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Finding Growth and Profitability in Bookselling: Barnes &Noble and Amazon

Barnes & Noble and Amazon were the bookselling industry’sleading companies. Yet Barnes & Noble’s revenues were decliningby 10 percent per year, and in the second quarter of 2015, Amazonhad lost more than $0.4 billion dollars (see Exhibit 11.1). Thebookselling industry was experiencing vast technological changewith the introduction of e-books and tablets, and Barnes &Noble and Amazon had to figure out what to do next.

Data source: Quarterly financial reports Exhibit 11.1 FinancialPerformance of Major Booksellers, 2nd Quarter 2015 Barnes &Noble and the Superstore Leonard Riggio, Barnes & Noble’sfounder, believed shopping was a recreational activity. Relying onthe philosophy that people bought books based on emotion, hetransformed bookselling into a giant industry.1 Too poor to attendcollege full time, Riggio had worked during the day as a clerk inthe New York University bookstore. In 1965, he created a campusbookstore of his own. During the next six years, he establishedfour other bookstores on campuses in New York City. In 1971, Riggiobought Barnes & Noble, then an unprofitable New York textbookseller, and in 1974 he opened a Barnes & Noble annex inManhattan where he aggressively marketed low-priced books that hadbeen returned to publishers. By 1986 he owned 142 collegebookstores and 37 Barnes & Noble’s stores. When he bought B.Dalton from Dayton-Hudson, Barnes & Noble became the largestU.S. bookseller. Barnes & Noble’s main competitor had beenBorders, an Ann Arbor, Michigan, chain.2 At the time, Walden Bookswas a part of Borders. Kmart had bought Walden in 1984. In the late1980s, B. Dalton and Walden owned more than 600 mall-based stores.Borders pioneered the concept of the bookstore as a superstore.Barnes & Noble was an aggressive follower. The son of aprofessional boxer, Riggio learned from his father to be quicker onhis feet and more nimble than his opponents. 203

Barnes & Noble acted more quickly than Borders and expandedmore rapidly than Borders. The superstores had a specialatmosphere. They were meant to serve as gathering places forpeople. They tried to get people to linger with comfortableseating, coffee to drink, and late-night hours. Some stores weredecked out like small or full-scale libraries. Most had comfortablechairs and writing tables. They hosted readings by famous authorsand other events. They played pleasant jazz and classical music inthe background. The stores made an effort to build a sense ofcommunity. Advertisements featured pictures of literary greats likeHemingway and Virginia Woolf. Barnes & Noble, in particular,tried to create a literary climate. It paid a great deal ofattention to décor, layout, furniture, display, signage, andselection of books. The special atmosphere meant that customersspent time browsing, and of course, the more time they spentbrowsing, the more they bought. Customers bought twice as muchmerchandise at a superstore as at a mall-based store. Barnes &Noble chose about 50,000 titles to display at each superstore.Local managers adapted the rest of their selections to localtastes. The result was that the typical store offered about 175,000titles packed into 30,000 square feet. The competition betweenBarnes & Noble and Borders was fierce. They were in a race tosee which would expand most rapidly. Both feared that Walmart andmassmarket retailers would take away their business. Kmart spun offWalden in 1995 because it could not keep up. In that year, Barnes& Noble and Borders captured about one-quarter of the U.S.market for books, with Barnes & Noble having a market share ofabout 15 percent and Borders having a market share of about 10percent.3 The focus of both companies was on aggressive expansion.The number of superstores in the United States kept growing. Itjumped to nearly 800 in the mid1990s. Many independent bookstorescould not keep up and folded. Barnes & Noble and Borders werefocused on the competition between them and their commitment tocontinued expansion. When Amazon.com began operations in 1995,neither company paid much attention.4 Barnes & Noble’s goal wasto expand at a pace of about 100 new stores per year. Yet by 1997,the estimate was that there were several hundred online booksellersoperating on the Web and that, by 1998, they already had captured 2percent of the adult book market.5

