Circuit City & Best Buy: Adaptation in Consumer Electronics Retail

One company clung to high margins while its market changed beneath it. The other adapted repeatedly. A study in the margin trap.

A Changing Market

In the 1980s and 1990s, the consumer electronics retail industry underwent rapid change. On the demand side, there were new product introductions: stereos, the Walkman, compact discs, and video games. These items were smaller and came with lower selling prices and margins than traditional products like appliances, PCs, and TVs. At the same time, there was rapid price deflation—a mid-level IBM computer fell from $3,500 to $1,500, and VCR prices dropped from $400 to $150. Before the 1980s, customers needed education on unfamiliar products, making assisted sales necessary. By the 1980s, a customer was buying her third TV, not her first. She saw the pattern of frequent new products followed by price deflation. The new customer wanted to buy but didn’t want to be sold.

The new customer coupled with rapid price deflation altered the competitive landscape. By 1990, multiple chains had gone public and expanded geographically into each other’s territories. Richard Schulze, Best Buy’s founder, estimates from 1983 to 2000, 576 consumer electronics retailers went bankrupt. Circuit City and Best Buy were the survivors of this shakeout—but only one would thrive.

Circuit City’s Margin Obsession

In 1986, Richard Sharp became Circuit City’s CEO. His strategy centered on rapid growth, dominant market share, and—crucially—superior gross margins. The principal tool for achieving margins was “step-up selling” through a commissioned salesforce: show customers a base model, walk them up to a higher one, and sell extended service plans whose economics were often more attractive than the margin on the item itself. In some cases, the bottom line profit of the ESP was as great as, or greater than, the profit on the merchandise itself. This created a powerful incentive to preserve the assisted-sales model even as customers were rejecting it.

This approach had worked historically, but customer preferences were changing. The new “informed” customer did not want nor need sales assistance. What the customer wanted was a central checkout where they could grab an item and leave. Instead, at Circuit City, customers were met by a commissioned salesman incentivized to step them up and sell them insurance.

Best Buy’s Adaptation

Best Buy read the customer differently. Richard Schulze recognized the shift and adapted his model multiple times. Best Buy would move to a non-commissioned salesforce and introduce the “Concept II” store format—large, warehouse-style stores with a central checkout, wide selection, and low prices. The model prioritized volume over per-unit margins.

— The full case study continues with Best Buy’s evolution through multiple store formats, Circuit City’s internal credit bank masking store economics, and how the margin trap ultimately destroyed Circuit City. —