"Assess Barnes & Noble’s response to the substitution threat from Amazon. How did Amazon respond in turn and to what effect?"

The creation of the internet has radically changed the approach and future of the retail industry forever, enabling a new channel for business between retailer and customer. This in turn, has created a new substitution threat to the traditional approach. Substitution is the extent to which “one product or service supplants another in performing a particular function or functions for a buyer” (Porter 1985: p273). The internet has become an enabler of increased competition, reducing entry barriers for new competitors by reducing the costs associated (Porter 2001: p66); in effect reducing differences and increasing rivalry between competitors.

In analysing the book retail industry, ‘Porters Five Competitive Forces’ is an important model used to determine “industry attractiveness” (Porter 1985: p4).

Fig. 2 - Online Book Retail Industry. The author has prepared a Five Forces Analysis of the book industry; based on available materials. Adapted from Porter 1985 (pp5-6).

This analysis reveals that the industry is very customer orientated, a result of high rivalry, low product differentiation and the amount of substitutes giving the customer greater bargaining power, thus leading to lower achievable margins.

The threat of new entrants is higher online than offline, due to the high fixed and sunk costs associated with offline bookselling. However, established firms have a temporary monopoly, with Amazon obtaining a first mover advantage, while B&N is an established brand name. Therefore, marketing budgets to compete with the named players would be vast. The low switching costs associated with shopping online, “offers buyers an inducement to switch” (Porter 1985: p278), with little or no disruption involved in the process; whilst customizable pages make it more attractive, and increase switching back costs, to traditional retailers. The purchasing power, in terms of volumes of books, of Amazon and B&N reduces the supplier’s power; although the suppliers retain some power through control of the distribution rights, prices and discounts on a majority of the titles produced.

To conclude, this analysis reveals that the industry is accessible and attractive to new entrants; nevertheless, competing for customer loyalty and establishing a name would be almost impossible for a newcomer without heavy financial backing and/or a novel idea. B&N’s response to the substitution threat was to straddle its operations, by continuing to operate its traditional offline model, maintaining customers who were unaffected by the substitution, and by developing a New Media division to launch in the substitutes channel. This allowed B&N to limit its customer base from moving to Amazon’s online model, whilst obtaining the ability to entertain both markets through its click and brick position. This click and brick presence will be touch upon in Question 3.

BarnesandNoble@AOL and BN.com

B&N entered the online market initially as the exclusive bookseller on America Online’s (AOL’s) Marketplace, with its own Web site launching later on in the year (1997). B&N went live with a deeply discounted price structure and a new personalized book recommendation service. On the same day of their website launch, May 13th 1997 (with a similar discounted structure), B&N initiated a high-profile lawsuit against Amazon, challenging its claim to be the “Earths biggest bookstore” days before Amazon's scheduled Initial Public Offering (IPO) (Ghemawat & Baird 2000).

Amazon’s immediate response to B&N’s AOL launch was to increase the range of titles offered, whilst expanding discounts on bestsellers. Amazon also announced the development of its own personalised book recommendation service. Upon B&N’s own website launch, Amazon announced further discounts of 40% on its list of bestsellers. Following Amazon’s successful IPO, they responded aggressively to B&N’s lower prices by offering further discounts.

Strategy

Fig. 3 - Porter’s Generic Strategies.
(Adapted from: Competitive Strategies: Techniques for Analyzing Industries and Competitors)

Amazon’s generic strategy was to be cost leader, and this prompted aggressive tactics and deep discounting upon the arrival of B&N to the online scene. However, B&N introduced an interplay between cost and differentiation in its approach by offering a personalized book recommendation service, which Amazon proposed to copy. Cost leadership is the first line of competition; however, as product differentiation is low and imitation high, a combination of cost leadership and differentiation strategies combined may be necessary to be successful and command competitive advantage in the online book retail industry. This suggests companies should follow a strategy that is originally opposed to Porter’s views that a firm must adhere to a cost, differential or a focused approach (1985: pp17-18); creating a differential focused approach.

Value chain

The differences between B&N’s online model and its offline model, as well as its differences to Amazon’s model, are displayed in its value chain. B&N's response to substitution was to establish its online operations as a separate organisation. This approach allowed B&N to avoid having to pay taxes on online sales, whilst improving its investor relations, the tracking of its stocks and its attractiveness to different kinds of people, such as high-tech staff.

Value chain comparison.
Fig. 4a - Procurement and Logistics.
Fig. 4b – Store Operations.
Fig. 4c – Marketing. (Ghemawat & Baird 2000)

B&N’s procurement and logistics approach differed to Amazon’s model (Fig. 3a). B&N benefited by having its own on-line dedicated warehouse, which gave them the opportunity to ship on the same day compared to Amazon’s one to five days, allowing them to claim that they were able to beat Amazon on delivery times. B&N's services were nearly identical to those of Amazon’s, closely resembling its website and online virtual storefront, albeit graphically richer and therefore with longer download times (Fig.3b). Amazon’s extensive experience in the market gave them the upper hand in the development and operation of their store; B&N, however, could exploit their experience in the book retail market in dealing with publishers, thereby reducing startup costs.

As displayed in Fig.3c, B&N had pinned their hopes on their brand name to see them expand into the online market. Albeit not advertising offline, B&N worked at building online traffic by partnering with other major Web sites. B&N made agreements to link up with AOL, where it entered the online market, and affiliated with the New York Times Electronic Media Company. These deals promoted sales through referral schemes and commission payments, as well as providing a complement to one another (Porter 2001: p69). Negotiations were also in place to introduce a counterpart to Amazon’s ‘Associates Program’, which allowed associates to earn commission on sales by directing potential customers to Amazon’s website (Affiliate program 2007).

Amazon’s Response

In response to B&N’s entrance into the online market, Amazon used its first mover position to attack B&N’s potential and resorted to imitating some of B&N’s activities Fig.4. In competition with B&N’s inventory, Amazons “Just-in-time” (JIT) method couldn’t operate efficiently enough as an intermediary of its suppliers. Consequently, Amazon invested in its own large distribution warehouse. Though this contradicted with Amazon’s original business plan of keeping to a minimum their fixed assets and the inventory that they hold, this move would allow them to speed up deliveries in-line with those of B&N. This would also allow them to purchase more books direct from the publisher and diminish wholesaler costs.

Threatened by B&N’s brand position, Amazon continued to spend heavily marketing offline, something that B&N did not do, instead basing their offline marketing on their brand position. In response to B&N's creation of a referral scheme, Amazon set about increasing the amount of commission paid to its associates. This commanded greater returns for the associate, thereby giving Amazon a better opportunity to negotiate deals than B&N; which they did, clinching deals with two leading search engines, as well negotiating a better deal than B&N with AOL.

Fig. 5 – Value chain comparison, Amazons online response.

Repercussions

This had significant repercussions for Amazon, as depicted in Exhibit 6 (Ghemawat & Baird 2000). The impact of Amazon’s retaliation caused its market value to fluctuate as B&N’s market value rose. The effects of reducing their prices to stay competitive were affecting their margins. However, in order to survive, Amazon had to fight off the competition from B&N to continue to maintain its customer base and to defend its online position; “Get large or get lost” (Internet Boom 2007). Thus, it was important for Amazon to incur substantial costs to stay competitive and to continue to provide customer value, and more importantly to continue to grow at all costs. Competition was rife between the two online competitors, with each move taken being followed by imitation or a counter move by the other; each move directly affecting the other. This helped continue growth in the market, although it was the customer who benefited most.

Next : Question Three