Business Review: PC Connection

PC Connection significantly improved the profitability of its business during the past year. Let's take a look at some of the key findings from their most recent 10-Q statement.

Through nine months, net sales increased by fifteen percent to just over $1.2 billion dollars. Earnings before taxes dramatically improved, from $7.8 million last year to $14.7 million this year.

• Small Businesses and Consumers = $655.6 million dollars sales and $4.3 million dollars profit. Sales improved seven percent, profit improved by $1.4 million dollars. Gross Margin was 13.5% in 2006 verses 12.5% in 2005.
  
• Large Accounts = $350.0 million dollars sales and $17.6 million dollars profit. Sales improved by a whopping forty-nine percent, profit improved by $5.2 million dollars. Gross Margin was 10.9% in 2006 verses 10.3% in 2005.
  
• Public Sector = $197.8 million dollars sales and a loss of $7.2 million dollars. Sales were essentially flat, while profit improved by $0.3 million dollars. Gross Margin was 12.3% in 2006 verses 11.5% in 2006.
  

By product offering, sales improved nicely across all merchandise divisions.

• Notebooks and PDAs = +7% (the largest merchandise division, $210,000,000 YTD).
  
• Desktops and Servers = +12%
• Storage Devices = +14%
• Software = +20%
• Net/Com Products = +19%
• Printers and Supplies = +11%
• Video, Imaging & Sound = +25%
• Memory & System Enhancements = +8%
• Accessories & Other = +23%

Management makes several interesting observations in this report.

• Small business sales increased among businesses, but decreased among consumers.
• Increases in online sales were offset by decreases in telephone sales.
• The number of catalogs mailed were decreased verses 2006, focusing instead on more diverse strategies to drive sales among businesses.
  
• Large accounts benefited from inclusion of sales from Amherst sales representatives, and a twelve percent growth in organic sales.
• Gross margins were improved by vendor considerations.

I enjoy reading about businesses that I am not familiar with. Specifically, I have generally worked for businesses with gross margins in the forty to sixty percent range, businesses that largely developed their own products.

In this case, PC Connection largely sources merchandise from vendors who can and do sell their own merchandise through their own distribution channels, or through other channels. For instance, HP computers can be sold via HP's website, or through businesses like Best Buy. Competitively, PC Connection would have to differentiate itself in some manner, so that customers choose their business. In my case, I buy from PC Connection because merchandise is shipped in a rapid and inexpensive manner.

As you can see, PC Connection faces challenges managing a business with gross margins in the twelve percent range. Downturns in business can cause the business to not leverage fixed expenses. Large accounts appear highly profitable, as sales and margin leverage a minimal expense structure. The majority of the profit generated by PC Connection is generated by only 87 employees. More than four hundred employees manage the small business segment.

It will be interesting to see if PC Connection can continue to drive sales and profit increases at a time when margin pressure increases in the computing industry. What do you think about the prospects for PC Connection?

Business Review: Overstock.com

Earlier this week, Overstock.com announced third quarter results, sharing with the public a year-to-date loss of $56,000,000 on net sales of $499,000,000.

There were many interesting tidbits in their 10-Q statement. Let's explore some of the comments.

In the third quarter, and early fourth quarter, sales decreased verses prior year. This will be very interesting to follow, going forward. We all follow the online sales forecasts from folks at Forrester Research and other outlets, forecasts that suggest continued and unimpeded double-digit online growth. Overstock.com is bucking this trend. Management states that sales decreased due to a decline in conversion rate. In other words, traffic supported growth, but fewer visitors decided to purchase something.

It is interesting that management elected to throw the marketing department under the bus. Management is quoted as saying "The areas of our business that most directly affect conversion rate, including personalization of the website, customer retention, e-mail marketing, site design and layout are the responsibility of the marketing department". Ouch! Apparently the quality, assortment and price of the merchandise do not play as large a role in determining whether customers want to purchase anything from Overstock.com. As a customer, do you buy from Overstock.com because of the merchandise, the price, or the design and layout of the site? Obviously, any marketing department can do better. Merchandisers can also do better.

Management stated that marketing expenditures were less efficient because marketing agreements with MSN, Yahoo! and AOL expired or were too expensive to cost justify. Management elected to increase spend on television and radio. This caused brand recognition to increase, but did not result in an increase in sales. Management says marketing dollars will be re-directed only to activities that increase conversion.

Technology costs increased dramatically, hurting profitability. Management states that the technology platform now supports a billion-dollar a year business.

There are several takeaways from what Overstock.com was kind enough to share with us about their business.

• Overstock.com will probably need a 20% to 40% increase in net sales, assuming marketing expense increases at half that rate, and technology expense decreases significantly, in order to achieve break-even status.
• Management did not publicly criticize the merchandise assortment as a reason for decreases in conversion rate. Wow. Is it possible that customers did not want to purchase what Overstock.com had to offer, or did not find the price of the merchandise amenable?
• Overstock.com publicly announced a problem that many other online retailers are going to run up against in the future. Overstock.com depended upon portals for reasonably priced advertising opportunities. Conversely, Portals charge what the market can bear for the real estate they offer. As you continue to yield control of your business to MSN, Yahoo!, AOL and Google, be willing to accept loss of control over your sales and profit trajectory.