Barnes & Noble's financial decline and recovery strategy

¶ … Tottering?) Giant

By a whole range of economic measures, the bookseller Barnes & Noble has been a financial (as well as a cultural) success. It is the largest bookseller in terms of total revenue in the United States, with hundreds of independent-standing bookstores (which use the Barnes & Noble name) and hundreds of more mall-based B. Dalton stores. The company also has an online operation. The collection of these different branches have helped the company achieve a remarkable degree of success.

Although the seemingly ubiquitous bookstore might seem to be a relatively recent phenomenon -- along with Starbucks, its retail partner -- in fact the company was founded in 1873 as a printing company. According to the company's website (www.bn.com), after opening its first bookstore in 1917, the company prospered at a modest level until 1971, when Barnes & Noble was purchased by Leonard Riggio and it entered what might be seen as its modern phase. It was the first book company to advertise on television and the first to provide deep discount on books. Beginning in the 1990s, the company moved away from smaller retail stores to the kind of super-sized retail stores that dot the American landscape today.

These strategies provided steady and steadily growing profits for the corporation for decades, with some minor fluctuations through 2006 according to its SEC filings (http://www.barnesandnobleinc.com/for_investors/annual_reports/2008_Annual_Report.pdf ). According to the Security and Exchange Commission (SEC) filings of the company, the company's operating revenue fiscal year 2009 was 5.12 billion. (All financial data is taken from public filings to the Security and Exchange Commission.) Its operating income for the same time period was $143 million. The corporation's total assets were $2.99 billion and its total equity for FY 2009 was $922 million. Its net income was $75.9 million.

However, beginning in 2006 and extending through last year, the company began to see a reduction in profits. According to its SEC fiscal year 2008 filing, the corporate-wide operating margin fell from 4.8% to 2.8%. It is at this point that projections made for a business plan that extends over the next three years begins.

Current operating margin: 2.8%

Projected operating margin FY 2014: 5.0%

Other key projections include the following. In each case, the figures are taken from the company's SEC filing for the first quarter of 2010 (which ended in March).

Current net income vector: Decreased by 1% from the fourth quarter profits of $80.4 million to the third quarter of 2010.

Net income vector for FY 2014: Increase year-to-year by 1.5 to 2%

Key to assessing the company's current financial status and determining how this might factor into future possibilities. Sale figures are key to an analysis of the company's health and a basis for the plans about the directions in which it can grow. The most recent SEC reportings for sales figures are mixed. While a company would generally like to have uniformly good sales figures, of course, Barnes & Noble's mixed sales figures can actually be seen as useful to the company in that they suggest with some precision where the most profitable elements of the company lie.

Net Sales up 33% in the third quarter of FY 2010; this was up $2.2 billion from the previous fiscal quarter.

The company on its corporate website attributes this to its profits from its newly acquired college bookstores. (This was the first full quarter since the company's acquisition of this division: Sales for this quarter were $566.) Sales were up for its online division, increasing 32% to $210 million.

Sales dropped 4.7% to $1.4 billion from Barnes & Noble retail store (non-college) sales, with same-store sales down 5.5%.

Instituting the reforms suggested here should improve both of these sets of figures. Here are the proposed projections:

Net Sales continuing to rise at a comparable rate, although there will no doubt be some variation from quarter to quarter.

Overall sales to increase 1% per year with measured growth in all of the sectors. Especial focus should be on standard retail stores to reverse their declining sales.

The company suffered from very high SG&A expenses ("Selling, General, and Administrative" costs in the third quarter of FY 2010, rising 23% during the quarter. While this is a significant increase, it arose almost entirely from the costs associated with the company's acquisition of the college stores and does not represent an on-going trend. The company's SG&A in the previous quarter was up 3.4%, a much more modest increase. However, the company would in better shape if it could decrease this number. This leads to another proposed goal for the company:

SG&A expenses reduced to 2.5 to 3% per quarter by FY 2014.

Current Strengths and Weaknesses

First Strength

The company has shown itself to be flexible in the past in terms of adjusting its business plan, and this flexibility itself must be seen as one of its major strengths. For example, it closed a number of its B. Dalton stores in 2007 and 2008 when they proved to be far less successful than the Barnes & Noble stand-alone stores (Simon, 2009). Future adjustments to its business plan may have to focus less on where its stores are and more on what is going on inside them.

Second strength

Barnes & Noble has been able to fashion its stores as both retail sites for buying books and as destinations-in-themselves. By including coffee houses in many of its stores (as well as non-book offerings such as large music selections and incidentals such as stationery) Barnes & Noble has fashioned itself as a place that people might want to visit even if they do not want to buy books. Whether this will continue to be a strength or will prove to be a weakness in the long-term will be discussed in greater detail below.

Third strength

Barnes & Noble has been able to capitalize on the growing popularity of electronic readers with its introduction of the Nook e-reader (Fowler, 2009). How much of a strength this mobile device (introduced for the 2009 holiday season) is cannot easily be determined since the company has so far refused to divulge exact sales figures. The ambivalent nature of its success was described last month by Savov:

In a conference call with investors yesterday, Steve Riggio described the Nook as a great success and the company's best selling product. The former is predictable, but the latter is kinda weird. You typically wait to have more than one own-brand product in order to describe anything as "best-selling," but we'll give him the benefit of the doubt and assume he's comparing the Nook against books published under the B&N name. It's still disappointing that, much like Amazon, Barnes and Noble refuses to issue actual sales figures. The closest we get to that is Steve's boast that the Nook's release has fueled a 67% increase in online ebook sales -- an effect that would have been even greater if the company had more stock of the device to sell. In the long-term, he sees the Nook as a stimulant of traffic and sales, both in its retail and online stores, and a central component of his company's strategy. As to the iPad? Steve skirted that question by noting that B&N ebooks are also available on PC, Mac, iPhone and BlackBerry devices. (Savov, 2010).

