Big Things Are Happening at This Retailer

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It has always been assumed that Amazon (NASDAQ: AMZN) has a distinct advantage over brick-and-mortar retail because the company doesn't need to maintain a large physical retail presence. But, Best Buy (NYSE: BBY) is looking to turn that disadvantage into an advantage by using its giant store base to create over 1,000 "mini-warehouses" from where it can fulfill online orders. The company currently has 50 stores which ship merchandise for online purchases, but CFO Sharon McCollam aims to increase that number to 1,000 over the next year.

A logistical challenge

There's a reason why in-store online fulfillment isn't a widespread practice -- it's difficult. It requires a system which can track inventory in all stores as well as distribution centers in real time and feed that into the online ordering process. The order then needs to be routed to the correct place, requiring quite a bit of coordination.

The benefits for Best Buy, however, are huge. In fiscal 2012, only 1.3% of visitors to bought something, a terrible conversion rate. It's estimated that between 2% and 4% on online shoppers don't make a purchase because the item is not available on the website, and that in 80% of those cases, the item is actually available in a retail store. If this new system works, it could provide a massive boost to Best Buy's online sales.

This new system is part of Best Buy's plan to reduce the cost of goods sold by $350 million over time. Currently, store merchandise and online orders are shipped from different warehouses. Revamping the supply chain should lead to significant cost savings and get the company closer to that goal.

Rethinking returns

Best Buy estimates that it loses $400 million per year because it sends returned items to third-party resellers, a standard practice in retail. To solve this problem, the company will create "clearance zones" within stores to sell the merchandise, boosting the productivity of square footage previously occupied by things like CDs and DVDs. The new inventory system will allow online shoppers to browse and purchase these clearance items as well, and if everything goes as planned, the company could achieve significant savings in this area.

Best Buy should be a far bigger online retailer than it is today, and the changes being made should propel the company towards that goal. Best Buy has the advantage of online shoppers being able to pick up orders in-store, on the same day if the item is in stock, something that Amazon simply can't do. If Best Buy is successful in revamping its systems, Amazon may have something to worry about.

The burden of online-only

Amazon has been spending huge amounts of money expanding its number of distribution centers, investing in automated warehouses to deliver goods as efficiently as possible. But, Best Buy will effectively have 1,000 distribution centers under the new system, and although it can't match the efficiency of Amazon, this allows customers to pick up items in-store on the same day. If you need something now, Amazon is not an option.

There has been talk of Amazon offering same-day delivery for quite some time, but it just doesn't make sense given the average distance between a distribution center and the customer. But, a company like Best Buy, with 1,000 stores, could conceivably offer same-day delivery in the future. Amazon's business model has limitations which put it at a disadvantage.

The bottom line

Best Buy is making a serious effort to make itself more efficient, revamping its supply chain and prioritizing online sales. The company should be able to achieve significant cost savings from the new system and even more cost savings from selling returned items itself. Online sales could start growing very quickly for Best Buy from here on out, and I wouldn't be surprised if the company eventually becomes the number two online retailer in the country behind Amazon. Big things are happening at Best Buy, and Amazon should be concerned.

The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.

Timothy Green owns shares of Best Buy. The Motley Fool recommends The Motley Fool owns shares of Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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