Bad Times at Borders
Where the bookseller went wrong
by Vickie Elmer
From the January, 2009 issue
[This article from the September 2008 Ann Arbor Observer is reprinted as background to Borders' announcement today that both CEO George Jones (shown) and CFO Ed Wilhelm have been replaced.]
If Borders Group's recent history had a book title, it might borrow one from Lemony Snicket-A Series of Unfortunate Events.
The bookseller is confronting more business and financial troubles than the kids in the children's series face leeches and hurricanes. In the past year it's skirted insolvency, sold assets worth about $150 million, and laid off 156 people at its Ann Arbor headquarters.
CEO George Jones, hired two years ago, says he's optimistic that his strategic plan will lead Borders Group, Inc., back to profitability. He sees promising early results from new prototype stores and a new, in-house website. And at a time when other national retailers are going bankrupt, a hedge fund has thrown the company a badly needed financial lifeline.
But Borders is still stalked by an array of demons, from elevated debt levels to what some call a "dumbing down" of its stores. Its customer loyalty program, Borders Rewards, which management lauds as a success, has cut into already-thin margins. And Wall Street has all but given up on the company: since mid-2007 its shares have lost three-quarters of their value. Many stockholders seem to be holding on only in hopes that someone else will buy the company: in August, Borders shares fell again after the Wall Street Journal reported that archrival Barnes & Noble was unlikely to make a bid.
The very thought would have humiliated the book lovers who built Borders. As the inventors of the book superstore, they looked down on Barnes & Noble as a cynical copycat. But it's been a long time since the company was run by book lovers. As Borders tries to reinvent itself, in-store displays now feature everything from Scotch tape and toy guns to AARP ads and digital music downloads. "Sometimes I have to pinch myself to
remember I'm working in a bookstore," says one worker at the Liberty Street store.
What led the once-proud company to this terrible turning point? The answers, as in any complex tale, are nuanced and numerous, and rooted in the past. But book industry blogger Morris Rosenthal offers a terse summary: Barnes & Noble, Rosenthal says, "outsmarted them by miles."
In a telephone interview, Jones seems at first to disagree. "It was a series of things-not so much what Borders did wrong," says Jones. He points out that many of the company's worst problems are outside its control. All booksellers are being hurt by growing online sales and competition from mass merchants such as Costco and Wal-Mart, which sell best-sellers at steep discounts. And Borders's music business is being decimated by digital downloads.
But Jones adds that he knew coming in that the company needed to overhaul both its stores and its financials. "I arrived in July 2006," he says. "For five or six years prior to that, the company had lost market share and performance was declining." That period coincides closely with the tenure of former CEO Greg Josefowicz-the company's first CEO who hadn't been hired by the Borders brothers themselves.
Tom and Louis Borders opened their first small store upstairs on State Street in 1971, and quickly grew it into one of the largest single stores in the country. Shoppers drawn in by discounted best-sellers were lured to linger, sometimes for hours, by a vast array of books and a deeply knowledgeable staff (employees had to pass a test on literature and books). Behind the scenes, Louis's pioneering computerized inventory system made it surprisingly profitable.
Borders helped turn Ann Arbor into a destination for book buyers, but the brothers had bigger plans. In 1985 they opened a second Borders in Oakland County. Like the original Ann Arbor location, the new store had handsome wood display cases, tables, and quiet corners with benches and chairs and readers tucked in them. Confounding skeptics who assumed that suburbanites had no interest in books, it surpassed the Ann Arbor store's sales within three years.
By then there were five Borders stores around the country, and the brothers had hired former Hickory Farms exec Bob DiRomualdo to build a national chain. There were more than twenty by 1992-the year the brothers sold out to Kmart for $157 million in stock.
The corporate takeover shocked both customers and employees-a colleague said that veteran Ann Arbor manager Joe Gable "went through all the stages of grief." But Tom Borders told Gable that he felt it was necessary to survive "the coming bookstore wars."
The "wars" were with Barnes & Noble, which by then had copied the Borders superstore model. The two companies would spend the next decade chasing one another around the country. In a few cases they opened competing stores across the street-or bid against each other for the same spot.
