  Circuit City’s failure to overhaul its selling practices to an evolved consumer market was the first subtle sign of its demise.

Lesson #2: Appreciate your competition.

The expanding online retailing presence was not the only threat to Circuit City by any means.  Unspecialized discount retailers like Wal-Mart and Target stole market share from the established players by broadening their electronics offerings in a short amount of time, adding further pressure on the specialized industry. These chains encountered few barriers to entry because they took advantage of their finely tuned supply chains, real estate strategies, and high foot traffic in their stores.  With a diminished consumer desire to be serviced by an expert sales staff, electronics was natural expansionary territory.  These companies also reflected their expanded electronic products on their websites, aligned with consumer trends, and often included exclusive online inventory not available in stores.  Circuit City did little to respond to these new strategies except by trying to further specialize in a diminishing market share.

Lesson #3: Maintain strategy-implementation consistency.

The increasingly commoditized industry of consumer electronics retail has very little to compete over besides price, especially given that online retailers such as Amazon and discount retailers like Wal-Mart compete solely on price, focusing on cost saving strategies.  Best Buy has moved into product variation, focusing on customer loyalty and good relationships with suppliers. Predicting growth of customer awareness about consumer electronic products, Best Buy not only converted its sales strategy from commission-based sales to a supermarket model, but also participated in its supplier’s production development and increased efforts to control inventory.  It also intuitively established a one-stop 24/365 technical customer service: Geek squad.  All of these are innovative responses to consumer demands, which run along a clearly defined strategy.

Circuit City eyed a strategic position of specialization in products and sales staff.  In general, Return on Sales (ROS) and Asset Turnover (AT) indicate the degree of a company’s differentiation and cost savings, respectively.  Although Circuit City intended to implement a differentiated strategy with high-end home theater products, in reality, its ROS indicates that it had limited differentiation. The company’s AT figures were even greater than Best Buy’s, revealing its focus on cost savings over differentiation. This shows how seriously the company suffered from a misaligned strategic identity. Moreover, Circuit City’s cash cycle (Day’s inventory + Day’s Receivables – Day’s Payables) was over twice as long as Best Buy’s.  This means that Circuit City’s power against suppliers and consumers was so weak that it not only had to wait more than twice as long for cash from customers, but also paid its merchandise inventory price much earlier (See Exhibit 1).

Furthermore, in spite of a cutting edge inventory management system Circuit City’s inventory-asset ratio was over 10% bigger that Best Buy’s. Essentially, the company was losing money everywhere, while also failing to adequately differentiate itself, which was its ultimate strategy.

Lesson #4: Pay attention to trends and forecast accordingly.

Through its selective hiring practices of knowledgeable sales people and increasingly limited selection of product offerings, Circuit City undertook a strategy to differentiate itself from its competition within the consumer electronics retail industry by positioning itself as the premiere destination for home theater equipment.  Circuit City’s investment in the proprietary format DIVX between 1997 and 1999 was its foray into media distribution. This effort to pair a new media format that it controlled with the high-end home theater equipment it was already selling ended as a $330m failure as DIVX failed to catch on.  In a decision to focus its offerings solely around home theater, Circuit City decided to abandon its position as the second leading appliance retailer in the country – a decision that immediately cut 14% of revenues during an American housing boom.  Similarly, the company spun off CARMAX, which went on to become the country’s number one used car dealer.

Realizing that differentiation was not working, Circuit City incrementally began to copy the strategies of its increasingly successful rival, Best Buy. The first such measure was in 2000, with the announcement of a $1.5b retrofitting of its existing stores to more closely resemble Best Buy’s store layout.  The company then shifted from commission-based pay for salespeople to hourly wages in 2003, 13 years after Best Buy did the same.  Finally, in 2006, three years after Best Buy acquired Geek Squad, Circuit City introduced Firedog, a thinly veiled copy of its rival’s service wing.  However, by this point Best Buy had already established itself as the industry leader, which ultimately forced Circuit to overextend itself in an unprecedented expansion of store openings at the cusp of the financial crisis.  This move proved to be fatal.  Within eighteen months, five top managers resigned and 3,400 salespeople were laid off.  In late 2008, Circuit City, the former industry giant, went into Chapter 11 bankruptcy, and was ultimately liquidated in early 2009, resulting in the loss of close to 30,000 jobs.

Lesson #5: Don’t use a band-aid on a gaping wound.

In 2000, Circuit City was among the top ten performing corporations in the country, in an industry which it had helped define during the thirty years prior.  In less than 10 years – a decade full of technological innovation and high consumer demand for electronics – the company utterly failed.  During the 1970’s Circuit City pioneered the consumer electronics superstore, but by 2007 it could no longer compete with rivals such as Best Buy, which had begun as imitators. The company made the terrible mistake of responding to outside threats with operational, rather than strategic, decision-making.  It tried to use band-aid solutions for its revenue problems which ultimately led to a further decline in sales.  By focusing on high-end electronics, the company was in a terrible position when the economy collapsed and consumers shied away from buying expensive products. In mimicking aspects of Best Buy’s strategy, Circuit City failed to make the trade-offs required to differentiate itself in the way it had intended and could only try to maintain its second place position.  Ultimately, what doomed Circuit City was its overconfidence in a model that had once been innovative, but was insufficient for changing consumer and industry trends.  By the time it realized its strategy was outmoded, it was too late to create a new strategy, because the company had already failed.

IBISWorld, Consumer Electronics Stores in the US, 2010
Circuit City Annual Reports, 2006
Circuit City Annual Reports, 2007
Data Monitor – Circuit City SWOT Analysis, 2008
Consumer Electronics Retail Graphs, 2008
Global Online Shopping Report, February 2008
WalMart Annual Report, 2008 Q3 Report, 2010

This report was a group project for the Global Strategy class of Thunderbird School of Global Management Professor Nathan Washburn, Ph.D.