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P A NK AJ G H E M A W AT

Leadership Online (B): Barnes & Noble vs.

Amazon.com in 2005
In 2004, Amazon earned $588 million in net income on revenues of $6,921 million, and Barnes &
Noble (B&N) earned $143 million on revenues of $4,874 million, including BarnesandNoble.com’s
net loss of $21 million on revenues of $420 million. Amazon, which had diversified significantly
beyond books, held roughly 70% of the online book market in the United States, versus about 15% for
BarnesandNoble.com At the beginning of 2005, Amazon’s and B&N’s stock market valuations
amounted to $18 billion and $2.3 billion, respectively (see Exhibits 1 and 2 for more details).

Amazon.com
In 2005, Amazon was the world’s largest online retailer, with 47 million active accounts. Since
1998, it had broadened its scope by internal expansion and acquisition. It moved from books into
other media (music/video, DVDs, video games, software), and then into electronics and a dozen
other categories. Nonmedia products accounted for 24% of Amazon’s revenues in 2004, up from 17%
in 2000, but margins on them lagged. Geographically, Amazon added operations targeted at the
United Kingdom (1998), Germany (1998), France (2000), Japan (2000), Canada (2002), and China
(2004). In 2004, 44% of Amazon’s revenues came from outside North America, versus 14% in 2000,
but international gross margins were low and had declined from 22% in 2002 to 19% in 2004 (versus
27% in North America.)

Amazon’s broadening of scope was part of a strategy that founder Jeff Bezos described as “getting
big fast” and that also involved heavy expenditures on marketing and on information technology (IT)
in the pursuit of “customer-centricity.” According to one study, Amazon’s marketing had reduced
the price elasticity of its demand to -0.45! 1 The yield from investments in IT included a widely
imitated store design, ideas for reviews and community features, personalization options, and even
patents—most controversially, for “one-click” checkout software, which Amazon sued
BarnesandNoble.com for infringing.2 To protect its know-how, Amazon also developed core

1 Judith Chevalier and Austan Goolsbee, “Measuring Prices and Price Competition Online: Amazon vs. Barnes and Noble,”
Quantitative Marketing and Economics I (2), June 2003, pp. 203–222.
2 Sabra Chartrand, “A Web site invites bounty hunters to disprove ownership of ideas, even those of its founders,” The New
York Times, October 23, 2000, p. 8; “Amazon.com Patent Covers Fee Program on Customer Referral,” The Wall Street Journal,
February 28, 2000, p. A34; and Dan Gilmor, “Jeff Bezos and the Amazon patent battle,” San Jose Mercury News , March 10,
2000.

Professor Pankaj Ghemawat prepared this case. This case was developed from published sources. HBS cases are developed solely as the basis for
class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective
management. This is a rewritten version of an earlier case, HBS No. 701-085, prepared by Professor Pankaj Ghemawat and Alastair Brown.

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705-492 Leadership Online (B): Barnes & Noble vs. Amazon.com in 2005

applications internally, insisted that its technology partners sign nondisclosure agreements and,
according to its VP of IT infrastructure, did not publicly discuss its IT architecture, programming
tools, database operations, or the size of its IT department. 3 At the same time, Amazon did attempt to
tap into others’ know-how. Thus, it hired several top IT managers away from Wal-Mart, prompting a
lawsuit by the latter that—like Amazon’s lawsuit against BarnesandNoble.com—was settled out of
court.

Amazon’s (and BarnesandNoble.com’s) aggressiveness and general euphoria about the Internet
combined to escalate Amazon’s operating expenses well above the levels forecast at the time of its
IPO: they peaked at $1.4 billion in 2000, were cut to $969 million by 2002, and amounted to $1.2
billion in 2004. Selling, general, and administrative expenses, in particular, hit $1 billion by 2000 and
then stayed close to that level. Amazon sought to get big fast because it counted on economies of
scale and scope to squeeze operating expenses to a small enough percentage of revenues. It also
pursued the resource efficiencies that it had originally targeted. Amazon continued to employ
negative working capital and to restrict investments in physical capital—except in distribution, where
it made significant investments after B&N’s attempt to acquire Ingram (described below), which
initially supplied 60% of Amazon’s books. Amazon turned its inventory 16 times a year, versus 8
times for Wal-Mart and 3 times for B&N. And Amazon still had only 9,000 employees, versus 42,000
for B&N.

