Tottering?) Giant by a Whole

¶ … 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

First weakness

Barnes & Noble is facing increasing pressure from other big box stores that sell books, including primarily Wal-Mart, although Target and Costco also offers books. The range and type of books at Wal-Mart and Target is insignificant compared to the number of titles at Barnes & Noble, but this is not as favorable to the company as it might appear. According to its 2009 10-K filing, up to five percent of the company's profit in any given year results from sales of bestsellers, and it is precisely these same titles that are available at big box general retail stores. (A company's 10-K filing is its most comprehensive report filed annually with the SEC and provides more detailed information on internal organizational structure and subsidiaries.)

Bestsellers tend to bring in customers who may then buy other books: As a result, Barnes & Noble (and other retailers) are willing to provide deep discounts (40% for hardbacks) for these bestsellers. Such deep discounts on a type of product responsible for such a large percentage of the company's profits will clearly have a negative effect on the company's profit margin.

Thus one of the corporation's key vulnerabilities at the present time is the competition that it faces for bestselling titles from big box retail stores like Wal-Mart. It shold be noted, however, that this race-to-the-bottom-of-the-price war for bestselling books carries risk for other companies as well, as Surowiecki (2009) describes:

Wal-Mart began by marking down the prices of ten best-sellers -- including the new Stephen King and the upcoming Sarah Palin -- to ten bucks. When Amazon, predictably, matched that price, Wal-Mart went to nine dollars, and, when Amazon matched again, Wal-Mart went to $8.99, at which point Amazon rested. (Target, too, jumped in, leading Wal-Mart to drop to $8.98.) Since wholesale book prices are traditionally around fifty per cent off the cover price, and these books are now marked down sixty per cent or more, Amazon and Wal-Mart are surely losing money every time they sell one of the discounted titles. The more they sell, the less they make. That doesn't sound like good business. (http://www.newyorker.com/talk/financial/2009/11/09/091109ta_talk_surowiecki#ixzz0j9zXEIuV)

It may well be that given the financial down-sides of such a strategy, it may well be that the other corporations following this strategy -- Wal-Mart, Target, Costco, Amazon -- may forgo it in the relatively near future. If they do so, then Barnes & Noble may be able to reduce the discounts offered on bestsellers while keeping their current market share of bestsellers and simultaneously increasing its profit margin on bestsellers (and therefore its overall profit margin).

Of course, Barnes & Noble also faces continuing competition from other retail booksellers, including primarily Borders and Books-a-Million. (Independent bookstores have not been a significant competitive threat for at least a decade. [Popper, 2009]) These stores currently have lower market shares than does Barnes & Noble, which is encouraging financial news for the latter. However, it is also true that Barnes & Noble has relatively few defenses against these companies -- and especially against Borders -- since all three are offering essentially the same products. Market share tends to produce market share, and so Barnes & Noble may well keep its higher market share simply because it has the momentum to do so. However, it should also look for ways to distinguish itself from these other two mass booksellers.

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.