Indigo Blues

By Frank Davis | January 12, 2002

People sometimes ask me why I’m so critical of Chapters. “We never had a decent bookstore here in Mariposa until the Chapter opened in ’97,” they’ll say. “Hell, you couldn’t even get a decent cup of coffee in town until the Chapters opened. What do you have against them?”

There’s some truth to what they’re saying. Many of the 75 Chapters stores that sprang up across Canada since 1995 are in communities that had been poorly served by existing bookshops. (This is less the case with Indigo, which tended to stick to the larger cities, and rarely if ever opened a store in a community that didn’t already have at least one Chapters.) Selection carries a lot of weight with book buyers, and each new Chapters store, initially carrying upwards of 100,000 titles, was far better stocked than the smaller competitors it drove out of business. These smaller independents — about 300 of them bit the dust in the late 1990s as a result of Chapters’ expansion — might have carried between 5,000 and 40,000 titles.

Now, more than six years after those giddy days of the first superstore openings, Chapters – now called Indigo Books & Music after the 15-store Indigo chain took over Chapters last spring (though Indigo intends to continue operating most of its newly acquired big box stores under the Chapters brand) — is fighting for its life. And because Indigo has such a stranglehold on the marketplace, the fate of the entire publishing industry hangs in the balance.

I’ve mentioned the booksellers, whose ranks have been — well, “decimated” understates things by several orders of magnitude. In the last year, we’ve also witnessed the troubles of General Distribution Services, one of the country’s biggest book distributors, which carries dozens of Canadian houses, ranging from General Publishing, Key Porter, and Douglas & McIntyre to many smaller presses, including about 30 members of the Literary Press Group. And while Chapters did not directly precipitate GDS’s troubles — that honour goes to General’s US bank, which went under and took GDS’s line of credit with it – Chapters’ business practices were a proximate cause, and a major reason it was so hard for General to find a new banker.

Then there’s the case of HarperCollins and Raincoast Books, whose troubles collecting money owed by Chapters were front page news during the summer of 2000. These two presses did eventually get their calls returned, but only because HarperCollins is one of the biggest publishers in the world, and Raincoast held a trump card, Canadian rights to the Harry Potter phenomenon. Few of their colleagues felt confident standing up to Chapters, with its 65 percent market share, and most of them had to endure six-month waits for payment, and saw more than 40 percent of the books they had shipped to the chain come back as returns – sometimes years after the initial sale. Writers were also caught in this flood of returns, and most saw significantly smaller royalty cheques as a result.

All this made 2001 the worst year ever for Canadian publishers. Twice in the past year the federal government felt compelled to step in and pump great gouts of cash into the industry in order to prevent mass bankruptcies.

But the crisis is over, right? Chapters has new, well-financed and stable ownership, and a new boss known as a retail whizz who bids fair to turn the ship around within eighteen months. The clouds have parted, the sun is shining, and all of us in the Canadian book community — writers,
publishers, distributors, booksellers, readers — can look forward to fine weather. Right?

Unfortunately, there are still some clouds on the horizon, and they’re not small. In fact, 2002 could be the worst year yet for this crisis that began in 1995 and became acute around 1998.

The biggest, darkest cloud concerns Indigo’s own prospects, which are far from brilliant. Indigo has set some daunting goals for itself, and the conditions they’re operating under are not making things easy.

For one thing, as a publicly traded company, Indigo must achieve profit levels that are high for the book trade, where profits of 3 to 6 percent are considered pretty good. People do not invest in the stock market for the kind of return they can get from a term deposit. The whole point of risking your money in the stock market is to garner a higher-than-average rate of return.

A privately owned bookstore can tolerate a relatively modest profit and indeed, since the 1970s independent bookstores have typically earned about 3 or 4 percent. Even if Gerry Schwartz and Heather Reisman, whose Trilogy Corporation owns about 70 percent of Indigo, were to be satisfied with such a modest profit — and that’s a pretty doubtful proposition when we’re talking about an investment of around $200m — that still leaves close to a third of shareholders, including some large institutional investors, who would not be satisfied with less than 6 percent.

There’s scant evidence that these sorts of profits can be achieved. In fact, in the six years of the superstore era, Chapters has never made money. Well, that’s not quite true; in 2000, Chapters did report a profit of $17.2 million on revenues of about $660 million. However, that included $41 million from the sale of assets, meaning they lost about $24 million on operations. In 2001, losses were $84.5 million on revenues of $686.5 million. That includes a $69.4 million writedown, so last year’s operating loss was about $15.1 million. Chapters’ tax loss carried forward at that point was over $58 million.

