Monday, April 30, 2012

What the Microsoft Investment in Barnes & Noble Means for E-textbooks

This morning, Microsoft and Barnes and Noble announced that the software giant is investing $300 million in a new B&N subsidiary that will include the Nook and B&N College divisions. Microsoft's investment gives it a 17.6 percent stake in the newco and ensures that Windows 8 will launch with the Nook digital bookstore in tow.

The question in the education segment is this: what does this new spinoff and the Microsoft investment mean for e-textbooks? In order to frame this question a bit more, let's consider the current e-textbook market for a moment.

First, there is the B2C or direct-to-consumer market. In this sector we have a number of players, small and large, that include Amazon, Apple, Barnes & Noble, Chegg, CourseSmart, Google, Inkling, Kno, and This market is relatively new and CourseSmart has been the leading brand because it possesses the largest catalog (it is owned by the top five higher educational publishers). The competition in this area has focused on (in order) availability, price, and cool user features that might differentiate competitors.

The B2C market is currently much smaller than the B2B side of the e-textbook market, but it is growing and will evolve quickly. In my recent five-year forecasts, I have been projecting an eventual consolidation around the major brands and technology companies, which would reduce the field to Amazon, Apple, Barnes & Noble, and Google (I have generally listed B&N in gray or with a question mark). I think the new B&N subsidiary and Microsoft's investment will keep the company on the list and solidify its place in that horizon.

Less talked about, but more lucrative, is the B2B or direct-to-institution market in education. This sector consists of enterprise sales to independent schools, small colleges, for-profits, career colleges, and distance education divisions. The customers in this market do not have traditional bookstores, their students are generally distributed, and the purchase and distribution models guarantee a much higher sell-through for e-textbook providers. While promising much more revenue, this market is also much harder to penetrate as it requires sales, services, and distribution scale that are hard to achieve overnight.

Currently, even though B&N College is a leading campus bookstore provider, it does not play in the B2B market for e-textbooks. The reason is that its NookStudy product was developed before the Nook and utilizes software and content frameworks/formats that are not compatible. This means that B&N College does not have any kind of a mobile solution for its e-textbooks, nor does its product address accessibility issues.

The partnership with Microsoft clearly promises to address B&N's weaknesses both on the B2C and B2B fronts for e-textbook sales. The company will likely move to merge its NookStudy product more formally into the Nook digital library, which will put e-textbooks on newer Nook models (coming this fall), and on Windows 8 devices. This will give B&N a technology reach comparable to Amazon but with a much more direct play in higher education. Moreover, because major textbook publishers are so afraid of Amazon, they will move quickly to ensure that their titles are broadly available through the newco.

Keep in mind that both Amazon and B&N lack the complete suite of services to compete in the B2B market, but rumors are that both companies have developed executable strategies to remedy those shortcomings within the next 12 months.

Of course, that still doesn't tell the complete picture regarding the newco's real impact on the e-textbook market. Here are some of the possible implications.

1. Competition for Amazon -- From the publisher perspective, the most important thing here is the potential of a major competitor for Amazon in the education space. Textbook publishers, like trade publishers, understand that, left unchecked, Amazon will become the major retail distribution point for e-textbooks, which will diminish the publishers' brands and profits. Look for publishers to work closely with Barnes & Noble on catalog availability, special formatting deals, etc.

2. B&N in the B2B Market in Education -- The second  big consequence is that the B2B market will become more crowded. B&N/newco will play aggressively here, as will Amazon. They have much ground to make up, but they will be disruptive.

3. B&N Gets E-textbooks on Mobile Devices -- This is not insignificant. By pushing e-textbooks out both through the Nook and Windows 8 devices, B&N/newco could have considerable clout. Naturally, much depends on the popularity of Windows 8 among young adults, and on newco's ability to maintain a decent market share in the tablet space.

4. More Digital Titles from Publishers -- Most importantly, the emergence of the B&N/newco in the e-textbook space will push more digital titles into the market. As I have written in my annual reports and in my recent book, the availability of content is one of the key factors in the increase of digital textbook sales in the U.S. This new company will ensure that e-textbooks represent more than 6% of the education market at year's end, and more than 12% by the end of 2013.

5. The Price of Textbooks Will Drop Within 3-5 Years -- Finally, more competition, even among the major players, will help accelerate the price ceiling for textbooks. Most of the market factors determining price decreases result from new content business models and competitors, but the continued growth of the digital textbook space will also facilitate the change. In particular, publishers will move more quickly to digital-first workflows, which allow them to improve unit sales and maintain or improve gross margins and profits in spite of lower unit costs.

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