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Barnes and Noble Will Lose the E-Book Wars

Brandy is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Barnes and Noble (NYSE: BKS) is clinging to its Nook family of e-reading devices. The company recently reported that unit revenues rose 38% last quarter to $542 million and announced the Nook Simple Touch with GlowLight, a new backlit e-ink model, that’s meant to compete with the Amazon.com (NASDAQ: AMZN) Kindle Touch. The company is also running a cross-promotion with Marvel for The Avengers movie, offering a $30 discount on select Nook devices with the purchase of qualifying e-comics.

Earlier this year, Barnes and Noble considered spinning off the Nook unit to reduce its losses. The day for that kind of move has come and gone. With its brick and mortar locations in danger of going the way of Borders, Barnes and Noble has no choice but to continue to battle against Amazon in the e-book wars. It’s a battle the company will lose.

Losing the Device Battle  

Ownership of e-readers and tablets is on the rise but not in a way that will benefit Barnes and Noble. According to a Pew Research survey, 19% of adult Americans own an e-reading device and a matching percentage own a tablet. In the e-reader market, which is where most of the Nook devices belong, Barnes and Noble has a 22% market share compared to Amazon’s 62%. The numbers are worse for tablets, an area dominated by Apple (NASDAQ: AAPL) iPad, where the Nook Color only accounts for 1% of the market compared to Amazon’s 14%.

The traditional e-readers, with the e-ink screens, are going to lose out to tablets in the long run. Amazon, sitting on much firmer ground overall, is suffering from cannibalization due to the growing popularity of tablet devices. Analyst firm Pacific Crest conducted a second quarter “intent to purchase” survey and the number of respondents planning to buy a Kindle Fire dropped to 4.5% from the first quarter’s 4.9%. Interest in e-ink Kindle Touch models plummeted from 10% to 5%.   

A fall in e-ink device sales won’t devastate Amazon because the company is already selling many of the models, including the relatively new Fire, for at or below manufacturing costs. The devices are meant to draw consumers into making Amazon-branded purchases that include e-books, mobile applications, and digital music.

Barnes and Noble could adapt a similar strategy but it lacks the large market share cushion. To remain competitive, the company would need to match Amazon in device price and sales. It would also need to exceed Amazon in e-book sales to pull ahead.

And Amazon’s e-book dominance is about to verge on monopoly.

End of the “Agency”

E-book prices are currently set through an agency model, where publishers get to set the price , placing e-book retailers on fairly even ground. The agency model came about in 2010, following the launch of Apple’s iBookstore, and limited Amazon’s ability to price slash e-books to draw in customers.

The agency model may be coming to an end thanks to some government intervention. The U.S. Department of Justice recently filed a lawsuit against Apple and a group of publishers, claiming that the agency model is essentially price fixing. Three of the publishers have already settled but Apple and the others fight on. If the DOJ is successful, the pathway could be cleared for Amazon to return to its price-slashing ways.

Final Thoughts

Barnes and Noble shares fell 4% on Friday based on concerns about its e-book business. Shares are currently trading near $11, close to the lower end of its 52-week range of $9.35 to $18.73.

The company will report its fiscal 2012 in June. The dust from the DOJ suit will have settled before that date and a poor report, combined with an Amazon discount victory, could send shares even lower than what’s seen now.

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