2 Cases Studies

C a n T h i s B o o k s t o r e B e S ave d ? CASE STUDY

B arnes & Noble (B&N) has been portrayed in

the past as a big bully that drove small inde-

pendent bookstores out of business with

aggressive pricing tactics and an unbeatable

inventory of books. Today, B&N finds its role reversed

as the company fights a fierce battle to survive in the

inevitable era of e-books. Booksellers were one of the

many industries disrupted by the Internet and, more

specifically, the rise of e-books and e-readers. B&N

hopes to change its business model to adapt to this

new environment before it suffers a similar fate as

many of its competitors, like Borders, B. Dalton, and

Crown Books, or their peers in other industries, like

Blockbuster, Circuit City, and Eastman Kodak.

More than ever, consumers are reading books on

electronic gadgets—e-readers, iPods, tablets, and

PCs—instead of physical books. Although B&N still

depends on its physical, brick-and-mortar stores to

drive its business (B&N operates 691 bookstores in

50 states, as well as 641 college bookstores), the com-

pany has thrown its energies behind development

and marketing of the Nook series of e-readers and

tablets. Once simply a bookseller, B&N now styles

itself as a seller of e-books, devices to read them on,

and apps that enhance the reading experience. The

company has had success gaining market share,

but at a steep cost, and to stay afloat, it will need to

contend with increased competition from Amazon,

Apple, and Google—not exactly feeble opposi-

tion. B&N has a market capitalization of $1 billion.

Amazon, B&N’s current top competitor, has a market

capitalization of $98 billion. How can B&N compete

against these tech titans?

The answer remains to be seen. B&N was likely

the only bookseller big enough to complete the con-

siderable task of developing an e-reader, marketing

it, and setting up manufacturing and retail opera-

tions for the device. Even if its competitors had been

faster to react to consumer demand for e-books, it’s

unlikely they would have made the inroads that B&N

has achieved into the e-book space. Reaction to the

Nook has been positive, as B&N has grabbed a sig-

nificant market share from Amazon and Apple in the

e-book marketplace. In 2011, analysts estimated that

B&N controlled approximately 27 percent of the digi-

tal book market (Amazon held 60 percent).

B&N’s progress with e-books has come at a steep

cost, however. The company incurred a loss of $73.9

million in 2011, compared to a $36.7 million profit

the previous year. The investment required to launch

and promote the Nook was the primary reason

for the shortfall, and expenditures are expected

to continue to climb. In response, B&N canceled

its stock dividend. The key questions for B&N are

whether the Nook will eventually bring in revenues

that justify its steep development and marketing

costs, as well as whether the Nook can help drive

traffic to B&N’s brick-and-mortar stores.

The economics of e-book sales are very different

from traditional book sales. Customers who visit

B&N’s Web site buy three digital books for every

one physical book, but booksellers still make more

money on print books than e-books. Still, B&N’s

Nook business has been growing rapidly, and

traditional bookstores are not. Total e-book sales were

nearly $970 million in 2011, more than double from

the previous year, and the percentage of e-books

within the total number of books sold is still on the

rise, measuring 14 percent that same year. Ironically,

one of the first companies to realize the potential of

e-books was B&N itself. As early as 1998, the com-

pany had partnered with software companies like

NuvoMedia to develop prototype e-reader called the

Rocket, but in 2003 it nixed the project because there

didn’t appear to be any money in it. At the time,

B&N was right, but technology has come a long way

since 2003, and so too have e-books.

B&N clearly took notice of the fate of Borders, its

chief rival. Borders stubbornly refused to adapt to

the Internet, first handing over its entire Internet

operations to Amazon, and waiting to relaunch its

own Web site until 2008, at which point the company

was already on the road to bankruptcy. Borders had

a devoted following, but it wasn’t enough to com-

bat the company’s $350 million debt and dwindling

profitability. B&N is the only national bookstore

chain remaining in the United States, and while the

company saw a bump in store traffic in the immedi-

ate aftermath of the Borders collapse, it also knew it

would need to shake things up to avoid a similar fate.

Other companies also have a stake in B&N’s

transformation. Publishing companies have been

forced to adjust their allocations of printed books

and new titles for stores, and books are beginning

to be released as apps in addition to physical books.

Apps for books are adding more features all the

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time, including the ability to manipulate and enlarge

images, flip through photo albums, watch videos,

read instant messages, and listen to the music of

characters within the book. These books, called

“enhanced e-books,” are considered to be the next

step in the growth of digital books, but thus far, the

performance of enhanced e-books has been mixed.

Publishers and e-reader manufacturers both are

teaming up on enhanced e-book projects. Penguin

will release 50 enhanced e-books over the course

of 2012. Apple is working with publishers to create

interactive digital versions of textbooks. But do

readers really need these features? Some publishers

believe that these apps cost more money than they

are worth, and worry that there is not a big enough

market for enhanced e-books to justify the expendi-

ture of time and money. However, this is the same

line of thought that was used about e-books them-

selves in the early 2000s, and e-book skeptics turned

out to be dead wrong.

