The “Strange Bedfellows” Files: Barnes & Noble and Microsoft

Nook LogoPolitics, they say, makes for strange bedfellows. Business makes for equally strange, if not stranger, bedfellows.

Lift, for a second, the curtain (blanket?) on Microsoft and Barnes and Noble (“BN”). 

In April this year, Microsoft announced a sizable (~ $300m) investment in BN (full disclosure: I used a Bloomberg article as the launching pad for this blog post and some of the numbers and quotes are from there) in exchange for 18% of BN’s nook subsidiary.

This was at a time when BN’s traditional brick and mortar business (like many others’) was declining. Sales of eBooks though were growing, aided in part by its Nook tablet. And with gross margins exceeding 30%, it was clear that the digital side of BN’s business was the future. In fact, arguing that BN was undervalued because the digital side was hobbled by the bricks and mortar business, some wanted the digital business (the Nook device + the eBook business) spun-off.

What does Microsoft want?

But the Nook tablet is based on Google’s Android system and while that may work for Amazon (whose own Fire tablet is based on Google’s Android system), at that time, I, for one, was not too sure exactly what Microsoft hoped to get from its BN investment. The picture is clearer today though and the investment seems like it could be a “win-win” for both BN and Microsoft.

Between April and today, Microsoft announced a Windows 8-based tablet, in order to capture its own share of the exploding tablet market and to minimize the downside resulting from tablets cannibalizing PC sales [since most PCs sold are still equipped with some version of Microsoft Windows and users typically buy or “acquire” Microsoft Office, etc., every PC sale “lost” to a tablet hurts Microsoft’s bottom-line directly.] With the global tablet market likely in the hundreds of millions (with only a very small percentage locked down by either Apple or Amazon), the tablet wars are just taking off. 

Thanks to Microsoft’s ubiquitous Windows brand, adoption and usage, I would imagine that out of the gate, it will capture a certain share of the tablet market. But Microsoft is likely asking itself how it can make sure that, every time a consumer passes over a PC purchase or considers a largish Internet access device, it can make the consumer only think of a Windows 8 tablet  (and not an Apple iPad or a Kindle Fire or …). That’s where BN comes in. 

Just another app?

BN currently has more than 25% of the eReader market, an impressive number. I am not sure what % of that is from Nook users and what % is from users of the Nook app on smartphones, PCs and other devices. Microsoft though could be eyeing the latter segment. If, with this investment, Microsoft is able to make sure that it has a compelling BN app available on the tablet, out of the box, BN users (who are used to BN’s “digital lockers”, as the article quotes BN’s CEO saying) and fans would then have one more reason to choose a Microsoft tablet and not an Apple or Amazon tablet:

All the companies (Microsoft and BN) have said about the deal is that it’s expected to close before the end of the year and the Nook app will be “deeply integrated” into Windows 8, the first version of Microsoft’s operating system that will power tablets.

That may mean users are prompted to make a pre-loaded Nook app their default reader, as Apple does with its iBooks, or it could be promoted in the Windows app store with free e-books.

Non-BN users and fans (book lovers and newspaper+magazine readers everywhere) might also be willing to give the Microsoft tablet a chance because of how good/compelling the BN app is…to be honest though, this is the one piece of the puzzle that still doesn’t make a lot of sense to me.

The Bloomberg article says that Microsoft, aside from its $300m investment, is going to spend another $305m on the partnership (over 5 years)…I have to think that for $605m, Microsoft is hoping to get more than just a compelling app and a certain “readymade” market. Is the Nook going to become a more full-fledged media platform for the Microsoft Tablet? Will BN and Microsoft launch their own video streaming service under the Nook brand? Since we are deep in speculation territory, why not go one step further and imagine that perhaps Microsoft will eventually acquire all of BN’s digital assets (as part of the spin-off) and merge them with another “compelling” tablet app provider, say, um, Netflix? Or will the Nook app be somehow engineered to gain additional insights into user behavior (superlatively insightful and useful data of course) that Microsoft can then use to increase its tablet marketshare and adoption? 

The fact that there are multiple possibilities here and/or the fact that Microsoft has something up its sleeve is possibly why

It doesn’t help that Microsoft and Barnes & Noble have been vague about how their partnership will turn things around, said Peter Wahlstrom, an analyst for Morningstar Inc. (MORN) in Chicago. Barnes & Noble must “prove they can make this into a viable model and they haven’t done that yet,” he said. Microsoft’s involvement “doesn’t fix it.”

BN’s Clear Benefits

For BN the partnership of course comes at a great time and it is easy to see why it would like the partnership.

Number one, of course, is the cash from Microsoft.  

Then, it has to be about growing its eBook market and revenue/profits. The more easy it is for consumers (across any device or platform) to buy high-margin eBooks (interestingly its Q2 2012 earnings showed flat Nook revenue but a 46% growth in digital content sales), the more BN benefits. If Microsoft is successful with the tablet and is able to penetrate the still untapped global tablet market, sheer user inertia, if not anything else, will force those that spend money on digital reading material to do so via BN’s default reading app and store. 

18% may be a small price to pay for that kind of potentially explosive growth and guaranteeing its future (either independently or as part of Microsoft).

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