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Barnes & Noble Flexing Publishing Muscle

After its troubled foray into online retail, bookstore chain Barnes & Noble's (BKS - Get Report) is looking for a surer thing in its latest initiative: a plan to beef up its book publishing business. And indeed, analysts say the company has made a largely foolproof bet that could help it with a number of goals, including getting lower prices from the same publishers whose turf it's encroaching.

Barnes & Noble currently publishes about 3,000 books, which account for around 3% of its $3.62 billion annual bookstore sales. The publishing initiative, announced last week with the appointment of Stephen Riggio to chief executive, is expected to expand that percentage to 10% in the next five to six years. Industrywide publishing revenues run around $25 billion a year.

"I think people will be watching to see how Steve does," says Jim Milliot, an editor with Publisher's Weekly. "But there's almost no way they can fail. They're talking about five to six years, so they'll probably go in incremental steps. They'll test what works in their stores -- if it doesn't then they'll just pull it back."

Succession

Steven Riggio took over the post from his older brother Leonard, who remains chairman. The younger Riggio previously oversaw the company's online operation, Barnes & Noble.com (BNBN), which has faltered since its inception and is expected to continue losing money this year. Steve Riggio won't directly oversee the publishing business -- Alan Kahn, an experienced book executive, has been named the president of that segment.

One analyst who asked not to be named said he put a buy rating on the stock after hearing about the publishing initiative, saying the increased competition will force publishers to lower prices. "They're going to have to respond at one point," said the analyst. "Industry growth is coming from Barnes & Noble and Borders. Amazon.com (AMZN - Get Report) is growing in used books."

The largest book retail chain in the U.S., Barnes & Noble controls 15% to 20% of the U.S. bookselling market. Borders is second, and the rest of the market is divided among discounters, wholesalers, smaller bookstores chains and independents. Analysts expect Barnes & Noble's sales to grow 11% in 2002 to $4.87 billion, while Borders' (BGP) sales are seen growing 3.5% to $3.39 billion, according to Thomson Financial.

Finding a Niche

Barnes & Noble doesn't plan to compete for high-priced talent in the first-run book market, where big bonuses crimp margins and have caused profits to dry up in recent years. Instead, it will focus on the low-cost, high-margin areas of publishing where it currently operates, including reprints of classics, and "lifestyle" and coffee-table books. Most of the books Barnes & Noble publishes are already in the public domain, which means that copyright protection has expired and the cost of publishing rights are low or nonexistent.

"They've been going increasingly in that direction," said Donald Trott, an analyst with Jefferies & Co. "It's a great profit opportunity."

Publishing its own books will give Barnes & Noble some exclusive product that other retailers, such as Borders, don't have. Borders used to have a publishing arm but left the business and has no plans to return. Analysts said Borders got out partly for reasons of geography -- it's based in Michigan, far from the publishing epicenter of New York -- and partly because it lacks Barnes & Noble's scale.

The whole idea behind a bookstore publishing books is that it can control both ends of distribution, and the more scale the better. The company can place its own titles in strategically favorable locations, while relegating competing titles to out-of-the-way shelves, or refusing to buy them at all.

Barnes & Noble probably doesn't intend for the publishing business to become another big leg of its operation, analysts said, but it will no doubt steal some sales from its suppliers. "The publishers, let's make no mistake about it, are not happy. But there's nothing they can do about it," said Milliot. "If Barnes & Noble increases its publishing sales, other titles are going to lose shelf space to Barnes and Nobles." Major publishing houses Random House, Simon & Schuster and HarperCollins declined to comment on the record for this article.

The Great Books

At any major house, backlist -- or books that have already been published once -- accounts for the majority of the sales, around 60%. "That is what they would be competing with Barnes & Noble for," said Milliot.

Barnes & Noble has long complained that despite being the industry leader with the nicest displays and best stores, it is still treated badly by publishers who charge less to discounters and low-end chain stores. Its new position on the supply side of the transaction, where it presumably won't discriminate against its own outlets and in fact will probably favor them, should help it curb the mistreatment.

"I think everything they do is a play to get leverage with publishers," said one source at a publishing house who preferred to comment off the record. A Barnes & Noble analyst echoed that sentiment. "They tried to buy Ingram a few years ago. Why did they do that? Because they wanted to screw the publishers," he said. Ingram is one of the biggest book distributors in the industry.

On the other hand, Barnes & Noble will be leery about putting too much pressure on the publishers, experts said. It and Borders recently settled a suit for $4.7 million claiming it coerced independent publishers into charging less. "The whole terms issue is very touchy," said Milliot. "I'm not so sure he wants to force the publishers' hand to give them better terms."

The main risk Barnes & Noble faces in bulking up its publishing business is that if it doesn't choose titles carefully, it could end up with a lot of unsold inventory.

"If they don't do it well, they'll have a lot of unsold books, and they'll have no one to return them to," said another industry expert who preferred not to be named. "They'd have to mark them down."

The risk isn't huge, however, for a company that has succeeded for so long by understanding which books people will want and which they won't.

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