Publishers are doing anything they can to support

B&N’s efforts to stay afloat, because the survival of

physical book retailers is important to effectively

market and sell books. Bookstores spur publisher

sales with the “browsing effect.” Surveys have shown

that only one-third of the people who visit a book-

store and walk out with a book actually arrived with

the specific desire to purchase one. According to

Madeline McIntosh, Random House president of

sales, operations, and digital, a bookstore’s display

space is “one of the most valuable places that exists

in this country for communicating to the consumer

that a book is a big deal.” Brick-and-mortar retail

stores are not only essential for selling physical

books, but also stimulate sales of e-books and audio

books. The more visibility a book has, the more

likely readers will want to purchase it. With the

demise of B. Dalton, Crown Books, and Borders, B&N

is the only retailer offering an extensive inventory

of physical books. Book publishers need a physical

presence.

Without B&N, the likely candidate to fill the void

is Amazon, and publishers are not eager for that to

happen. Amazon’s goal for e-books is to cut out the

publishers and publish books directly, selling books

at an extremely steep discount to drive sales of its

Kindle devices. Editors, publicists, and other entities

within the publishing business view Amazon as an

enemy. Selling books at Amazon’s prices is not a ten-

able business model for publishers in the long-term.

Publishers received even worse news in April

2012, as the U.S. Department of Justice (DOJ) sued

Apple and five of the country’s largest publishing

houses for colluding to fix e-book prices. In response

to Amazon’s aggressive pricing strategy, publishers

and Apple had agreed to an “agency pricing” model,

in which publishers set the price and retailers take a

commission. (Under the wholesale arrangement with

Amazon, the publishers received half of the list price,

but this gave them no control over the pricing of

their product.) Many books would be sold by Apple

for about $13, with Apple taking a 30 percent cut.

By increasing the price of e-books by a dollar or two,

publishers stood to gain an extra $100 million. Even

Amazon was under investigation for striking deals

with publishers that forbade them from offering the

same level of discounts provided by other e-reader

manufacturers. The bottom line is that the DOJ

action is bad news for publishers, who need B&N

now more than ever.

Because the Nook was booming and brick-

and-mortar stores had been stagnating, B&N has

been considering spinning off its digital business

from its fading bookstore business. On April 30,

2012, Microsoft announced that it would invest

$300 million for a 17.6 percent stake in a new

company consisting of B&N’s Nook tablet and

e-reader business and its College division. As part

of the deal, a Nook application would be included

in Microsoft’s Windows 8 operating system. This

arrangement will provide B&N with additional

points of distribution from hundreds of millions of

Windows users around the world, and both compa-

nies will share revenues from sales of e-books and

other content. B&N might eventually spin off this

new company.

The deal also furthers Microsoft’s strategy of

investing in new businesses to move beyond its

Windows and Office software franchises. A Nook

e-reading app could also enhance Microsoft efforts to

establish a digital storefront to market e-books, apps,

and other content for Windows 8, which is critical to

plans for entering the tablet market.

B&N has also experimented with ways to drive

traffic to their physical stores using apps on the

Nook. Although this is a seemingly impossible

task, they are at least coming up with some inven-

tive ideas. For example, if you connect to a Wi-Fi

network in a B&N store with your Nook, you can

get free extras in many apps and games like Angry

Birds, where you can unlock a bonus character that

normally costs a dollar. Other companies are using

similar techniques to promote board games, toys,

movies, and of course, physical books. B&N has also

expanded its store space for toys and games and

added new display space for its Nook devices. There

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are also plans to experiment with slightly smaller

stores.

These promotional campaigns probably won’t be

enough to stop B&N’s dwindling in-store sales. What

will the future hold? Will B&N be able to succeed as

a digital company, and is there a future for its brick-

and-mortar stores? Is there a way for e-books to help

sell print books, just as print books have stimulated

demand for their digital versions? Although B&N has

made a spirited effort to revamp its business and go

toe-to-toe with several tech titans, it’s possible that it

might be too tall an order for the storied bookseller.

Sources: Michael J. De La Merced and Julie Bosman, “Microsoft Deal Adds to Battle over E-Books,” The New York Times, May 1,

2012; Shira Ovide and Jeffrey A. Trachtenberg, “Microsoft Hooks

Onto Nook,” The Wall Street Journal, May 1, 2012; Julie Bosnan,

“The Bookstore’s Last Stand,” The New York Times, January 29,

2012; Paul Vigna, “E-Books, Apple, Amazon: The Deadly Hallows

for Publishers,” The New York Times, April 11, 2012; Brian X. Chen,

“Barnes & Noble Uses Apps to Lure Customers Into Stores,”

The New York Times, January 27, 2012; Alter, Alexandra,

“Blowing Up the Book,” The Wall Street Journal, January 20, 2012;

Rick Newman, “4 Lessons from the Demise of Borders,” U.S. News

and World Report, July 20, 2011; Chunka Mui, “Borders and Kodak

are Facing Doomsday: Who’s Next?” Forbes, July 22, 2011; and

Jeffrey A. Trachtenberg and Martin Peers, “Barnes and Noble:

The Next Chapter,” The Wall Street Journal, January 6, 2011.

CASE STUDY QUESTIONS

1. Use the value chain and competitive forces

models to evaluate the impact of the Internet on

book publishers and book retail stores such as

B&N.

2. How are B&N and the book publishers changing

their business models to deal with the Internet

and e-book technology?

3. Will B&N’s new strategy be successful? Explain

your answer.

4. Is there anything else B&N and the book

publishers should be doing to stimulate more

business?

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