The Retail Threat Amazon Never Saw Coming

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

Many investors think of huge retail operations and two names come to mind first. The current king of retail is Walmart, and the king of online shopping is (NASDAQ: AMZN). However, one thing that's certain in retail is, no company can stay on top if they don't see the next threat coming.

This is a crazy idea right?
In a recent article, fellow Fool Rick Munarriz commented on a Barron's article that suggested Microsoft (NASDAQ: MSFT) might consider just buying Barnes & Noble (NYSE: BKS) whole. Microsoft already owns about 17.6% of Barnes & Noble's college bookstore and Nook business, and the company is looking to sell their retail operations, why not just take the whole thing over?

Rick's take was this deal has virtually no chance of happening. He pointed out issues like physical bookstores becoming more irrelevant because of digital copies. He said that taking over the college bookstores wouldn't make sense, as they will eventually go digital as well, but it won't be on a Surface, it would likely be on an iPad or Android device.

Not so fast, what if...
The Barron's article suggested that Microsoft could probably take over Barnes & Noble at about $25 a share, and that this would give the company's retail strategy a jump-start. This idea isn't actually as crazy as it sounds at first.

Rick dismisses the idea of Microsoft being able to fill a Barnes & Noble store, but that wouldn't be the point anyway. First, the stores are already full, and imagine what Microsoft could do with some of the space. The company needs a place to showcase its Windows smartphones, Surface tablets, and Xbox hardware. What better place than Barnes & Noble? The company could carve out a less profitable area from each store and install shops within the store for these items.

For all of the talk about physical items going digital, Amazon's own results don't bear this out. The company has sold an untold number of Kindle devices, yet their sales growth in media is in the high-single digits. By comparison, Amazon's general merchandise sales (aka. physical stuff) grew by 28% this last quarter.

Clearly there is opportunity selling physical items as Google (NASDAQ: GOOG) is reportedly looking at a service called Shopping Express. This service would connect customers to local stores for delivery of goods. This service might be either through subscription like Amazon Prime, or with a small fee per delivery. Google knows it can't ignore the Amazon threat to its search dominance. If customers can go on Amazon and search for virtually any product, why do they need to go to Google first?

Microsoft could use the 677 Barnes & Noble retail stores as a way to get better distribution for their own products. Best Buy is one of the better retailers for Microsoft products, but inside that store, Windows 8 sits alongside iPads, Android smartphones, and even Kindle products. If Microsoft owns Barnes & Noble, they have a captive audience to market their goods to.

Those college kids
One of the ideas that Rick scoffed at, was the concept of Microsoft taking over the Barnes & Noble college bookstores. He questioned whether anyone believes that college kids would dump their iPhones and Android devices for Windows 8 units? To be honest, I think the potential is there for those college kids to do exactly that.

It's dangerous to assume that industry leaders will stay leaders forever. Rick is assuming that Apple and Google have such a huge lead that it's insurmountable. I would suggest where Microsoft needs to be is in all of those colleges. What better way to turn the tide in the tablet and smartphone war? Microsoft could market their products to generations of future smartphone and tablet buyers.

Younger consumers are more willing to try new and different devices. It's not unrealistic to believe that Microsoft could gain market share through these additional distribution points. On this same topic, Rick says that college bookstores will eventually go digital, but not on a Surface. I would counter by saying, why not? While iPad and Android tablets are current leaders, there is no reason a Surface tablet couldn't do the same job. There is no reason between the NOOK lineup and the Surface lineup that digital books would be a problem.

Pricing them into the ground
Of course most of this is speculation, but there is one hard fact that should have Amazon shaking in its boots. Microsoft has the margins and the cash to put the company out of business. Consider in the current quarter, Amazon's gross margin was 24.13% and Microsoft's margin was 73.46%. Microsoft's high-margin software business could more than offset any weakness in cutting prices to compete with Amazon in digital content, books, smartphones, tablets, video games, etc. In addition, Amazon ended last quarter with about $8.36 billion in net cash versus over $67 billion in net cash at Microsoft.

I'm sure Google is aware their margins might take a hit if they roll out this Shopping Express concept, as local retailers won't just sign up for free. However, Google's advertising business gives the company a 60% gross margin, so they can afford to take a small hit if it means protecting their search dominance.

The fact is, Barnes & Noble's sales were just $2.2 billion versus over $21 billion at Microsoft in the last three months. If the king of software decides to take over Barnes & Noble, they could essentially sell everything through the stores as loss leaders and crush Amazon in those categories. This crazy idea isn't as crazy as it first sounds. Microsoft could make this buy, and they would instantly become Amazon's worst nightmare.

Chad Henage owns shares of Microsoft. The Motley Fool recommends and Google. The Motley Fool owns shares of, Google, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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