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Amazon and Internet Commerce Jeff Bezos, the founder of Amazon,was a summa laude graduate of Princeton in 1986 with a degree incomputer science.6 He had worked for a telecom start-up and a hedgefund. Seeking to begin a business of his own, he examined 20possibilities for Internet commerce before settling on bookselling.He understood the opportunities in books to be high because theindustry was very fragmented and because Internet selling offeredmany advantages over conventional book stores, including enablinglarger selection, greater inventory turnover, higher sales persquare foot, and higher sales per operating employee. Bezos movedfrom New York City and started his business in Seattle, Washington,to take advantage of the software talent and proximity to Ingram’slarge bookstore and electronics wholesale warehouse in Oregon.Before building its own warehouse complex, Amazon relied on Ingram.There also happened to be no state taxes on retail purchases in thestate of Washington, which made Internet sales more competitivewith retail. To begin operations, Amazon had to innovate. It had topioneer in the development of software for Internet shopping. Itcreated the look and feel of an Internet shopping site that now hasbecome common. It provided information about the books it sold,posted author interviews, offered free book reviews, and gave linksto other sites and features. Amazon spent vast sums of money onresearch and development (R&D), in 1999 obtaining a patent forits oneclick technology, which allowed customers to order from itssite with a simple click of the mouse instead of going throughseveral steps. In contrast to a physical store, which had fixedtimes when it opened and closed, Internet shopping could take placeat any time of the day. The venture capital firm Kleiner PerkinsCaufield & Byer invested $8 million dollars in Amazon to helpit get started, and the business grew rapidly. In less than a year,Amazon had nearly $1 million in sales. Repeat customers providedmore than 50 percent of its business, and the average transactionwas greater than $50. Technical and business books made up a highpercentage of the early orders. The company went public in 1997,and its market capitalization rose to $560 million on the firstday. Bezos suddenly was a multimillionaire because he owned 42percent of the stock. Investors continued to have confidence inAmazon’s business model year after year, although Amazon did notreport that it was profitable, and it was not clear when it wouldbe. The company stayed afloat by means of the positive cash flow itgenerated. Customers paid Amazon with credit cards; Amazoncollected the sale price within a few days from the credit cardcompany, but it was weeks before it paid its suppliers. Barnes& Noble launched its own book-selling website in the spring of1997.7 The website featured personalized book recommendations anddeep discounts every bit as good as Amazon’s on most items. Barnes& Noble used its brand name to capture leadership in thegeneral interest and fiction categories. Because of its

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warehouses and greater experience in shipping books, it tried tobeat Amazon’s delivery times. It built new warehouses, in Atlantaand Reno, which it added to its existing warehouse in New Jersey toensure prompt distribution. It also built its own version of theone-click technology, which it called “express lane” ordering.However, the company was not able to seamlessly integratebrick-and-mortar operations with the Internet, which permittedAmazon to make the claim that it, not Barnes & Noble, was“earth’s biggest bookstore.”8 Since 1970, Barnes & Noble’sslogan had been that it was the “world’s biggest bookstore.” Barnes& Noble sued, arguing that Amazon was not a bookstore at all,but a book broker. Amazon, in turn, counter-sued, and it sought aninjunction against Barnes & Noble for stealing its one-clicktechnology. In 1999, Barnes & Noble had an IPO, which spun offBarnesAndNoble.com, its online business, as a separate company.Bertelsmann, a German mass media corporation, owned 36 percent ofthe new company, Barnes & Noble owned 36 percent, and 36percent of the shares were sold to the public. One month before thespin-off, Amazon took a number of aggressive steps to counter anysuccess that BarnesAndNoble.com might have by adding 1.5 millionmore titles to those it already listed, introducing a personalizedbook recommendation service, and starting to sell bestsellers at a50-percent discount. The 50-percent discount was especially gallingto BarnesAndNoble.com, which was forced to match the discount andthus sell books at cost. Amazon’s aggressive moves had theirdesired effect. The stock of BarnesAndNoble.com climbed just 27percent on the first day of the IPO, a huge disappointment in anera when stocks routinely doubled or tripled the initial askingprice. Amazon was beating BarnesAndNoble.com on the most importantInternet criterion: “eyeballs.”9 It had 8.4 million registeredInternet customers compared to BarnesAndNoble.com’s 1.7 million,and its Internet market share was 75 percent whereasBarnesAndNoble.com’s was 15 percent. Barnes & Noble made anoffer to buy Amazon’s Oregon supplier, Ingram’s Book Group in 1998,only to be rebuffed because of antitrust scrutiny