Barnes & Nobles' Good Old-Fashioned Idea

Barnes & Nobles' Good Old-Fashioned Idea

Barnes & Nobles' Good Old-Fashioned Idea

Moneybox
Commentary about business and finance.
Nov. 9 1998 6:43 PM

Barnes & Nobles' Good Old-Fashioned Idea

Friday's announcement that book retailer Barnes & Noble will be purchasing book distribution giant Ingram Book Group for $600 million brought forth the expected predictions of doom and accusations of anti-competitive behavior from the American Bookseller Association and from Amazon.com. But while the deal may in fact make economic sense for B&N, the lamentations from its competitors reflect a basic misunderstanding about the nature of this deal in particular and of vertical integration in general.

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Ingram is the country's largest book wholesaler. It owns 11 distribution centers around the country and is the major supplier to many independent bookstores and to Amazon.com. For the ABA--which represents the independent booksellers--and Amazon, that means that their most important competitor will suddenly become their biggest supplier. This in turn has seemed to raise the specter of Barnes & Noble gouging its competition in order to drive them out of business, so that the ABA called the deal "a devastating development that threatens the viability of competition in the book industry."

Now, the FTC and the Justice Department almost never challenge acquisitions that involve companies expanding into different businesses rather than acquiring competitors, so it's likely this deal will pass antitrust muster. Regardless, the ABA's concerns are misplaced. Ingram is a $1-billion-a-year business because it supplies books to all these booksellers and Amazon. If B&N were to have Ingram raise prices or decrease its offerings to its competitors, Ingram would become a less profitable, smaller company that would be worth much less to B&N shareholders. It's hardly good business to buy a company and then pursue a business strategy guaranteed to make it less successful.

Ah, but perhaps making Ingram less successful would make Barnes & Noble more successful. If Amazon or the small bookshops can't get books from Ingram as easily, or if they have to pay more, or if they can't get books at all, won't they go out of business and barnesandnoble.com can swoop in and pick up all their customers?

That might be plausible if Ingram were the only book distributor out there. But it's not. If an opportunity exists to make a profit selling books to Amazon or independent booksellers because Ingram is gouging them, another distributor will step up to the plate and make that profit. Only in cases where monopoly power exists can a company get more for its product than it would in a competitive environment. (That's why they call them monopoly profits.) And this situation doesn't exist in book distribution. More to the point, even if there were no other major players in the industry, there soon would be if Ingram really pursued such a self-destructive strategy. Book distribution requires some brick-and-mortar assets, but it's not rocket science.

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In fact, it's more likely that Amazon will move to a different supplier than that Ingram will abandon Amazon, since it's hard to convince yourself that it's OK to be dependent on your major competitor. But Amazon should have been pushing itself to be less dependent on a single supplier anyway, so the deal may end up helping them in that sense.

For Barnes & Noble, then, the point of the deal is not to freeze out its competitors. Rather, the acquisition is a classic example of backward integration. B&N has obviously decided that the benefits of bringing supply in-house--reduced transaction costs, improved book delivery times, greater geographic reach--outweigh the costs, which include both the initial $600 million but also the operating costs of integrating a new business. (What the deal doesn't do, it's important to see, is save B&N money by taking Ingram's profit margin out of the equation. It's not like Barnes & Noble is now going to get books 20 percent cheaper now that it owns Ingram. Ingram still has to charge B&N the same prices it charges everyone else--the prices that it needs to charge to meet its cost of capital--or else it will become unprofitable.)

It's safe to say that this acquisition would have made little sense before B&N invested so heavily in barnesandnoble.com. Owning Ingram will improve B&N's Internet business almost immediately, giving it overnight delivery capabilities in 80 percent of the country, and it will also presumably improve its inventory management. B&N itself won't need to keep as many books in the store if it knows that it can replenish books overnight.

It's ironic that at a time when New Economy rhetoric is all about the replacement of old-style corporate structure with ever-changing alliances and networks, B&N has done that most old-fashioned of things--vertically integrate--in order to make its New Economy business flourish. The jury will be out on this deal for a while, since B&N presumably could have accomplished many of its goals by just contracting with Ingram to handle distribution for barnesandnoble.com. But it's important testimony that in at least a few corporate hallways the idea that if you want to do something right, you have to do it yourself still carries weight.