Ah, but that’s Chapters, chronically mismanaged and all that; Indigo is run by Heather Reisman, who runs a tight ship and who loves books. Except that the 15-store Indigo chain was, if anything, in even worse shape than Chapters when it swallowed its much larger rival. Last year Indigo lost $31.7 million on revenues of $94.8 million, and the year before that it dropped $23.3 million on sales of $65.9 million.

Keep in mind that Chapters lost all this money despite enjoying terms of trade available to no other bookseller in the country. The much-ballyhooed “Code of Conduct” that Reisman agreed to as a condition for being allowed a stranglehold on the publishers merely enshrines the terms that Chapters had unilaterally imposed on the industry in the middle of 1998. Theoretically at least, Indigo is stuck with these terms until 2006 – they’ve promised not to ask publishers for more.

Indigo says the merger will result in economies that will save the chain $17 to $24 million a year. Let’s give them the benefit of the doubt. They’re going to have to do much better than that, and they’re going to have to do it while solving some major headaches.

First of all, they have to close down a lot of stores, at least 15 (Indigo’s number), but probably more like 30 — including that one that my friend in Mariposa likes so much: the town just isn’t big enough to sustain it. Chapters deliberately saturated the country with bookstores, part of a strategy to surround and destroy its independent competitors. The plan all along has been to close many of those outlets once they had served their purpose. Even if Heather Reisman personally wanted to abandon this plan she couldn’t, because the country is now oversupplied with bookstore space. Three years ago, Chapters was generating $382 per square foot of retail space; a year later, this number had fallen to $281. The reason for this is simple. Chapters continued opening new stores even when the market for books was no longer growing, with the result that the later (post-1998) wave of superstore openings merely cannibalized sales from existing Chapters / Coles / SmithBooks outlets.

Closing 15 to 30 stores might save money in the long term, but has near-term consequences not only for Indigo/Chapters but also for writers and publishers. There’s a lot of inventory in those stores. Indigo will try to return as much as the publishers will let them get away with, and that will have catastrophic consequences for the publishers and writers. (Returns that result from store closures are over and above the 42 percent level – dropping to 30 percent after three years – permitted under the Code of Conduct.) That still leaves tens of millions of dollars of inventory that will have to be written off — last year, without closing any stores, Indigo was obliged to write off more than $20 million in inventory. And the inevitable “everything must go” inventory blow-out sales are one more battering the remaining independent booksellers will have to endure.

Hold on, it gets worse. Even with all things being equal, it will be tough for Indigo to ever turn a profit approaching the 6 or 8 percent they need. To understand why, we have to take a little trip down History Lane.

Before there were superstores and chain bookstores and independent bookstores, there were just plain bookstores. These tended to be what’s called mom-and-pop operations, which just means they were privately owned and run. The stores tended to be located in larger towns and cities. Often just off the main shopping areas, these booksellers generally preferred to invest their capital in inventory, which drew customers to them, rather than in expensive leases, which might put them in the casual customers’ path. Their understanding was that books are information rather than mere commodity, and information-seeking buyers were willing to walk an extra fifty feet off Main Street to get what they want. While mom and pop naturally wanted to make money, they could tolerate lower profits, as long as they were able to pay themselves a reasonable salary and put something aside.

This began to change around 1970, when the first “chain” bookstores began to pop up around the US. The chains differed from the traditional stores, which at this time began to be referred to as “independent” booksellers, in two ways. They were controlled by large corporations, and their capital was raised in financial markets. In other words, the owners of these new stores could not tolerate low profit margins the way their independent competitors could. Their profit requirements were determined by the capital markets — what investors could be earning if they placed their money instead in Consolidated-Bathurst, or General Electric, or McDonnell-Douglas. The other difference was in their approach to the marketplace. The chains chose to spend their operating capital on rent instead of inventory. They moved into pricey locations in the burgeoning malls and shopping centres, and paid for those higher occupancy costs by focussing on a narrower selection of bestsellers that sold at a faster rate. Profits probably never much exceeded 6 percent, but practices of cherry-picking and discounting drew the most profitable part of the business away from the independents, which saw their profits decline to around 3 percent.

