Case: Consumer electronics market and profitability drivers

In this review, we examine the target market and profitability of Nordic electronics retailers. The industry suffers from structurally low relative profitability, which we believe is due to intensified competition following a concentrated market, high price points of products, and price-conscious customers. We believe the key drivers for profitability improvement are the rise in the popularity of private label products and improved cost efficiency, which each player in the industry seems to focus on. In addition to Verkkokauppa.com, which we cover, the review includes the Swedish Kjell Group and Dustin Group, the Norwegian Komplett Group and Elkjøp Nordic (Elgiganten), a subsidiary of Currys, listed in the UK.

Market overview – Intense competition and price pressure

The consumer electronics market has grown at roughly the pace of GDP over the past decade. Over the years, the industry has increasingly focused on larger players thanks to their better pricing power compared to smaller players. In other words, the price competitiveness of smaller players has been significantly weakened as larger players push down consumer prices utilizing better purchase terms. This is welcomed from the consumer’s viewpoint, but at the same time, companies’ profitability is under clear pressure as each player calls for low prices in their marketing communication.

A strong online penetration is natural for consumer electronics (the share of e-commerce in total sales is among the highest in retail). This has enabled new business models, like Verkkokauppa.com, Komplett and Dustin, that operate on an e-commerce-first basis. E-commerce model also enables a wider audience through which companies have grown their customer base. However, there are still plenty of brick-and-mortar-focused players in the industry, whose e-commerce capabilities are also reasonably good in our opinion. We believe the shift to e-commerce will accelerate in the future and suspect that players with a strong position and good capabilities in e-commerce will be one step ahead of brick-and-mortar stores.

Over the past five years or so, the market has experienced strong ups and downs. During the COVID era, goods consumption rose to unusually high levels, which stimulated retailers’ sales throughout the industry. Consumer electronics retailers saw even stronger sales thanks to front-loaded electronics investments driven by the home improvement trend.
In addition, the mobility restrictions of the COVID era accelerated online migration, which was particularly visible in the revenue levels of online companies.

Weakened consumer purchasing power triggered by increased inflation, the war in Europe, and the weakened economic situation led to a rather pronounced decline in the industry at the end of 2021 or during 2022 at the latest. Players selling more cyclical consumer electronics have suffered the most from this, while the organic revenue of Kjell Group, which focuses on accessory sales, has declined less. Market weakness has also hit corporate customers, with Verkkokauppa.com's B2B sales falling by about 15% (7% per year) since 2022. The same trend can be seen in Dustin Group’s revenue development, which we estimate has decreased organically by some 10% per year. Although corporate customer trade is perceived to be more defensive than consumer trade due to high replacement demand, the growth conditions of the segment have been lowered by the weak financial performance of SME customers in particular, which has led to customer exits through bankruptcies. Relatively weak comparison figures and rising consumer purchasing power should give impetus for revenue growth, and we estimate the industry outlook to be positive in 2025. Moreover, turn in B2B sales requires improvement in recruitment needs.

Players have different margin profiles

In our view, the relative profitability conditions of the industry are structurally low due to the tightened competitive landscape in a concentrated market, high price points of products, and customers’ price awareness. This is particularly visible in the lower sales margin compared to the average gross margin of retail industry (~30%). The gross margin of the companies in this review has on average been 21.5% over the past seven years, boosted by Kjell Group, which focuses on more profitable accessory sales. Without Kjell's influence, the margin has been around 16%. Elkjøp Nordic with the largest volumes (~8x larger than Verkkokauppa.com) also stands out, and we believe it can negotiate the most favorable purchase terms of the bunch and thus achieve fairly healthy margins regardless of customers' price sensitivity. Considering this overall situation, forming a purchasing consortium or consolidation of smaller Nordic players would be fairly justified. Theoretically, if Verkkokauppa.com, Komplett and Dustin would merge purchasing or business operations, each company would have the potential to improve profitability. In our view, the competitive barriers for these players are reasonably low, as their core businesses focus on different areas (Verkkokauppa.com Finland B2C, Komplett Norway/Sweden B2C and Dustin B2B).

The business model determines the cost ratio

The companies in this review can be roughly divided into two different groups based on their business models: 1) e-commerce-focused and 2) brick-and-mortar-focused. The business model is visible in fixed costs relative to revenue. Among e-commerce-focused players (Verkkokauppa.com, Dustin Group, Komplett), the average cost ratio in the previous seven years has been under 12% of revenue, while the ratio of operators focused on brick-and-mortar stores has been clearly higher (Kjell Group 31.5% and Elkjop 16.2%). Brick-and-mortar-focused players tie up a lot of capital in store personnel, the share of which is, in turn, relatively low for online stores. Strict cost control has been vital for smaller online players when competing against the larger Elkjøp and Power operating in the Nordic countries as the bigger players can press down the final prices of their products with good purchase terms (i.e. lower purchase prices).

Profitability is structurally low

Due to high variable costs (i.e. low gross margin), the profitability of companies in the industry is structurally rather low, especially for those focusing on product sales. Thus, it is also challenging to find scalable business models in the industry. The adjusted EBIT margin of the companies in this review has been 2.8% on average over the past seven years, Kjell stands out positively from the group, which we believe is due to its pricing power. In general, the profitability in the industry has been on a downward trend, which we believe is caused in particular by a challenging market environment but also by increased price competition.

However, low relative profitability does not indicate that the business will not create value. The companies' business models are generally asset-light and balance sheets (inventories) rotate quickly, which enables a return that exceeds the cost of capital at reasonable earnings levels.

For example, Verkkokauppa.com (ROE-% average 25%) and Dustin (ROE % average 13%) have achieved reasonable returns on capital over the past seven years (source: Bloomberg). 

To tackle the low margin level, the companies have adopted several measures in their strategies to improve their gross margin. We believe that nearly every company in this review aims to increase the sales of more profitable private label products and value-added services. There are also measures to improve the cost structure, but in our view, cost efficiency has been quite tightly tuned in the industry. At the Nordic level, we consider a 3-4% EBIT margin as a sustainable level, but, for example, in the Finnish market, intensive competition and price-sensitive customers seem to push the sustainable profitability level below the Nordic level.