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 2009 | REDgroup 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 2010 | REDgroup 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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Comments (8)
Tony Nash
(logged in via Facebook)
Very good article and research. Well done. Anyone reading the above article should definitely pay attention to Malcolm Neil's comments as he worked at RED Group and is now at Kobo so I am confident that adds a lot more accuracy to the information.
I am the CEO of Australia's largest pure online book retailer, Booktopia, and I make a comment today just to highlight that not all Australian bookstores have gone backwards during the same period and are thriving right now and as the article never made…
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Malcolm Neil
(logged in via Twitter)
Interesting piece and overall an analysis that has merit.
Some figures to correct.
I’m not sure where you got your figures from but RGR market share while trading normally has always sat above 25% of the retail market.
To your point regarding the eBook strategy I must correct you.
The key component of the new digital market is content not devices. Devices do help drive content sales but without breath of content, as the lack of market penetration of other eReaders has shown it is not enough…
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John Kelmar
Again we find another successful business has gone under through mismanagement. Many people appointed to management positions in Australia appear to be under-qualified and/or inexperienced. Whilst a University degree may assist in the knowledge stakes, many Australian universities have lowered their standards so much that one would question the quality of their graduates.
Running a business cane be made a lot easier if the owners remember that it is not the P&L or Balance Sheet which tells the whole story, but the Cash Flow statement is the true barometer of success.
A Big Business is just a Small Business with a number of multipliers added, however most managers tend to forget the concepts that created their success when they were in a Small Business. If they never had a Small Business, then they should not be allowed near a Big Business.
Andre Sammartino
(logged in via Facebook)
I'm intrigued by your argument regarding the e-commerce angle. What evidence do we have that bricks and mortar book retailers bring any competitive advantage to this domain? The giants you mention (Amazon, Book Depository) both started as dotcoms and were/are thus not burdened with channel clashes (conflicts between shelf prices and online prices), physical store infrastructure and management etc.
What resources and capabilities do you think the RED Group would have had in the online space? And…
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Rich d'Rich
(logged in via Twitter)
Good analysis.
Except that I'd suggest that all businesses go through strategic mistakes, and most of them survive because they have adequate capital to wear the loss. RED group's indebtedness meant that they couldn't trade through problems, adjust their business model and keep going.
That's in addition to the concept (which is dear to private equity firms) that business skills are portable and there is no need for special expertise. Obviously, in book retailing, there was.
Kwanghui Lim
(logged in via Twitter)
Special thanks to Helen Westerman for doing a great job editing the article.
Anthony
(logged in via Twitter)
Good read. Interestingly, The Conversation is also an e-publication. Even Waterstone's is struggling in the book-hungry UK market. Businesses that can't adapt will fall away. Always has been, always will be. The writing is on the (digital) wall.
Roger Clark
(logged in via Facebook)
Would agree with Chris that one factor was the reduction in quality of the offer - Borders range of books and music declined rapidly after the purchase, and large areas of the stores were given over to giftware.
I had assumed that their model at the takeover would have been to run A&R as the bargain/basic area of the business, and Borders as the higher end section. Instead they seemed to bring Borders down to the level of A&R. When Borders first opened in Australia, it was great to have a shop that you knew would most likely have the book/music that you might have read about somewhere. While I agree that the online world has changed the way bookshops work, there is still a place for the bricks and mortar shop that offers what people desire.