In 1995 Kmart spun off Borders as a publicly traded company. BGP debuted on the New York Stock Exchange at $7.25 a share. In the next few years, investors dazzled by the company's 20-30 percent annual growth rate would push it as high as $40. DiRomualdo, whom the Borders brothers had brought in as a part owner, grew rich. One old hand remembers him saying, "I love this company-it made me a millionaire!" (DiRomualdo couldn't be reached for comment.)
As intoxicating as the great growth of the 1990s was, some veterans believe it set the stage for the company's decline. "I remember saying at a meeting, 'We are putting the cart of store expansion before the horse of hiring good people and enough good people,'" recalls a former executive. "The response was a level gaze across the conference table and a level word-'Yes.'"
"Bookselling is an art," says another former executive. He believes Borders gradually lost that art as it brought in managers from other retailers. The employee test was dropped in the late 1990s. And in 1999, DiRomualdo's successor came from a Chicago supermarket chain.
When Greg Josefowicz took over in 1999, the art of bookselling was not his biggest problem. With the web bubble at its height, investors were dumping their shares in Borders and other traditional retailers. "The Internet was not just viewed as a competitive issue," Josefowicz recalled in a 2004 Observer interview. "It was viewed as a potentially disabling issue."
Borders spent millions developing its own elaborate website. But sales never really got going-and after the bubble burst, maintaining it looked like a costly mistake. So Borders decided to turn its web operations over to amazon.com, in a deal that lasted almost eight years.
On the face of it, the partnership made sense-Borders could focus its attention and cash on rolling out more superstores, and Amazon would manage the online business. In hindsight, though, Morris Rosenthal calls the decision a "fiasco."
A writer and independent publishing analyst who blogs at fonerbooks.com, Rosenthal says the deal allowed Amazon to siphon off younger web-savvy customers and solidify its position as the number-one destination for books online. And it slowed Borders's move into the digital age.
George Jones acknowledges the mistake. "We were taking our really good customers and turning them over to a competitor," he says.
The online world took another bite out of Borders's business as music downloading and MP3 players started supplanting CDs. According to Ed Wilhelm, Borders's chief financial officer, music accounted for 20 percent of Borders superstore sales in 2000. Today the figure is just 7 percent.
Borrowing from the supermarket business, Josefowicz introduced "category management," which allowed publishers to shape entire sections of the stores. The change irked employees who'd once had more autonomy-but there were fewer of those each year, as the company gradually replaced its full-time sales staff with less expensive part-timers.
Borders Rewards, another import from the food industry, offered customers who signed up big discounts and free merchandise for shopping. It proved hugely popular, and 25 million members now receive emails and other weekly specials.
Josefowicz also oversaw a major store remodeling, including a chainwide rollout of Seattle's Best Coffee cafes. (Barnes & Noble already had a deal with Starbucks, forcing Borders to settle for the company's lesser-known brand.) At the same time, he accelerated new store openings, adding forty-nine new locations in 2004 and 2005.
At first, the changes seemed successful: between 2005 and 2007, superstore revenue edged up from $2.7 to $2.85 billion. But the sales figures were dangerously misleading. All of the increase came from new locations; sales at existing stores were actually falling. Far worse, they were no longer making money. The popular Borders Rewards discounts alone were eating up 1 percent of the company's revenue, even as rents and payrolls were rising. Between fiscal 2005 and 2007, operating income from the Borders superstores nosedived from 6.4 percent of sales to just 1.1 percent.
The company earned about $100 million in 2005. In the next two years, it lost a total of more than $300 million.
The company already had borrowed money to finance openings, remodelings, and a buyback program to boost the company's stock price. Now the losses piled on more debt. This past January, Borders's 2007 annual report showed $547 million in short-term debt-a threefold increase in just three years.
In fiscal 2003 Josefowicz earned a salary of $710,000 a year, supplemented by bonuses ranging from $319,000 to $568,000, based on Borders profits and comparable-store sales. But he didn't earn a bonus in fiscal 2005, because the company missed its profit targets. The executive officers got no stock options that year, either.
