Competition and the Elastic Enterprise: What Barnes & Noble Must do with Nook

I admire Barnes & Noble. The company has guts. I most admire Barnes and Noble’s (B&N) ability to reinvent itself. In fact its recent success with its Nook digital business put them on a path to become an elastic enterprise. So why did a company that I admire for its moves to greater elasticity lose 30% of its stock value in a single week?

Well, B&N’s Nook business has been a mixed blessing. The Nook business revenue is growing at double digits but so are expenses. Such performance puts the entire company in the red. To make matters worse, the Nook business requires more investment and is unlikely to be profitable anytime soon – despite its meteoric topline growth.

In the first week of January 2012, B&N management rattled its investors with a one-two punch: downward guidance and an announcement that the company would explore its “strategic options” regarding its Nook digital business. Shares of B&N stock (NYSE:BKS) plummeted.

In an interview on CNBC, B&N CEO, William Lynch emphasized the strength of B&N’s core business and continued growth in the Nook digital business. Nook sales grew over 70 percent and related digital content sales posted a 113 percent increase during the nine-week holiday period. Physical retail same store sales were also up 2.5 percent. But, losses were revise upward and could be as much as $1.40 a share for fiscal 2012, which ends in April. He also reiterated that the company would explore its strategic options for the Nook business.

Earlier in the week, highly respected B&N board member, Gregory B. Maffei, CEO of Liberty Media (one of B&N’s largest investors) suggested in a conference call that B&N may need other “partners to fund that game” referring to the Nook business. And Barclays Capital analyst, Alan Ruffkin downgraded the stock citing concerns about profitability and the wisdom of retaining the Nook business in B&N.

What should B&N do with Nook? Here is my take.

B&N is effectively the last big box physical book retailer standing. Its physical retail franchise is profitable. But it’s not a high growth business. It’s also not a high margin business and doesn’t seem likely to produce the levels of free cash needed to grow the high flying Nook business. Hence the Nook business is a drag on the physical retail business. But the reverse is also true. The physical retail business is a drag on the Nook business.

Nonetheless, the decision is complex. There are complementarities between the physical and digital worlds. As the Nook business progresses certain digital services and products can be enhanced with physical assets, terrestrial experts and value-added services. For example, the trend toward digital textbooks could be enhanced with pre and post-degree educational services at a terrestrial retail location.

If the Nook digital business were more mature, perhaps the retail outlets would be less of a hit on elasticity and less of a liability to B&N’s core business. And to date Amazon has eschewed physical complementarities and enjoyed great success.

On the other hand, Apple’s physical retail business is vibrant, complementary and synergistic. But Apple sells multiple products with multiple use cases and serves many customer segments. Hence physical interaction with an expert is value added and enhances the customer experience.

The current Nook business is different. B&N stores are really showrooms for the Nook device and helpful for device sales now. But without an investment in complementary services and expertise in the stores, that value will decrease over time as customer digital competencies improve. In the future value-added complementarities may emerge, but not fast enough for current shareholders.

Therefore, in view of current realities, B&N should set the Nook free. But simply spinning off the Nook business is not enough.

Here is what B&N needs to do:

1. Spin off the Nook business and buttress with a major partner, preferably an elastic enterprise. B&N should retain an ownership, keep tight linkages where beneficial, and position to benefit from current and future complementarities. A spin off will more properly value the Nook business and if done properly will reward existing shareholders. It will also attract other investors.
2. Aggressively build the Nook business ecosystem. Add unique offerings for differentiation. Further diversity digital content. More digital content offerings create variety, a better value proposition, and more customers. B&N has made some good moves in this direction with its Nook Apps (e.g. Angry Birds, Scrabble, Words with Friends) and it growing app-developer ecosystem partners (e.g. Rovia, Zynga, Electronic Arts, Evernote, Agile Fusion). It’s moves with visual arts publishers, like Viz Media for Manga and Anime extend the use case for Nook devices and extend their business ecosystem.
3. Make Nook a digital mobile app that runs on other devices. This will expand the Nook business ecosystem and enhance the customer experience. For the foreseeable future, Nook should continue to offer its own physical device because there will be increasing synergies between physical device features and digital content, and that will yield more strategic options.
4. Explore radical adjacencies. For example, Nook could partner with B&N’s large university book sales business. As higher education goes digital, Nook can differentiate into other industries with digital offerings beyond the university context and connect a different set of customers with content and app developers across the entire spectrum of knowledge areas, including consumer, technical, and professional. Other radical adjacency opportunities will also emerge.
5. Continue to invest in the Nook business platform. Build on the positive momentum and keep the technology and business processes fresh. Expand universal connectors so the maximum number of parties can easily partner with Nook via Cloud, mobile, and other content providers globally.

Nook is at an inflection point. It does present B&N with a quandary. However, bold steps now can unleash new strategic options. Be aggressive now, expand the ecosystem, and build the Nook digital mobile franchise. A burgeoning global business ecosystem that continues to differentiate and grow can yield a rich and competitive Nook digital business. B&N benefits by moving to profitability and increasing options for the future. And new complementarities will come later as Nook builds a sustainable and elastic business.

One thought on “Competition and the Elastic Enterprise: What Barnes & Noble Must do with Nook

  1. Pingback: Everyone Beware: Microsoft is Alive Again and May Become an Elastic Enterprise « The Elastic Enterprise

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