At the risk of repeating myself (well, I am repeating myself, so I guess it’s not a risk, but a reality): In a perfectly competitive market, companies make no profit.
Now, strictly speaking, the “profit” in that sentence is what’s called “economic profit.” (Economic profit takes into account the cost of capital required to run your business. If you don’t make enough money to cover your cost of capital, then you’re not making a real profit, even if you’re making enough money to cover your expenses.) But the point is the same. Competition is great for innovation, it’s great for consumers, and it’s great for productivity. It’s not great for CEOs, employees, or shareholders, though.
Nowhere is this point being made more strongly than on the Internet. The closer we get to a “frictionless market,” where buyers and seller are able to compare prices instantaneously, and bargain with tremendous ease, the closer we get to a world in which real profit is extremely difficult to come by.
Take the latest news from Barnes & Noble, which pre-announced its quarterly and annual results this week, warning Wall Street that it was going to fall short of analysts’ earnings estimates. Although same-store sales at the B&N superstores–same-store sales are the most important category for retailers, since you can’t keep adding new-store sales indefinitely–rose 5 percent for the year and 4.7 percent in the last quarter, that was slightly below expectations. More importantly, the sales increases did not translate into bottom-line increases. In fact, Barnes & Noble forecast that its earnings in the coming year would rise only 14 to 17 percent, compared with previous expectations of closer to 20 percent.
Sales at barnesandnoble.com, the company’s Web site, did skyrocket, but B&N did just one-ninth the business Amazon.com did in 1998. Amazon is clearly both cannibalizing sales and, again more important, driving down Barnes & Noble’s margins. B&N is responding, in part, by spending millions of dollars to give customers in its superstores access to the same database that its online customers have. But while this may help keep sales in-house, it doesn’t solve the company’s basic problem, which is that it has to keep paying for its superstores to stay open even as it’s trying to drive business to the Web.
As dubious as Amazon’s business strategy–lose lots of money up front, because every customer you add is worth a certain number of dollars in the future–may be (mainly because there’s no guarantee that customers will remain loyal to Amazon in the future), the company has the great virtue of singlemindedness. Its commitment to the online model means that it has none of the fixed costs that B&N does. It also means that Amazon can deal better with falling margins, since its capital expenditures effectively never exceed its revenues. (Like Dell, Amazon gets paid by its customers before it pays its suppliers.)
B&N, on the other hand, has all these superstores, and is planning to open more of them, which means that it has to stock all of them with books, many (most?) of which will never be bought. And its ability to respond to the price competition offered by Amazon and by its own online subsidiary is limited, again, by those fixed costs. That doesn’t mean B&N is doomed. But it does mean that we’re starting to see, in the bookselling industry, exactly what real competition looks like. And at least for B&N shareholders, it isn’t pretty.