And so, at the beginning of 2006, Josefowicz announced his plans to "retire," though he was only fifty-three. He was nominally still a consultant through early 2008, under a new contract that paid him $2.5 million over two years, but he appears to have played no role in the company since then. (Josefowicz didn't respond to requests for comment.)
The company's troubles now read like an encyclopedia of business duress. Its technology, once a strategic advantage, has fallen behind so badly that it hampers store workers and headquarters staff alike. "Computer systems are notoriously out of date, ineffective, and inefficient," says one former IT staffer. Its competitors are bigger and better financed-Amazon alone currently is sitting on $1.5 billion. Between its own problems and the weak economy, some fear Borders could follow retailers like the Sharper Image and Linens 'n Things into bankruptcy.
"The direction things have taken and the stupidity of the response leads to Chapter 11," says one former Borders manager. "I don't see any easy way out of this thing."
Barnes & Noble, meanwhile, faced most of the same challenges-but the Manhattan-based company emerged in much better shape.
Brothers Leonard and Stephen Riggio started out with college bookstores; they now own more than 500 on campuses across the country, including one in the Michigan Union. Expanding into consumer bookselling, they bought the century-old Barnes & Noble store in Manhattan and made it the cornerstone of a second national chain. They took the consumer stores public in 1993.
Though the Riggios came late to the superstore game, they played it better than Borders did. Some observers argue that B&N was smarter and more strategic in choosing locations, and negotiated better lease terms. And its response to the Internet bubble was sheer genius.
Like Borders, Barnes & Noble moved online in a big way in the late 1990s-but unlike Borders, it used other people's money. B&N persuaded German publishing giant Bertelsmann to pay $200 million for a 40 percent stake in barnesandnoble.
com; it then brought in even more cash from web-crazed investors through an initial public offering. After the bubble popped, the parent company quietly reabsorbed the website. Today, its online selling arm, while tiny compared to amazon.com, is a success: barnesandnoble.com has sales of $500 million a year, equal to the sales of about eighty of its stores.
The two chains' Ann Arbor stores feel very different. The Barnes & Noble store on Washtenaw Avenue seems serious and bookish, with its dark wood cases and library tables. It offers ample magazines, a wide array of religious and children's books, and a bright, sunlit Starbucks. It sells journals and cards, as Borders does, but skips many of the gift items that are increasingly showing up at Borders stores.
Borders downtown on Liberty Street, by contrast, is more like a department store, filled with sale signs, accessories, and impulse buys. Yoga mats and small weights sit near exercise and health books. The children's department stocks toys and puzzles, kids' tea sets, and kits to make pot holders as well as Goodnight Moon and Curious George books. Displays of lip balm, action figures, and candy dot the aisles.
While the add-ons promise greater profits, a worker complains that they've also "dumbed down" the store and undermined its destination appeal. "They're grasping at straws," says another person who has worked at a number of stores and at headquarters, "looking for the next big thing, since book sales are flat."
Barnes & Noble, in contrast, seems to have kept a clearer focus on books and publishing. It also benefited from founder Len Riggio's creativity and competitive zeal. "Riggio is one of the brilliant guys in retail," says Morris Rosenthal. "He figured out that B&N could publish a growing percentage of the books they sell, underprice the competition, and earn the publisher split." Reportedly, more than 10 percent of B&N's sales now come from its own imprints.
"Riggio, whatever people might say about him-that he's a philistine, not enough of an intellectual-he is a good businessman," Rosenthal says. "He's run that company quite well in the face of really unprecedented competition."
According to the two company's federal filings, B&N stores are larger and have more books, on average, than Borders stores do. The average Barnes & Noble store outsells the average Borders by $1 million a year and has higher profit margins too.
The bottom line: while Borders lost more than $300 million in the past two years, B&N earned $285 million. Reflecting the economic downturn, B&N's stock price has fallen by about a third since last summer. Even so, stockholders still value it at a relatively robust $1.4 billion. Borders's value, in stark contrast, has slumped to just $338 million. Can a company with 1,000 locations, half of them superstores, really be worth so little?
