Barnes & Noble had a rough holiday season: Same-store sales fell compared to a year ago and revenue from sales of the Nook tablet stalled. Despite a heavy investment in the Nook business, Barnes & Noble is expected to have a three-year cumulative loss of more than $700 million, according to Barclays Capital — an indication that the bookstore’s multi-front war with online retailer doesn’t seem to be working.

On January 3, Barnes & Noble leadership acknowledged that the firm faces many challenges. The company said its holiday sales for the nine-week period ending December 29 were $1.2 billion, down 10.9% from a year ago. Same-store sales for the period were down 3.1% due to “lower bookstore traffic.” Nook product sales fell 12.6% from a year ago.

Barnes & Noble isn’t alone. Many traditional retailers are struggling against online powerhouse Best Buy has hatched plans to downsize its stores, focus on installation services and match Amazon’s prices. Target, too, has said it will match prices from Amazon and other select online retailers in 2013. Bricks-and-mortar retailers are battling a phenomenon called “the showrooming effect,” the consumer practice of checking out a product in a retail store and then buying it online at a better price.

“Barnes & Noble and Best Buy are places that are showroomed like crazy,” says Wharton marketing professor Stephen Hoch. Hoch predicts that neither chain is likely to survive Amazon’s assault because the stores don’t have the service levels to stand out. “Go into a Barnes & Noble or a Best Buy and you see big box stores that should know their businesses. What you find out, however, is that employees don’t know their business, and you don’t get great help.”

This means that price matching schemes are likely to be futile. “These retailers are competing with a crazy man — [Amazon CEO] Jeff Bezos,” adds Hoch, who notes that Amazon is focused on growing revenue, not necessarily profit margins.

Despite the bankruptcy of chief competitor Borders in 2011, Barnes & Noble has struggled to increase sales. It has actively moved to address consumers’ rapid shift from print to digital books and to combat Amazon’s expanding Kindle business. However, Barnes & Noble’s Nook now faces a growing number of competitors in the sector, including Apple’s iPad and iPad Mini and Amazon’s Kindle HD devices, as well as a bevy of tablets based on Google’s Android platform. The challenge for Barnes & Noble is that it lacks a strong digital content ecosystem relative to Amazon, Apple and Google. Both Apple and Amazon, for example, have invested heavily in video content and digital music distribution. Barnes & Noble historically has focused solely on books.

Meanwhile, Barnes & Noble has primarily relied on its physical stores to market and sell the Nook. As store traffic fell for the three months ended December 31, Nook sales slipped, too. “Barnes & Noble’s results … cast doubt on whether the Nook is key to the company’s future,” notes Daniel Raff, a management professor at Wharton. “It’s an open question whether Barnes & Noble can keep up and make digital vital enough to support the whole.”

The company may not have much choice. According to the Pew Research Center, the number of Americans who read e-books jumped from 16% of those ages 16 and older in 2011 to 23% in 2012. The book reading population for that same age group fell to 75% in late 2012 compared to 78% in 2011. Thirty-three percent of Americans ages 16 and up owned an e-reader or tablet as of late 2012, up from 18% in late 2011.

“Barnes & Noble is the last bookstore chain standing,” says Wharton management professor Steve Kobrin, who is also publisher and executive director of Wharton Digital Press. “There’s still a niche there, but it may go to small independent bookstores.” Barbara Kahn, Barnes & Noble’s merchandising isn’t giving consumers much of a reason to visit stores. “The best retailers are experiential,” she says. “Online retailers can provide big assortments and better prices. If a retailer focuses on price and category, online [retailers] will always win. Barnes & Noble has to … do what online can’t do — social interaction, physical presence and experience.”

Destination or Death?

Would consumers miss Barnes & Noble if it disappeared? According to Wharton marketing professor

Indeed, to create a book-to-digital bridge with its customers and to drive total sales, Barnes & Noble needs to become more of a destination for consumers, experts at Wharton suggest. Kahn points to Urban Outfitters, J. Crew, Apple and select grocery stores like Whole Foods as examples of chains that provide experiences beyond simply showcasing rows of products. “Merchandising is the most important thing in retailing,” she adds.

Another example of a destination retailer is Starbucks, which sells coffee, offers digital content and provides free Internet access. Starbucks’ advantage, however, is that hot coffee is tough to sell online, quips Hoch. But Knowledge at Wharton technology and media editor Kendall Whitehouse notes that Barnes & Noble has launched store-within-a-store concepts, such as its Nook area, children’s section and special promotional areas tied to films like The Hobbit. Yet, while the bookstore chain offers Starbucks coffee, free Wi-Fi and areas for children’s books and toys, the company generally hasn’t translated “hanging out” to increased sales.

Barnes & Noble has devoted much of its merchandising focus to the Nook. According to its regulatory filings, the chain has more than 1,300 stores and views them as “a major competitive asset…. The company will continue to integrate its traditional retail, trade book and college bookstore businesses with its electronic and Internet offerings, using retail stores in attractive geographic markets to promote and sell digital devices and content. Customers can see, feel and experiment with the Nook in stores,” Barnes & Noble said in the filings.

However, it also disclosed in the filing that the company plans to reduce the total number of retail stores it operates. Hoch agrees that Barnes & Noble will have to shrink its store footprint in order to remain competitive. The problem with physical retail chains is that it’s hard to retool store formats quickly, Hoch says, noting that Best Buy faces a similar challenge.

