Hey, Let’s Get Into Manufacturing and Compete Against Apple: Name the Company

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All eyes in the book retailing world yesterday were glued to Amazon (AMZN), which reported another jump in sales accompanied by another drop in profits. Forget about the way the market responded to that news – clearly, a significant part of the action came from disappointed or panicky short sellers closing out their positions – and focus instead on Amazon’s razor-thin profit margins.

Now turn to Barnes & Noble (BKS), a retailer that is trying to compete head to head with the much larger Amazon in three of its core product areas: books, e-readers and the latest generation of e-readers that double as tablets. A quick look at the chart below will tell you precisely what the market’s verdict on that strategy, and the company’s level of success, has been.

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BKS Chart

Barnes & Noble won’t release its results for its fiscal third quarter until February 19, but while analysts are currently predicting it will announce a profit of 60 cents a share, that won’t be as impressive as the 71 cents a share announced for the third quarter of the prior fiscal year. And its same-store sales were down 3% in its fiscal second quarter. So it’s not surprising that the company plans to shutter up to a third of its 689 retail outlets – a big move, since the closure of about 15 stores annually in the last decade has been more than offset by the opening of 30 new ones, on average.

The question hovering over Barnes & Noble’s head is the Nook, its entrant in the e-reader/tablet sweepstakes. Amazon shows just how costly it can be to invest heavily in the development of such devices, especially given the need to keep pace with rivals introducing new versions every six to 12 months. Nonetheless, Barnes & Noble has bet heavily on the Nook as a ticket to future success, just as Amazon has staked its future on the Kindle and Kindle Fire. Barnes & Noble, indeed, has gone further by transforming large portions of its retail stores that once were devoted to books, into Nook showrooms.

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AMZN Revenue Quarterly Chart

But in recent years, the gap between the rate of growth in revenue for Amazon and Barnes & Noble has only grown wider. During the just-ended holiday season, a nine-week period ended December 29, Barnes & Noble said its sales at stores open at least a year dropped 8.2%, with the bulk of that slump – about five percentage points – coming from sales of Nook devices. True, Pearson PLC (PSO) is investing some $89.5 million in Nook, in exchange for a 5% stake, joining Microsoft (MSFT), which last year spent $300 million for 16.8% of the division. And sales of digital content – if not the devices themselves – did climb about 13%. Still, the broader trend remains bearish.

Is Barnes & Noble another Kodak? Another Blockbuster? Another Best Buy (BBY)? Another retailer/manufacturer overtaken by technology and unable to innovate or adjust rapidly enough?

The problem may actually be a broader one, and one that Amazon must struggle with as well. To give us what we want, as consumers, requires constant and costly investments in innovation, and retailers simply aren’t set up to do that efficiently; their margins tend to be skimpy. If either firm was charging a significantly higher price for their latest e-reader/tablets – coming closer to the prices that Apple (AAPL) levies for its iPads – then this column would have a different tone and focus. Instead, both companies have emphasized that their digital devices serve almost as loss leaders, encouraging users to spend heavily on content once they have their Nook or Kindle in their hands. But content isn’t cheap, and here again, margins aren’t wide. Meanwhile, both companies are financing these costly initiatives through their other sources of revenue – conventional book retailing, in the case of Barnes & Noble.

It remains to be proven that Barnes & Noble is the 21st century’s version of a buggy whip manufacturer. Indeed, it may well prove to be that cyber books and “dead tree books”, as they are known among some bibliophiles, can coexist quite happily for decades to come. But there’s no evidence suggesting that Barnes & Noble’s efforts to ride both of these trends will prove successful, and certainly it’s hard for the big box bookstore to command the same kind of fierce loyalty among its customers that smaller, independent book retailers do.

This isn’t a stock to own unless and until Barnes & Noble comes clear on its long-term plans not just for its bricks and mortar store but for its Nook division, which right now may be the wave of the future, technology-wise, but is little more than a giant cost center for the company and its investors.

Suzanne McGee, a contributing editor at YCharts, spent nearly 14 years as a reporter at the Wall Street Journal, in Toronto, New York and London. She is also a columnist for The Fiscal Times, and author of "Chasing Goldman Sachs", named one of the best non-fiction books of 2010 by the Washington Post. She can be reached at editor@ycharts.com.


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