The man charged with finding a future for Borders has a retail career spanning thirty years and a half dozen companies.
George Jones worked for Target in the 1980s, where he helped focus its strategy on fashion and a positive shopping experience to compete against Wal-Mart and Kmart. From 1991 to 1994 he was president of Roses Stores, a troubled general-merchandise chain in the Southeast. Roses ended up in Chapter 11, closing more than 100 stores before it returned to profitability. From there Jones joined Warner Bros., where he oversaw licensing deals and 150 Warner Bros. Studio Stores. Those stores closed in 2001, just as Jones left the company to join Saks, a luxury chain that was struggling with keen competition and declining profitability.
Jones earned a salary of $950,000 as president of the Saks Department Stores division, but left in 2005 after being moved out of the number-two job at its parent company. Recruiters Korn/Ferry International brought him to Borders Group the following summer. Borders hired him as chairman and CEO at $775,000 a year, sweetening the pay cut with options to buy 400,000 shares of stock.
Board members won't comment, but presumably they appreciated Jones's turnaround abilities and his depth and variety of retail experience. As for Jones, "I joined Borders Group in July 2006 because I believe in its brand and its people," he wrote in his first letter to shareholders in early 2007, taking particular note of the company's "strong and enviable bond with millions of customers." But, Jones added, the company had not kept up with "the rapid changes in how consumers access information and entertainment." And indirectly he faulted some of Josefowicz's moves, saying that the remodeling program and Borders Rewards had "failed to boost store traffic and transactions sufficiently."
After visiting a number of stores around the country and bringing in two trusted colleagues to assist him, Jones set about reinventing Borders. His strategic plan, announced in March 2007, seeks to make the company "a headquarters for knowledge and entertainment."
As Jones and other Borders executives tell it, the future of Borders is on display at the store that opened south of town in February. The entrance and checkout counters are framed by the company's fastest-growing units, a Seattle's Best Coffee cafe and a Paperchase stationery department. "Lifestyle" sections specializing in travel, cooking, and children's books have been expanded, and though there are fewer other books, more are displayed face out, the better to catch the eye. At a "Digital Center," customers can download songs to an MP3 player, burn a CD, or turn their photos into a coffee-table book.
Donna Strach, a registered nurse at St. Joseph Mercy Hospital, shops the Lohr Road store every other week; she likes the assortment of cookbooks and books to buy as gifts. She uses Borders Rewards coupons but sometimes has trouble finding merchandise to buy with them. As for the digital downloads, "I don't even understand half of that," Strach confesses.
Gene Alloway, who worked at Borders in the mid-1990s and now co-owns Motte & Bailey, Booksellers, is less impressed. To him, the prototype store "looks like they're starting to give up on selling books. They're filling it up with tchotchkes." And he finds it odd that a company that used to pride itself on selling important books now focuses on relatively few authors and titles.
"We're as much of a bookstore as we ever were," Jones insists. The CEO has said he loves bookstores and reading-John Grisham novels and biographies-and staffers say he visits the Liberty Street store regularly to buy books and movies. But he argues that the expanded mix of merchandise-from digital cameras to coloring books to stacks of games to more books tied to pop culture-makes business sense.
"The concept store has been wildly successful," says Borders CFO Ed Wilhelm. According to Jones, the company set "pretty ambitious" first-year sales targets for the prototype stores-and so far, eight of the nine opened to date are exceeding them. Customer surveys, he adds, show that most customers really like the new stores.
The company plans to open four or five more prototypes and then start integrating their most profitable elements into the existing stores. Shrinking music departments will make room for mix-and-burn music download computers and "destination centers" focusing on travel, cooking, and wellness.
Last year the company revamped Borders Rewards to reduce costs and increase customer visits. Though Jones acknowledges that the customer loyalty program has hurt profit margins, he says it's "a great way to build relationships with our customers" and target promotions. "We're getting better and better on how to use it," he says.
And this past May, Borders finally took back its online business. Execs say they expect the new borders.com to be profitable by next year.
Says Jones, "We've taken steps that we can to make great progress."
While Jones was making over Borders's public face, he faced even more dire problems behind the scenes: the company's growing debts left it terribly vulnerable to the global credit crunch.
