Throughout the 1990s, booksellers experienced healthy growth driven primarily by the opening of brick-and-mortar locations. In the past five to six years or so, retail growth has slowed, forcing names like Barnes & Noble (NYSE: BKS), Borders (NYSE: BGP), and Books-A-Million (Nasdaq: BAMM) to look toward e-commerce as a way to drive the top line. But with Amazon.com (Nasdaq: AMZN) and many others flocking to the Internet, the bookseller industry is more crowded than ever.
In the face of slowing growth and intense competition, Barnes & Noble and Borders have begun to reevaluate their respective strategies in an attempt to drive sales. In this edition of Fool on Call, we'll look at comments made by management in the latest quarterly earnings conference calls to see what each enterprise is doing to address the challenging environment.
Barnes & Noble enters the pricing war
With sales slowing, reconfirmed in its latest results with revenues up just 2% for 2006, Barnes & Noble realized that other measures were needed to increase transactions among customers. My colleague Ryan Fuhrmann described one part of its strategy, which was the introduction of its customer loyalty program.
In the fall, the company enhanced its membership program by giving participants an extra 10% off on hardcover books. The expectation for the fourth quarter was that Barnes & Noble would be hit with roughly $10 million of charges against profits as a result of the discounts. But the response has been so strong that management conceded in the call that the $10 million estimate was "low by a few million dollars."
One would hope that the revenue lost through the discount program could be offset by increased transactions. Unfortunately, we aren't seeing that yet. In the fourth quarter, same-store sales decreased 0.1% for the quarter and 0.3% for the year. CFO Joseph Lombardi stated in the call that both of these metrics were "slightly below guidance."
The main reason the loyalty program isn't leading to a windfall in sales is because all of the other major competitors also have loyalty programs. CEO Steve Riggio remarked, "We're seeing a vastly different environment than just three years ago." As he states, "All of the major players have some form of loyalty program that gives extra discounts, earns customers' points, or offers subsidized expedited delivery."
It doesn't sound good, does it? And we shouldn't expect a miracle turnaround in 2007, either. In fact, the same trend will also weigh on earnings this year. The margin effect will be further exacerbated by the release of a new Harry Potter book, a mass volume publication that is sold "at very low margin."
But if you listen to management elaborate further on the program during the question-and-answer portion of the call, you actually come away feeling a little better about the price war. One analyst asked what the long-term effect of the loyalty program would be, and Riggio's response shed some light. He stated, "As it was [with] the last time we launched the member program back in 2000, the short-term effects are negative in terms of gross margin, but over time they tend to come back and build."
The goal, then, is to lock in core customers, entice them with discounts, and recoup the cost down the road. The same analyst asked when we might see Barnes & Noble start to recoup the initial losses, but management offered no time frame.
Borders redrawing its borders
Whereas the primary point of discussion in Barnes & Noble's call was on the membership program and pricing, the leadership team at Borders had a very different agenda to address. Both companies face the same intense competition, but for Borders, one way it sees it can maximize its opportunities is by refocusing attention on what works and doing away with what doesn't.
What hasn't been working for Borders is its Waldenbooks division, as well as the international marketplace. As a result, we'll see the company "significantly" pare back future investments in these areas. This will permit it to concentrate resources on revitalizing its superstores business in the domestic market.
Comps for Waldenbooks were down 7.5% for the year. That's just not going to cut it. To deal with the problem, Borders has been shutting down underperforming units. In 2006, it closed 124 Waldenbooks stores. Referring to the closures, CFO Ed Wilhelm stated, "In 2007, we will continue on this path." Ultimately, Borders aims to get Waldenbooks down to a core of winning stores, estimated to be about 300.
With less attention given to Waldenbooks, management is able to focus its attention on its core business: domestic superstores. But that doesn't mean we should expect an aggressive store growth strategy. On the contrary, CEO George Jones made it clear that Borders will "slow the pace of opening new domestic superstores" until it has had a chance to revitalize its existing store base.
All the way from store layout to compensation to supply chain, Borders stores are undergoing a significant overhaul with the ultimate goal to improve the customer experience. While existing stores are being remodeled, the company is also in the design stage for a new prototype concept store.
Throughout 2007, Borders will continue to develop the prototype model, with a goal to unveil the first new concept store in early 2008. Jones sounded enthusiastic, stating, "The new concept store ... will dramatically enhance the shopping experience and set Borders apart so that customers will pass up the competition to shop with us."
The battle for customers continues
With growth stagnating in the industry, Borders and Barnes & Noble are looking for ways to drive sales from their existing bases. For Barnes & Noble, a price war to lock down core customers now, with the plan to make profit gains down the road, is at the heart of its strategy. Borders, which also has a membership program, is looking at its store environment for ways to drive customer traffic.
My colleague Alyce Lomax advised investors that since this is a transition year for Borders, there should be ample opportunities to buy into its stock. I agree, and the same advice holds true for Barnes & Noble. With the bookseller industry touting discounts, patient investors might be able to find a discount on both companies.
Read on for related Foolishness:
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Fool contributor Jeremy MacNealy has no financial interest in any company mentioned. The Motley Fool has a disclosure policy.
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