Barnes & Noble

Barnes & Noble increased its share of the U.S. book market from 13% in 1997 to 17% in 2004,
largely behind its Superstores, whose number went up from 483 to 666. B&N acquired a video game
& entertainment software retailer for $215 million in 1999, but disposed of it in 2004. This left it
focused on books and on BarnesandNoble.com, which had been spun out of B&N only to be spun
back in.

The Riggio brothers, who controlled B&N, wanted an early IPO of BarnesandNoble.com, but a
30% drop in the NASDAQ index after June 1998 led to its deferral. Instead, in October 1998, B&N
sold 50% of BarnesandNoble.com to Bertelsmann for $200 million plus an agreement that each
parent would invest another $100 million in it. (An IPO of 20% of BarnesandNoble.com for $420
million was completed in May 1999.) This tie-up also offered BarnesandNoble.com access to varied
content and channels because Bertelsmann was the largest publisher in the world (and in the United
States, through Random House), operated a book club with 25 million members, and owned BMG
Entertainment, a global music company, among many other media properties. 4 However, little
coordination was attempted with Bertelsmann. BarnesandNoble.com, which continued to be run as a
separate entity, did expand into music, videos, software, gifts, and even online course offerings, but
its scope remained much narrower than Amazon’s given its focus on retailing books in the United
States.

Where B&N did attempt to stretch its scope was vertically, into book distribution. In November
1998, right after its deal with Bertelsmann, B&N announced plans to acquire Ingram, the largest book
wholesaler in the United States and a major supplier to Amazon and Borders, among others, for $600
million (one-third in cash, two-thirds in stock). Opposition from competitors and publishers led to an

3 John Foley and Steve Konicki, “Amazon’s IT Agenda,” Information Week, November 6, 2000.
4 Karen Miller, “MEDIA: Bertelsmann’s Online Onslaught: The globe’s third largest media company is making up for lost
time,” Newsweek International, October 18, 1999; and Celia McGee, “Magazine makes new war with publisher,” Knight-Ridder
Tribune Business News, October 25, 1999.

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Leadership Online (B): Barnes & Noble vs. Amazon.com in 2005 705-492

inquiry by the Federal Trade Commission that caused the deal to be called off. B&N did, however,
invest substantially in its own warehousing and logistics.

The late 1990s also saw B&N starting to invest in technologies even more radical than online
retailing. E-books distributed digitally to customers to save on printing, inventories, logistics, and
returns were one area of focus. An e-book section was added to BarnesandNoble.com’s website, and
several acquisitions ensued, as did attention to vanity publishing. B&N also invested in print-on-
demand, which could reduce some of the same costs as e-books. Acquisitions began in late 1999, and
in early 2000, B&N announced a major deal with IBM for the technology and manufacturing
components of print-on-demand facilities in its distribution center. B&N’s total investment in e-
books and print-on-demand ran into hundreds of millions of dollars.

These investments in electronic publishing and distribution did not, however, help in the short
run in online retailing, where BarnesandNoble.com’s revenues remained a fraction of Amazon’s.
According to one study, the price elasticity of demand facing BarnesandNoble.com was -3.5,
compared with -0.45 for Amazon, and BarnesandNoble.com priced 10%–15% lower. 5 Technologically,
BarnesandNoble.com’s site was not considered very distinctive, and it often seemed to be playing
catch-up to Amazon. To improve its position, B&N announced three major initiatives in October
2000 to integrate its online and offline operations: the placement of Internet service counters in all
stores to enable orders from BarnesandNoble.com, which offered lower prices, partial integration of
online and offline loyalty programs, and the facility of returning books and CDs purchased from
BarnesandNoble.com to B&N’s traditional stores.