In summer 2007 the company seemed poised to get a loan from Wall Street investors. But with the financial markets melting down, the deal collapsed. Looking for other ways to raise cash, Borders then reached an agreement to sell its stores in Australia and New Zealand-only to have the buyer back out just two days before closing.
As its losses mounted, Borders was forced to revise one of its loan agreements last August. Its accountants questioned whether it would have enough money to pay its bills by the end of the year. And meanwhile, consumers were starting to cut back on their spending.
"The retail market got much more difficult, not just for us but for all retailers," Jones says. "We just started budgeting much more conservatively for this year."
Last fall, Borders sold its bookstores in Great Britain for $30 million, retaining a small equity stake. And this spring, it closed on a $43 million loan from Pershing Square Capital Management. The hedge fund had been buying up Borders shares for months, and currently owns 18 percent of the company. "They came forward, to give us this certainty" that the liquidity problems would not materialize, Jones says.
But in exchange, Pershing wanted a lot from Borders. Founder Bill Ackman is known as a shrewd investor who buys undervalued stocks and then pushes companies aggressively to improve their business-a model that led Barron's magazine to dub him "Mr. Pressure." In exchange for the loan, Pershing got warrants that will allow it to buy millions more shares and a promise that Borders would sell off many assets.
Ackman's approach has previously paid off in purchases of McDonald's and Wendy's stock; more recently, he's acquired stakes in Cadbury Schweppes, Sears Holdings, and Target. And along with his stake in Borders, he owns about 2.89 million shares of Barnes & Noble.
Ackman has two representatives on the Borders board, including Pershing partner Mick McGuire. McGuire did not return phone calls from the Observer, but Pershing's influence can be seen in a series of recent fiscal changes-starting with last spring's announcement that the entire company was for sale. No buyer came forward, though the company says the search continues. Meanwhile, in June, it finally sold the Australia and New Zealand stores for about $91 million plus some deferred payments next year.
While selling assets to reduce debt, the company is moving aggressively to cut costs. It's announced plans to shrink expenses by $120 million this year and next, including reducing its corporate staff by 20 percent. The 156 people laid off in June at its Ann Arbor headquarters included many longtime employees-Joe Gable among them. (Gable won't comment but is said to be pondering a job at Shaman Drum Bookshop on State Street-just a few doors down from the stores he once managed for the Borders brothers.) Another 118 jobs were eliminated at Borders's distribution and sales arms.
In the online community livejournal.com, Borders employees report that more jobs are being cut in the stores, along with perks ranging from 401(k) retirement contributions to free coffee. Many say they're afraid that the company will eliminate their jobs-and could undermine its own future by slashing staff and services too severely.
Jones, though, says he's focused on the future of Borders: "We will continue on with the strategic plan-we feel like we're on the right track with it. To use the analogy, we're sailing along nicely with our boat-hit a storm or a hurricane and you make adjustments, batten down your hatches, detour a bit-but stay on course."
Analysts who follow Borders Group are divided on its prospects. In recent conference calls with Jones and other Borders executives, they've asked how sales are holding up, how much revenue is being lost in music sales, and how long it will take the new borders.com website to become profitable (it is projected to break even this year and make money in 2009). But some investors remain enthusiastic.
"I wholeheartedly believe they have a future as an independent company," says Todd Sullivan, a value investor who owns Borders shares and is a cofounder of wallstnewsletters.com. Jones is "doing all the right things" by investing in a website and in the stores, Sullivan says.
Of course, Sullivan bought his Borders shares near their low of $4 in late March-so his investment has already gained value. Few others can say the same. According to Securities and Exchange Commission filings, Pershing paid $9 to $13 a share for its Borders stake. For that reason alone, Sullivan does not expect the company will be sold anytime soon: at current prices, a sale might cost Pershing half of its investment.
The future of Borders depends on both its own skill and the state of the economy. Anything could happen, from bankruptcy to a turnaround led by a revitalized generation of stores. But for now, ironically, its very poverty is helping to preserve its independence.
[Originally published in January, 2009.]
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