Why Barnes & Noble should go from bookstore to Nookstore

April 13, 2011, 9:00 AM UTC

In the late 1990s, the book industry was upended by the rise of the superstore. With big footprints in exurban shopping centers, Barnes & Noble (BKS) and Borders (BGP) superstores offered what many shopping-mall-sized and downtown mom and pop stores couldn’t: aisles upon aisles of hardbacks, paperbacks and magazines, and cushy cafés to lounge around and read them in, for hours on end. Thousands of independent booksellers found themselves outclassed by such accoutrements, and went out of business.

But what seemed like a secular shift turned out to be a mere blip in the history of selling the printed word; today, the once-mighty superstores are struggling mightily. Borders filed for Chapter 11 bankruptcy protection back in February and is in the midst of closing 30% of its stores. Barnes & Noble, once thought indomitable, is hurting, too. With its stock down nearly 80% over the last five years, the retailer still hasn’t been able to find a willing buyer since it put itself on the market last August, and it may end its search altogether.

The road ahead for Barnes & Noble will prove tough. Few brick and mortar companies have successfully negotiated the choppy waters to safe digital harbors. But Barnes & Noble, unlike Borders, has one bright spot going for it. That bright spot, in fact, might one day be Barnes & Noble, period. And that bright spot is, of course, the Nook ereader and ebook business.

“Barnes & Noble didn’t get into this market very early, but when they got into this, they got into this very smart,” says Forrester research analyst James McQuivey about the company’s ereader. “They went in with with both feet, quickly got a device on the market as opposed to picking someone to partner up with like Borders did, and when the firestorm in 2010 hit, they already had their device ready to go. Borders did not.” (Pop quiz: Do you even know the name of the Borders ereader? It’s called the Kobo. And it’s now on clearance for $60 at Borders stores that are liquidating.)

In fact, McQuivey thinks Barnes & Noble has a better than 50% chance of making the switch to digital if it becomes even more aggressive about its Nook hardware, software, ebook and accessory business. And there is room for growth. Based on a Goldman Sachs analyst report, the Nook business is on a hockey-stick growth curve, with sales going from $62 million in 2009 (the year the device launched) to an estimated $1.163 billion for 2012. Meanwhile, the book business — sales at brick and mortar locations — will decrease, according to the same estimates, from $4.37 billion this year to $3.95 billion for the company’s fiscal year 2012.

The industry, particularly for Barnes and Noble, is changing, and executives in the company know it. At GigaOm’s Big Data conference last month, the company’s vice president of loyalty retention marketing, Marc Parrish, took the stage to discuss how the transformation of the book business is happening more rapidly than digital affected the movie, music, or newspaper industries. As Fortune reported, Parrish even said ebooks will dominate sales within the next 24 months. Not a huge surprise, considering the Association of American Publishers reported that ebook sales in the U.S. brought in $70 million last January, a 116% increase from the same month last year, while adult paperback sales fell from $104.2 million to $83.6 million during the same period.

To the company’s credit, McQuivey believes the Nook recently surpassed Sony’s ereaders to become the second-most popular on the market, second only to Amazon’s (AMZN) Kindle. But he also believes Barnes & Noble needs to do more — much more. In a conservative scenario, the company would shutter at least 30%, or 211, of its 705 retail locations, within the next three to five years. “If it were me? I’d cut deeper, faster – like two to four years,” he says, suggesting a boutique model where B&N reduces store capacity by 50% through a combination of store closures, reduced store footprints, and decreased shelf space.

They had better move fast — Amazon doesn’t intend to provide much breathing room to its ereader competition. Jeff Bezos’ company just released a sponsored Kindle at a $25 discount, trying to further solidify its hold on readers’ wallets. And sales of Apple’s (AAPL) iPad, which also serves as an ereader, are surging.

Meanwhile, for stores that it can’t get rid of quickly, Barnes & Noble could even take the “store within a store” approach that some big-box retailers like Target (TGT) are using. Essentially, the bookstore could monetize otherwise fallow square-footage, by leasing out chunks of it to other retailers.

Regardless of the path executives take, the Barnes & Noble of the future (if there is one, of course) will probably look nothing like it does today. The company could even choose to drop the name altogether and let Nook become the consumer-facing brand. Just a few short years ago, Barnes & Noble was imposing its will on the book business, muscling out an ill-prepared competition.

Barnes & Noble has already gotten one thing right in having an ereader ready to help it do battle with Amazon. But as far as successfully transforming itself into a digital company? Well, that’s just Chapter One.

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