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Closing 155 of its retail locations wasn't enough to prevent bankruptcy for Circuit City

The state of the global economy and that of the U.S. economy are making things difficult on many companies in the U.S. as sales fall and credit terms tighten. Consumer electronics retailers and computer manufacturers are among the companies that are feeling much of the economic pressure.

One of the biggest retailers to find itself in a serious economic crunch is Circuit City. The consumer electronics retailer announced today that it is filing for Chapter 11 bankruptcy to protect itself from creditors after cash flow problems began to prevent it from completing its turnaround efforts.

The bankruptcy filing is far from the first sign that the electronics retailer was suffering. Circuit City announced just last week that it was closing 155 of its stores across America. The massive store closures would eliminate 17% of Circuit City's U.S. workforce.

Reuters reports that out of the last six quarters Circuit City has reported a loss in five of them. The consumer electronics leader is Best Buy followed closely by Wal-Mart according to Reuters. Losing the competition posed by Circuit City in the markets where its stores are closing would at a glance seem to be a good thing for other consumer electronics retailers.

However, Circuit City is having massive liquidation sales at the closing locations that could prove to be a big problem for Best Buy – at least in the short term. In the beginning stages of the liquidation sales discounts at Circuit City are said to be at least 30%. As time goes by and the stores get nearer to closing, the discounts will only get bigger. The discounted merchandise could pull important holiday shoppers from the more stable electronics retailers into closing Circuit City stores.

Analyst Dan Binder from Jefferies & Co told Reuters, "Longer term, you've got Best Buy, who's dominant in the sector, taking share. But in the short run it could feel the pain of the liquidation activity."

Filings from Circuit City for Chapter 11 showed the company had $3.4 billion in assets and $2.32 billion in debt as of August 31 with more than 100,000 creditors. Circuit City first started to consider closing stores in October. At the time the Wall Street Journal reported that the closing of the stores was an attempt to stave off Chapter 11.

Only a few weeks later Circuit City announced on November 3 its plans for closing the 155 stores across the country. A big factor in the decision to file Chapter 11 was the fact that Circuit Creditors had tightened credit terms extended to the retailer considerably. Some creditors were even requiring upfront payments before shipping goods.

Circuit City CFO Bruce Besanko wrote in a court filing, "In large part, a Chapter 11 filing is due to three factors, all of which contributed to a liquidity crisis that prevented the company from completing its turnaround goals outside of formal proceedings: erosion of vendor confidence, decreased liquidity and a global economic crisis."

Best Buy had said previously that it would consider taking over locations that rivals closed. There is no word from Best Buy on whether it will take over any of the Circuit City stores that are closing.



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By Eris23007 on 11/10/2008 8:12:39 PM , Rating: 5
Jason,

The notion you're addressing here is one of "sunk costs." Sunk costs are dollars which have already been spent by a business and cannot be recovered, such as those spent to build a new store.

One fundamental concept taught early in an undergraduate-level (and MBA-level, for that matter) business curriculum is to ignore sunk costs when making business decisions. While this seems counterintuitive, it is absolutely the correct advice: who cares how much you spent on something in the past - business decisions MUST be based purely upon expected future performance.

As someone else pointed out, newer stores are not necessarily more successful. Older stores may be more successful due to a superior location, better management & staff, or simply a long-standing clientele. The incorrect decision may have been the locations and/or economic climate in which CC chose to build their new stores.

So, if you have an old store which is making a strong profit margin compared against a brand new store which cost you millions of dollars to build but is losing money, and you have to reduce operating expenses due to insufficient cash flow (the situation in which CC finds itself), which are you going to close? No question, the new store.

I cannot comment on this specific decision that Circuit City made, as I do not know the details of this store vs. the others not selected for closure. That's not the point. The issue is that you used flawed logic in concluding that Circuit City acted illogically. Ignoring sunk costs is absolutely appropriate.

Not only that, you termed their decision "sheer lunacy."

I don't know about others, but I've observed this over-reactionary pattern in a number of your posts, especially as pertains to others' business decisions. Have you considered that maybe you are unqualified to cast these judgments? The people making these decisions are certainly not perfect, but likely have extensive training and years of experience operating large businesses.

You might benefit from considering others' perspectives before leaping to such emotional (and logically flawed) conclusions. You might also benefit from taking a few business classes to understand the theory underlying the decision-making processes you so regularly trash.


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