Posted on Thursday, May 3, 2012
Strategically, Microsoft’s investment in Barnes & Noble’s Nook Reader is no big deal. Sure, Microsoft overpaid a third-tier player to preserve a foothold in an emerging product sector and the chances of that $605 million investment paying off are slim. Microsoft had few options, however, and the price is a tiny part of Microsoft’s cash hoard.The more interesting aspect of the story is how Microsoft and Barnes & Noble, both of which once sat atop their respective industries, responded differently to technology advances that threatened to disrupt both their positions. Microsoft foresaw the coming of both mobile computing and e-readers and still got toppled. Barnes & Noble got surprised, at a time when technology is crushing its industry’s business model, yet responded far better than Microsoft did.
Therein lies an interesting tale—one that offers both hope and caution to other market leaders facing similar disruptions.
Microsoft invested early and heavily but flubbed its efforts. Microsoft pursued a tablet for more than a decade before discontinuing its efforts in 2010, just months before Apple introduced the iPad. Microsoft also began developing an e-reader years before Amazon captured that market with its Kindle. Both efforts failed even though they had top management support—up to and including Bill Gates—and burned hundreds of millions of dollars in investment.
The root cause of both failures, according to Dick Brass, an executive in charge of both efforts at various points, was that Microsoft couldn’t get out of its own way. Brass bluntly characterized the problem as “internecine warfare:”
“Internal competition is common at great companies. It can be wisely encouraged to force ideas to compete. The problem comes when the competition becomes uncontrolled and destructive. At Microsoft, it has created a dysfunctional corporate culture in which the big established groups are allowed to prey upon emerging teams, belittle their efforts, compete unfairly against them for resources, and over time hector them out of existence. It’s not an accident that almost all the executives in charge of Microsoft’s music, e-books, phone, online, search and tablet efforts over the past decade have left.”
[via The New York Times]
Microsoft now finds itself playing what will likely be fruitless games of catch up against strong competitors in most of the areas in which it sabotaged itself, and therefore couldn’t field homegrown offerings.
Microsoft has come to rely on a less than inspiring playbook: pay a premium to acquire or prop up a second- or third-tier offering to slow competitors and preserve a strategic option.
For example, Microsoft tried to acquire a distressed Yahoo and, failing that, spent billions to acquire Yahoo’s users for its search engine. It paid $8.5 billion to acquire the orphaned Skype to add eyeballs to video chats in Xbox and Office. Microsoft is paying billions to prop up fast-fading Nokia, in the hopes of salvaging a market for Windows-based smartphones. Now it is committing $605 million to Barnes and Noble for a small stake in the Nook, which is at best a strong contender for third in the tablet or e-reader space (depending on how generously we frame the Nook’s allure).
On the other hand, Barnes & Noble’s success to date demonstrates that market leaders can innovate and, indeed, reminds us that they must. Barnes & Noble was not a first mover in e-readers, but it responded with speed and determination. Thus it has survived (so far) the inevitable digital transformation that has already destroyed Borders, its long-time arch nemesis, and will likely soon bring down Books-A-Million.
Introduced two years after the first Kindle, Nook was a credible response and grabbed a respectable 20 percent market share from Amazon and Sony. A year later, Barnes & Noble exploited Amazon’s slowness in fielding a color version to carve out a solid niche for itself with the Nook Color, a color tablet that Barnes & Noble was smart to position against the black-and-white Kindle as opposed to the iPad. One analyst estimates that in last year’s critical 4th quarter, Barnes & Noble sold about 1.5 million Nooks, compared with Amazon’s 6 million Kindles.
Strategically, the Nook is less about selling e-readers than it is about selling e-books. Amazon is apparently selling Kindles at around cost, so it is probably safe to assume that Kindle competitors are never going to make much money, either. The Nook, however, defends Barnes & Noble’s ability to sell e-books. On that front, Barnes & Noble is also doing reasonably well. It claims about 27 percent of the US e-book market, with Amazon at about 60 percent.
Barnes & Noble’s success with its Nook came at a heavy cost on earnings, however. Barnes & Noble has neither the business model nor the deep pockets to sustain a long-term battle in this space, especially as the tablet and e-readers categories converge and the Nook inevitably has to go up against the iPad.
For Barnes & Noble, the restructuring of the Nook as a separate subsidiary and the selling of the stake to Microsoft make all the sense in the world. Its uphill effort gets a significant boost. The fact that Microsoft’s investment values the new subsidiary at $1.7 billion, more than twice the market valuation of Barnes & Noble at the time of the announcement, is further affirmation of the success of Barnes & Noble’s innovation efforts.
In a 1999 essay entitled “Beyond Gutenberg,” Bill Gates predicted that the sales of electronic books would equal those of paper books “within a decade or so.” Gates was spot on; sales at Amazon hit that point around April 1, 2011. Who would have guess that in the race to respond to that foresight, Microsoft would have been out-innovated by Barnes & Noble?