In 2002, Steve Riggio took over as B&N’s CEO from Leonard Riggio, who remained chairman of
the board. In January 2003, B&N acquired Sterling, a publisher of do-it-yourself titles (e.g., home
renovation, auto repair, etc.), for $122 million, as part of a five-year program to build up
(nonelectronic) private label publishing to 10% of the company’s revenues. Rivals such as Borders
reacted by removing Sterling’s titles from their shelves. Later that year, B&N exited e-books.

In July 2003, B&N bought back Bertelsmann’s 37% stake in BarnesandNoble.com for $165
million. In January 2004, it repurchased the 25% of BarnesandNoble.com that was publicly traded for
$115 million and folded the company back into B&N.

5 Judith Chevalier and Austan Goolsbee, op cit. The periods sampled were in 2001.

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705-492 Leadership Online (B): Barnes & Noble vs. Amazon.com in 2005

Exhibit 1 Market Values

3 500 0

3 000 0

2 500 0
Am a z o n
2 000 0
$ M illio n s

1 500 0

1 000 0

500 0 B a r n e s & N ob le

0
199 7 1998 1999 2 00 0 2001 2 002 200 3 2 00 4 2005

Source: Thomson Datastream, accessed May 3, 2005.

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Leadership Online (B): Barnes & Noble vs. Amazon.com in 2005 705-492

Exhibit 2 Operating Comparisons ($ millions)

1998 1999 2000 2001 2002 2003 2004

AMAZON.COM INC.
Sales 610 1,640 2,762 3,122 3,933 5,264 6,921
Cost of Goods Sold 466 1,312 2,022 2,239 2,858 3,931 5,244
Selling, General, & Administrative 196 674 998 848 881 984 1,170
Depreciation, Depletion, & Amort. 52 252 406 266 88 78 76
Total Operating Expenses 248 925 1,404 1,114 969 1,062 1,246
Operating Income (104) (598) (664) (231) 106 271 431
Pretax Income (125) (720) (1,411) (557) (150) 35 356
Adjusted Net Income (125) (720) (1,411) (567) (149) 35 588
Net Cash Flow from Op. Activities 31 (91) (130) (120) 174 392 567
Total Assets 648 2,472 2,135 1,638 1,990 2,162 3,249

BARNESANDNOBLE.COM INC
Sales 62 203 320 405 423 425 420
Cost of Goods Sold 41 146 262 313 327 321 @NA
Selling, General, & Administrative 98 165 216 184 134 123 @NA
Depreciation, Depletion, & Amort. 7 14 36 42 34 27 @NA
Total Operating Expenses 105 179 252 226 167 151 @NA
Operating Income (84) (123) (194) (134) (72) (47) @NA
Pretax Income (83) (102) (276) (244) (74) (46) @NA
Adjusted Net Income (83) (48) (65) (67) (20) (11) @NA
Net Cash Flow from Op. Activities (55) (58) (168) (85) (40) 8 @NA
Total Assets 202 680 529 287 210 348 @NA

BARNES & NOBLE INC

Sales 3,006 3,486 4,376 4,870 5,269 5,951 4,874
Cost of Goods Sold 2,143 2,484 3,170 3,560 3,856 4,324 3,387
Selling, General, & Administrative 586 672 821 912 975 1,133 1,061
Depreciation, Depletion, & Amort. 88 112 145 148 149 164 182
Total Operating Expenses 674 784 965 1,060 1,124 1,297 1,243
Operating Income 189 218 241 250 289 330 244
Pretax Income 157 219 (33) 109 199 296 219
Adjusted Net Income 92 124 (52) 64 100 152 143
Net Cash Flow from Op. Activities 181 187 81 457 329 509 @NA
Total Assets 1,808 2,414 2,557 2,623 2,995 3,507 3,351

Source: Standard & Poor's Compustat®. Figures for Barnes & Noble are for fiscal year ending in January rather than
December.