What really went wrong for Borders and Angus & Robertson

The demise of Borders’ parent, REDgroup Retail means bookshops will close. doortoriver/flickr

REDgroup Retail accounted for 20% of Australia’s $1.6B book market and in another life, might have been Australia’s version of the Amazon success story.

Instead, last month the parent of Borders and Angus & Robertson in the region as well as Whitcoulls in New Zealand went into voluntary administration. As recently as last week, layoffs and store closures were being announced.

The demise has been variously blamed on the online book market, a strong Australian dollar, import restrictions, high rentals, bad management and overpriced books.

But is this what actually happened? The real picture that emerges is of strategic marketing blunders, the failed merger of Borders’ regional operations with A&R Whitcoulls, a lack of knowledge about the burgeoning e-book market and an inability to adapt from being a traditional bookseller.

Looking at the books

To understand what happened, a good start is examining the summary data of REDgroup’s annual reports and financial data from 2008 to 2010.

Financial year (end-Aug) (A$M) 2008 2009 2010
Trading Revenue 429.5 645.0 581.0
Total Revenue 450.2 684.9 603.9
Operating Profit before tax -5.4 -14.4 -43.6
Operating Profit after tax -4.6 -14.7 -43.0
Net Profit after tax -4.9 -15.2 -43.7
Cash 31.5 8.8 15.2
Net Assets 116.7 80.7 36.9
Key Ratios
Operating profit before
tax/trading revenue
-1.3% -2.2% -7.5%
Return on Equity -4% -19% -116%
Debt/Equity Ratio 399% 407% 902%

These figures reveal REDgroup consistently under-performing over the past three years.

REDgroup made negative profits throughout this period, with net profit going from -$4.9 million in 2008 to -$14.7 million in 2009 and -$43.7 million in 2010. Sales went up between 2008 and 2009 before dropping in 2010.

The important thing to note is that the poor performance was already there even before the strong Aussie dollar, and before e-books took off.

In fact, e-books are a relatively recent phenomenon: Amazon reported the Kindle overtaking hardcover books only in July, 2010, and they will overtake paperback sales only later this year.

A second observation is that the poor performance existed even before A&R Whitcoulls took over Borders’ outlets in Australia, New Zealand and Singapore. Performance was endemic in the financial year ending August, 2008, whereas the Borders acquisition occurred in June 2008.

So even during better days, the book retailing business wasn’t a wildly profitable one. The industry has a large number of sellers and experiences strong rivalry (A&R and Borders combined only control 20% of the market, with Dymocks around 11% and a large number of independent firms serving the remaining 69%).

Challenging environment

Operating a bookstore is challenging because of the need to maintain and manage large stocks of physical inventory, tough suppliers and the seasonal nature of demand for books, which peaks during the year-end holidays.

We can also dispense with another explanation: high rentals. The amount spent on leasing and rentals was around $52 million in 2008, $82 million in 2009 and $81million in 2010.

So while rentals and leases went up in FY 2009 after the acquisition of Borders, they actually declined slightly in 2010.

Throughout this period leasing and rentals remained roughly constant at 12-13% of revenue; they were not what led to the firm’s failure.

So what really happened?

A primary source of concern is the acquisition of Borders’ operations in Australia, New Zealand and Singapore. It is unclear why one might want to combine a company like A&R Whitcoulls that was already unprofitable with Borders’ regional operations which were struggling and which its parent company was ready to abandon.

Borders, A&R and Whitcoulls represent different brands with little synergy to be gained by combining them into a single firm. Each of these brands appeals to somewhat conflicting, and sometimes competing, segments of the market.

There is even less synergy between Borders and REDgroup’s other brands: Calendar Club and Supanews, and neither of those generate significant profits. REDgroup ended up paying a large sum to purchase Borders (estimated at around $110 million) and to integrate Border’s operations into the fold, including $22.8 million in 2008.

Unfortunately, there is little to show from that expenditure. Put simply, this was a failed merger.

Private equity

Several analysts have blamed the private equity structure at REDgroup for its collapse. When a private equity group takes on a firm, it imposes a high debt burden with the hope of turning the firm around and selling it off at a premium.

There may be some validity to this concern because REDgroup is saddled with high levels of debt: A$50 million in loans in 2009 that went up to $102 million in 2010 plus liabilities to trade creditors of around $80 million.

However, ownership structure cannot be the entire explanation for two reasons. Firstly, many other bookstores around the world are in trouble, including those that are public rather than privately held (such as Barnes & Nobles and Borders in the US).

Secondly, while REDgroup’s debt levels are high, the interest payments amount to $9.4 million in 2008, $20.2 million in 2009 and $24.1 million in 2010.

So, they represent only about 4% of total revenue. Had it succeeded in turning the firm around, this level of interest payment wouldn’t have been seen as a crippling burden.

Blunders

Instead, REDgroup made several strategic blunders which ended in it unable to pay its creditors, having to refinance its loans in 2009, breaching banking covenants in 2010 and going into administration this year.

One of the main problems was poor choices in online retailing and e-books.

