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3 Pieces of Investment Advice From This Retailer

Monday - 8/19/2013, 5:54am  ET

It’s not unusual when a troubled company reports earnings to find out more about its competition than the company itself. In fact, investors should continue to follow troubled companies, not only to see if they can turn themselves around, but also to get tips on how their competitors might continue to grow. For this reason, I would argue that shareholders should follow the troubles of Barnes & Noble closely, as the two companies are more closely related than some would think.

It’s about time!
In a move that has taken management far too long, Barnes & Noble finally said that its strategy is to offer customers what they want on any device, instead of sinking more money into the Nook business.

What’s interesting is, the challenges facing the Nook lineup today are some of the same challenges facing Barnes & Noble as a whole. The problem in both cases is that neither the tablet nor the store offers anything proprietary that its competition can’t duplicate and sell at potentially cheaper prices.

The first lesson
The most obvious lesson that investors can take away from Barnes & Noble's challenges is that a narrowly-focused retailer can’t offer the same things that everyone else does, or eventually the business model will fail.

I would make the argument, in fact, that Wal-Mart presents just as much of a challenge to Barnes & Noble as Amazon does. Wal-Mart can offer a much smaller selection of the same goods that Barnes & Noble carries, but at cheaper prices. What’s ironic is Barnes & Noble’s gross margin in the retail business is 27.36%, but because of the company’s huge losses in the Nook business, its overall margin is just 17.89%. When you compare this margin to Wal-Mart’s gross margin of 24.66% or Amazon’s margin of 26.56%, you can see the toll the tablet business is taking on the company overall.

Wal-Mart also has two huge advantages that Barnes & Noble can't hope to match. First, the company has over 4,000 domestic locations, versus under-700 for Barnes & Noble. If convenience is important to shoppers, Barnes & Noble is in serious trouble. As if this wasn't enough, Wal-Mart is moving more and more toward being a dominant player in the grocery business, and 55% of sales are already from this category.

Going forward, Wal-Mart plans to continue expanding its grocery offerings, and most new locations already have a full service grocery store inside. The reason is simple--Wal-Mart knows that customers have to make a trip to the store to buy groceries, and in many cases this trip occurs at least once a week. If customers are already in the stores every week buying what they need, they are likely to pick up a book, CD, DVD, or Blu-ray at the same time. Why make a separate trip to Barnes & Noble if customers can get everything they need from Wal-Mart?

In addition, everyone knows Amazon has a massive selection and is more than willing to undercut anyone on pricing to take market share. With these two companies facing Barnes & Noble each day, the bookseller simply needs to rethink the way it does business. Unless Barnes & Noble can garner deals to offer books, magazines, music, and other wares that are unique to its stores, the decline in the company’s business will continue.

Maybe digital isn’t the big deal everyone expects
A second investing lesson might be that digital sales may not be the huge opportunity that many analysts expect. A consistent theme heard about both Barnes & Noble and Amazon is that digital sales will eventually take over physical sales. However, the numbers don’t seem to bear out that customers are jumping to digital as quickly as analysts might expect.

Over the last several quarters, Amazon’s digital sales growth has dropped from about 18% to the high single digits. Given this slowdown at arguably the biggest player in digital sales, you have to wonder if digital sales will ever live up to expectations. Barnes & Noble saw digital content sales decline 8.9%, which just seems to further prove the point that digital may not be a huge growth market after all.

This problem might be bigger than we think
The last investing lesson from Barnes & Noble’s recent earnings is potentially the most problematic for multiple companies. While some would argue that Barnes & Noble’s Nook tablets have problems specific to themselves, a bigger issue could be tablet sales in general.

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