It is tempting to read such reticence on the part of the company to release sales figures as a sign that the Nook is not doing as well as expected -- or hoped.

One might have predicted that the Nook would be able to capture a healthy market share of an increasingly popular genre given that is has a key advantage of Amazon's Kindle, the current market leader in e-readers: The Nook allows customers to share books with other Nook readers for no cost. This is an option that Amazon's reader lacks. However, in the absence of hard sales figures, it is also possible to imagine that the Kindle -- having gotten under the wire first -- may have saturated the market. The Nook also faces competition from Sony's e-reader and from the i-Pad.

Current Weaknesses and Potential Risks

Second area of risk or weakness

The second major risk is also cited as a potential strength -- which sounds contradictory but it is in fact true that the Nook has the potential to be either a substantial weakness or strength for the company. Given how little is yet known about the profitability (or market share) of the Nook, it is impossible to assess in an accurate way how much the company should base its future plans on the success (or failure) of the Nook).

Third area of risk or weakness

Barnes & Noble receives a relatively small degree of its profits from its online division. Amazon.com has a far greater market share for online sales. This would not be such a problem for Barnes & Noble if profits from retail stores and online enterprises were equivalent. But retail stores have much higher operating costs, of course, and so Amazon can afford to undercut Barnes & Noble in terms of much of its pricing structure. This will remain a weakness for Barnes & Noble as long as it relies so heavily on its in-store sales. (Of course having retail stores is also an advantage for many people continue to want to be able to drop in to a retail store on the spur of the minute, browse for a while, and then pick up something to read that day.) According to its quarterly SEC filing, Amazon's book sales increased by 7% in the first quarter of FY 2009 because of the popularity of its Kindle 2.

Pursuing a More Profitable Strategy

A few weeks ago Barnes & Noble hired a new CEO. Reading the tea leaves around who was selected it is possible to discern (at least in broad form) the direction that the company intends to take to meet the kinds of projections outlined above. The new CEO, William Lynch, was instrumental in designing and initiating the company's online division and headed the introduction of the Nook. Given the selection of Lynch, it is impossible not to believe that the company is intending to rely more and more on its online sales and its e-reader.

But is this the wisest course? There are two basic modes that businesses can use to compete with other companies. They can either do the same thing that other companies are doing but offer these same products or services in some way that is perceptibly better than its competitors. Or they can create a new niche and offer something that their competitors are not doing. In seemingly casting its future lot with its online and e-reader divisions, Barnes & Noble is betting that it can do the same thing as its competitors -- but do it better.

Given the thin margins that it currently has -- when it is making a profit -- this seems less than an obviously good strategy. The current bookseller marketplace (online, electronic, and traditional) is already so crowded with such low profit margins that trying to eke out greater profits by extending its current strategies seems ill conceived. It is hard to imagine that there will be a significantly greater potential profit for Barnes & Noble if it continues to split its revenues (and its profits) between retail stores and online services. Or rather, Barnes & Noble should not depend on its e-reader and online services in a traditional way. Just trying harder with the same model and the same overall market design will not be sufficient to protect Barnes & Noble from declines in profits or market share.

In an already-saturated marketplace, and with more competitors in the online and e-readers media likely to occur, Barnes & Noble should increase its focus on its retail stores. This does not mean that it should abandon its online and Nook divisions. But given that it makes the majority of its money from its retail stores, and given that most new competition is likely to come from online and e-reader rivals and not from new brick-and-mortar stores, a renewed focus on these stores seems the wisest choice.

So how might Barnes & Noble increase the profitability of their retail stores? One obvious way is by incorporating electronic media into the store sites, by embedding the use of e-readers and smart phones, for example, into the physical buildings. For example, if a person buys a coffee at a Starbucks in a Barnes & Noble, the person might be able to download a collection of recipes for free in the store onto his or her e-reader. This might lure a customer into a store who would not otherwise go there. Of course, this step alone would not be sufficient: It is simply an example of the ways in which Barnes & Noble could increase the value to the customer of offering options that require the customer to come into the store. And once customers are in the store, they may well buy other items.

Other possibilities along this path might include at least some of the following. A customer who buys a book in a series for full price in the store would get an earlier book in the series for free or at least for a greatly reduced price for the Nook. Another possibility would be to have book-printing machines installed in stores. These print-on-demand machines are already making appearances in bookstores (and have been for several years). They allow a customer to print any book from the inventory in under a half-hour and can be used to supplement the physical stock of the store, giving the store a capacity that is closer to the variety of Amazon.

Moreover, POD machines are ideal for printing books that may have only regional demand. One of the points that Barnes & Noble has used as a strength of its organization is that one can go into any Barnes & Noble in the country and get the same books -- in much the same way that McDonald's offers the same French fries to everyone. But it is still true that books are not equivalent to other retail products and this one-size-fits-all approach thus plays less well for bookstores than for other kinds of stores (especially franchises). POD technology could provide books about local history, books on local travel, books of short stories or poetry written by local authors and so forth -- thus making the visitors to Barnes & Noble stores feel that the store is more attuned to them as local residents.

One of the things that Barnes & Noble retail stores can offer its customers that can never be offered by online retailers is a sense of place even in a sense of community. Local authors, POD technology, in-store bonuses for e-readers, bulletin boards as a supplement for those who meet in the store for weekly reading groups -- these are the tactics that will rescue the retail bookstore as they blend traditional technologies with cutting-edge ones.