“I don’t think Barnes & Noble has a prayer,” Hoch says. “The thing the company does have is 674 college bookstores. Those are different because Barnes & Noble has a captive audience and can sell memorabilia.”

Raff suggests, however, that it’s too early to write off the company. In fact, the pessimism directed toward the bookseller may be overdone, he says, noting that Barnes & Noble was resourceful in devoting store space to the Nook and has assets that could be utilized. “When you talk ecosystems, it’s not just the digital stuff,” Raff points out. “The comfortable majority of publisher profits are physical books, and they need distribution.”

Indeed, Barnes & Noble’s biggest asset may be the reality that publishers need shelf space to sell books; without Borders, there are few options. “The American publishing industry would be aghast at losing that shelf space” if Barnes & Noble went out of business, Raff says. As a result, the publishing industry could be more willing to cut deals with Barnes & Noble to offer digital rights bundles with hard-copy books, he adds.

The company could take advantage of this leverage, Whitehouse says, by offering combined paper and digital versions of the same book — assuming the chain could get publishers to agree. Comic book publishers are among those already experimenting with bundled digital and hard-copy sales. While an e-book offers many benefits, the printed edition still has some advantages, Whitehouse notes. “If I buy a book, I want to own it. That’s not the case with a digital asset. The digital version has a lot to offer, but if you want to own a book permanently, you need a paper object.”

Barnes & Noble clearly is dealing with “an extraordinary set of industry dynamics,” according to Wharton marketing professor Peter Fader. “Things usually don’t change that much in industries. Good customers stay good customers,” says Fader. “But the transformation from book to tablet and bookstore to app store has been unbelievable. I just didn’t think it would happen that quickly.”

The change presents opportunities for Barnes & Noble to grow its Nook footprint, but growing that business could cannibalize sales at its physical stores. “Barnes & Noble is in a tough situation with its assets,” Fader notes, adding that Best Buy faces a similar issue, but consumers still visit to check out an ongoing stream of new electronics. “If people are coming into the stores, you can get them to stick around and buy something. No one needs to come into a Barnes & Noble, so the risk is not having the traffic at all.”

People vs. Products

One of Barnes & Noble’s core assets may be the people on its sales floor. “The more the retailer can provide service with a face on it and provide amenities, the better chance it has of surviving,” says Raff. “You can create a destination for merchandise and prices, but service and a response to your desires will get you ambiance.”

Merchandising and staff are critical to any rebound, Kahn points out, noting that the best retailers hire their own customers to be in-store staff. For instance, athletic shoe stores hire running enthusiasts who can advise shoppers on the best local trails. “If Barnes & Noble is just about buying books, customers can get that online. But what if it can also provide customers with insights from, and conversations with, people who understand the experience? Barnes & Noble has to figure out what makes it a good retailer and play to its strengths.”

For example, Home Depot in recent years has tried to bolster its service by hiring more floor staff as part of the chain’s ongoing battle with fellow home improvement giant Lowe’s. Best Buy, too, has indicated that a key aspect of its survival strategy is to rejuvenate the in-store experience.

What is unclear, however, is whether Barnes & Noble leadership sees people as important an asset as rolling out a new version of the Nook. To make that people investment, Barnes & Noble will have to steal a page from its old rival, Borders: Raff notes that the now-defunct bookseller used to give its employees knowledge tests during training to ensure that they had a thorough understanding of store layout and the books available.

When Barnes & Noble said on January 3 that sales for the nine-week holiday period would be weaker than expected, the most worrisome detail for analysts was the shortfall in digital sales. Nook device sales fell by an undisclosed amount during the holiday shopping season. According to Barnes & Noble CEO William Lynch, “Nook device sales got off to a good start over the Black Friday period, but then fell short of expectations for the balance of the holiday.” Lynch added that the company is “examining the root cause of the December shortfall in sales” and will adjust.

The Nook’s biggest shortcoming, analysts suggest, is that it doesn’t stand out in a crowded tablet market. Barnes & Noble appears to be caught between declining store sales and tough digital competition. “The significance of the deceleration calls into question whether a tipping point in digital is happening,” Stifel Nicolaus analyst David Schick said in a research note. “This has always been a potential concern, but evidence is beginning to mount that the iPad mini likely pressured sales of Nook tablets, and the Kindle Paperwhite was the clear favorite e-ink reader among critics and reviewers this holiday,” beating out the Nook GlowLight and SimpleTouch.

Barnes & Noble hasn’t been standing still, however. In 2012, the company forged partnerships with Microsoft, as well as publisher Pearson. On December 28, Barnes & Noble announced that Pearson had invested $89.5 million in the Nook unit, or 5% of the division. Microsoft owns 16.8% of the Nook division due to a $300 million investment in October and Barnes & Noble controls a 78.2% stake.

Those investments will continue to help the Nook division, which could eventually be spun off. The Nook business — devices and digital book sales — will have annual revenue of about $3 billion this fiscal year, according to Barnes & Noble. Fader suggests that Barnes & Noble can’t afford to take a “loss leader” approach to the Nook like Amazon does by selling the Kindle Fire largely at cost and then making money on sales of content and other goods. Barnes & Noble also has a challenge in building a digital ecosystem. “If it could build an ecosystem, great. But there are only so many ecosystems,” Fader notes. “Barnes & Noble will be crowded out.”