The past two years has seen an acceleration of changes in the book retailing industry due to two changes: online retailing of physical books and e-books.

As a result of these changes, bricks and mortar retailers such as Borders and A&R are adding less and less value. Consumers receive the same book whether they buy it online or from a physical bookstore, and increasing numbers are choosing to read books on electronic devices.

There are still segments of the market where physical retailers add value, especially in differentiated or specialist markets where independent bookstores largely compete, but these were not areas REDgroup focused on.

REDgroup focused mainly on physical stores aimed at broad audiences. By 2010 they did only $16 million of business online, or only about 4% of total revenue.

Most of their revenue continued to be through Borders (48%) and A&R (39%), but those book sales were earning them less and less money.

Profit contribution from books fell from $8.1 million in 2009 to -$19.4 million in 2010.

Distracted

Why did they react in this way?

For one thing, a lot was going on internally at REDgroup. There were several major reshuffles at the senior and CEO level, so no one was running the ship with a long-term view.

Looking closer, it is apparent REDgroup’s capabilities were mainly in traditional retailing. They did not have any expertise in publishing, editing, online selling, or electronic books. Their ability was to provide a store where customers could browse, buy coffee and gifts, and shop for books. They did what they knew, rather than expanding their capabilities to respond to the tsunami of change around them.

Strategists often recommend pursuing either a differentiate strategy (focusing on customers with a high willingness to pay), or going low-cost.

REDgroup did neither, and in fact tried to charge a premium for general purpose books instead of finding ways to compete with online sellers that were offering them for much cheaper. Numerous price comparisons appear online; also see this submission by the Australia Booksellers Association.

What kinds of customers could they possibly hope to attract this way? One possibility is the impulse shopper, but such shoppers have many other things they could spend on.

Another target might have been people reluctant to shop online, but these consumers turned out to be more willing than REDgroup to learn new skills, and an increasing number switched to buying from firms like Amazon or the Book Depository.

‘Amazon of Australia’

Perhaps, instead of acquiring Borders, REDgroup should have bought an online retailer, or an e-books company. They could have become the Amazon of Australia.

Or the local equivalent of the Book Depository in the UK, which apart from selling books online also offers self-publishing services and runs a division, Dodo Press, which reissues out-of-print books.

To be fair, REDgroup did try to enter the e-book market, but made the wrong strategic bet. Instead of going with Amazon or Apple, they formed a strategic alliance with a Canadian firm, Indigo, to sell the Kobo e-reader, a less compelling alternative.

It is hard to understand why REDgroup would limit themselves only to the Kobo reader. After all, even JB Hifi sells Apple iPads. This reinforces my argument that they lacked a good understanding of the online market.

In many industries, firms that have survived large waves of change had to creatively diversify and adapt. For example, when travel agents became increasingly irrelevant, American Express morphed from being a travel services firm into a financial powerhouse.

In this context, REDgroup failed to respond to the Internet. Examine this chart and you will notice that its revenue composition hardly changed between 2008 and 2010.

REDgroup remained a traditional book retailer to its end, with e-books, gifts and other operations hardly making a dent, and no serious attempt made at selling books online.

It wasn’t the Internet that killed REDgroup. They failed to adapt and learn how to exploit the power of the Internet.

Timeline of a crash:

Mar 2007 Borders USA puts its Australian and New Zealand operations up for sale
Jul 2007 Both Dymocks and A&R rumored to be interested in buying Borders stores
Aug 2007 Reports of a dispute between A&R and its suppliers
May 2008 A&R Whitcoulls reports net profits of A$6.5m, revenues $226m for the first 6 months of FY2008
Jun-2008 A&R Whitcoulls acquires 30 Borders Stores (23 in Australia, 5 in New Zealand, 2 in Singapore). Transaction valued at $110m
Aug 2008 Ian Draper steps down as ARW managing Director
Oct 2008 A&R Whitcoulls reports a 9% increase in revenue in 2008 over 2007. EBITDA was $16m in 2008 down from $18.8m in 2007, before accounting for the acquisition costs for Borders
Dec 2008 ARW rebrands as REDgroup
June 2009REDgroup refinances and extends debt of $27.2m
Nov 2009 REDgroup reports full-year results $42m EBITDA, up 300% from 2008. Revenues up 52% at AU685m. But this is before $22.8m one-off costs including for integrating Borders
Dec 2009 REDgroup signs an agreement with Kobo for e-readers
Apr 2010 REDgroup reports healthy first quarter results, progress integrating various firms, joint venture with Kobo e-books
July 2010REDgroup reports it is likely to breach two of its three banking covenants
Sep 2010 New chairman appointed
Oct 2010 REDgroup reports full year loss of $43m announced (after tax) for fiscal year ending Aug 2010
Nov 2010 CEO Dave Fenlon Resigns
Nov 2010 Reports of reorganisation, redundancies and cost-cutting, including a narrowing of its DVD/CD product range and a focus on gifts
Nov 2010 Borders Australia reduces e-book prices to compete against Apple
Feb 2011 REDgroup enters voluntary administration.

Source: Author’s search results from google news, findata.com, bookbee and wikipedia.

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