That state of affairs lasted about twenty years, an era which saw the rise of what came to be called “the blockbuster syndrome,” as the big bookstore chains started calling the shots in publishers’ editorial departments.

Around 1993, Barnes & Noble began the modern superstore era in the US. The big-box bookstore tried to combine contradictory features of the independents and chain stores: they would be as large and as well-stocked as the leading independents, but they would also be located in areas with lots of foot traffic. No, wait: they were going to be much bigger than the biggest independents! and carry three times as many books!! and become anchor tenants in the biggest, flashest locations in the newest and glitziest shopping centres!!!

The success of this scheme depended on creating such a buzz around books that stock turnover sped up — not just for the bestsellers, but for the slow-moving backlist as well. This was a gamble, since nobody had ever figured out how to get mid- and backlist to move in the same kinds of
numbers as bestsellers do. They still haven’t.

Barnes & Noble had a contingency plan in case things didn’t work out this way. They would have a weapon that their competitors did not have: market dominance. They were going to get it by starting out with an war-chest of capital which would be used to crush the independents, and
with them out of the way they would exploit their dominant position to demand from publishers the terms they needed to make their beggar-thy-neighbour business plan succeed.

This was the blueprint that Larry Stevenson at Chapters and Heather Reisman at Indigo imported to Canada.

However, this approach isn’t working in the US, a much bigger market, and it isn’t working here either. Reisman, and a handful of big publishers, are betting that eventually it will — but they have no choice, as by now they’re all over the same barrel. To admit the model doesn’t work would be to declare bankruptcy.

This isn’t to say there’s no place for superstores. In fact, for decades Canada has had a superstore that works. It’s called The World’s Biggest Bookstore, on Edward just off Yonge Street in Toronto. It’s far enough from the main drag to save fantastic amounts on rent, but close enough to be within easy reach of customers attracted to what remains the largest selection of books in Canada. While it lacks the toney decor and the cappucino bar of the modern superstore, World’s Biggest arguably boasts a feature that few of its younger siblings can show: a black bottom line. What’s more, for years it generated that profit while abiding by the same rules as its competitors. There probably is room in Canada for a chain of such stores, maybe a dozen or more. Too bad Chapters boss Larry Stevenson and Heather Reisman didn’t take World’s Biggest as their model — but of course it’s entirely typical of Canada’s riche, both nouveau and ancien, that they would be dazzled by the zircon-encrusted import model while ignoring the homely but effective domestic version. It’s not as if they didn’t know about World’s Biggest: it’s been part of Chapters (and before that, Coles Bookstores) all along.

In the meantime, this tragedy will continue to play itself out with terrible effects. Publishers will continue suffer the effects of a Stevenson’s and Reisman’s hubris. Writers will find it harder to find publishers for their work, and fewer of those publishers will have access to bookstore shelves. Independent booksellers will continue to suffer the effects of going up against a large, dominant competitor which enjoys vastly better terms of trade than they do. Readers will see a reduction in choice as the big-box stores curtail their selection, and will find it increasingly difficult to get their hands on books they know exist. (Chapters ambiguously reports titles they do not carry in stock as “temporarily unavailable”, implying they are out of print.)

So that’s why I’m not pulling for Indigo/Chapters. They have introduced powerful, distorting forces in the world of Canadian books, causing hundreds of bankruptcies among booksellers and a crisis in the publishing industry which threatens the existence of many small and medium-sized companies, and reducing the market for the work writers do. This might be defensible if they had expanded the market for books in this country. But in fact, the average number of books purchased by Canadians has declined during the superstore era. Even if Indigo manages to avoid bankruptcy themselves (another sale, this time probably to a US buyer, is a distinct possibility), before this is over their practices will likely drive more booksellers, and likely some publishers and distributors as well, out of business. A couple of pursuing-the-zeitgeist decisions by Canada’s Competition Bureau, allowing the creation of Chapters in 1995 and its takeover Indigo in 2001, threaten to undo the efforts of two generations of Canadians to establish an indigenous book publishing industry.

This will come as a shock only to those who have a financial or ideological investment in the Chapters experiment. The market seems to agree with me. Last spring, Trilogy paid $17.50 per share to take control of Chapters. By last summer, share prices had slumped to $8. Today those shares are trading in the same $4 neighbourhood that precipitated Indigo’s takeover bid in the first place. If I turn out to be wrong, you could make a killing picking some up at that price.

2700 w. January 12, 2002


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