Why Best Buy Failed in China

Minnesota-based Best Buy (BBY) is best known for its big-box retail stores that sell consumer electronics products. The company was first established as the Sound of Music in St. Paul, Minnesota, in 1966 before becoming Best Buy in 1983. The retailer went public on the Nasdaq two years later, raising $8 million in its initial public offering (IPO).

After solidifying its presence as a major electronics retailer across the country, Best Buy decided to expand internationally, opening its first location in Canada in 2002 and Mexico in 2008. The company also set its eyes on China, buying a major stake in a domestic company in 2006. The move proved to be far from ideal, as Best Buy officially withdrew from the Chinese market in 2014 by selling off the majority stake in its local partner, Five Star Appliance.

Multiple factors contributed to the company's failure in China's growing economy, including a highly competitive counterfeiting market, its prices, and its big-box format.

Best Buy Enters China

Best Buy was banking on its successful model in the United States and China as it eyed China. The country represented a huge growth opportunity for Best Buy because of its growing middle class and proximity to electronics manufacturers. After studying the market for three years, Best Buy officially entered the Chinese market by buying a majority stake in local retailer Jiangsu Five Star Appliance in 2006.

It started operations with nine branded stores that mimicked their American counterparts in layout, organization, and selling tactics. This meant that they were stocked with knowledgeable customer service representatives who guided customers through a product mix that consisted of American product staples, such as espresso machines and home entertainment systems.

Best Buy reported a 33% increase in revenue from its retail operations in China during the fourth quarter of 2008. The company cited a favorable business model and expected higher profitability moving forward.

Best Buy's Problems in China

The flood of customers that Best Buy expected in China failed to materialize. Instead, after struggling for six years, the company had a meager 1.8% of the country's market share. Best Buy closed down all six branded stores in 2011.

The firm already bought out Five Star Appliance in 2008 to propel its growth in the growing economy. Brian Dunn, the company's chief executive officer (CEO) at the time, said the store would focus on mobile sections of its Five Star chain.

Best Buy ran 184 stores in China under the Five Star brand, whose reach was primarily limited to the eastern Jiangsu province. This restricted Best Buy's position in the market. Although this proved challenging, Best Buy's main problems in China stemmed from three main issues: piracy, cost-conscious customers, and the unpopular big-box retailer format.

Piracy

China is consistently ranked among the top producers of counterfeit products in the world. It isn't uncommon for these goods to be sold online through reputable e-commerce sites in the country and abroad. As much as 79% of the goods seized by U.S. Customs and Border Protection in 2020 were pirated products.

China’s extensive manufacturing infrastructure made it easier for competitors to make counterfeit Best Buy products and sell them at a lower cost than the store. As China is well known for copying American products, Best Buy's China-based competitors were easily able to take advantage of the now proximate products to make cheaper or otherwise more desired versions of electronics.

Cost-Conscious Customers

The Chinese customer also turned out to be very price-sensitive, and Best Buy's products were more expensive than those of its competitors. Research showed that Chinese middle-class customers don't mind paying premium prices for well-known brands. For instance, Apple's iPhone sales in China surpassed the United States despite its premium pricing.

Brand misperceptions can negatively affect sales, as well. Best Buy's target market was also middle class. But, the company failed to provide adequate explanations for the premium prices of its products to that audience.

Big-Box Retailer Format

Best Buy's failure to work in the local retail format is what negatively affected the company's prospects on multiple levels. The firm's bloated cost structure contributed to its expenses and was eventually reflected in product pricing. For example, the firm chose to own and manage operations for entire showrooms instead of renting out space to individual manufacturers like most Chinese retailers.

The latter strategy transfers costs, such as store employee expenses and inventory management, onto manufacturers. Best Buy also replicated its store warranty model in China, where customers are more familiar with manufacturer warranties for products. The problem was that warranties cost extra, which further inflated product prices.

After changing the company's sales model to suit local conditions, then-Asia President David Deno said the retailer's moves in China were "stupid and arrogant." According to Kal Patel, Deno's successor, the store's intention in replicating its U.S. model was to "change the industry" in China. "What we learned, very crucially, is that in China you cannot make revolutionary change. You have to work at the pace of the Chinese consumer," he added later.

The Bottom Line 

The combination of intense competition from e-commerce stores, such as JD.com and Tmall, and slow growth prospects for the Chinese economy spelled the death knell for Best Buy's China operations. Whether Best Buy returns to Chinese shores after the economy improves remains to be seen.