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CEO Heather Reisman changed Indigo?s business model from just a seller of books to a 'cultural department store' that sells such items as reading lamps and decorative dishes.Kevin Van Paassen

Heather Reisman is, as usual, clutching a new book in her hand. But this one isn't just another bestseller to tout as one of "Heather's Picks" on the shelves at Indigo Books & Music Inc. It's a book that may hold a blueprint to the chain's survival.

In her quest to reinvent her stores, Ms. Reisman is finding inspiration in the latest work by Howard Schultz, entitled Onward. In it, the Starbucks founder serves up a candid account of his shakeup of the flagging café chain, which lost its direction several years ago - and, in the process, lost some of its cachet with coffee drinkers.

Starting in 2008, Mr. Schultz tore apart the business plan. Reinstalling himself as CEO, he closed 900 underperforming stores, fired thousands of employees, added new products and slowed dramatically the hunt for new locations. It worked: The customers eventually came back, and last year Starbucks enjoyed a sales boost of nearly 10 per cent, while more than doubling its profit.

Indigo has now arrived at its Starbucks moment, and Ms. Reisman knows it. The wave of digital adoption that swept through music and video retailing, decimating them, is now hitting book sellers, forcing them to redefine their business model. The writing is on the wall: In the U.S., Borders Group Inc., the second-largest book chain, is closing hundreds of stores and letting go thousands of employees after filing for bankruptcy protection in February; Barnes & Noble Inc., the world's top book retailer, has been searching for a suitor since last summer - unsuccessfully so far.

That the electronic revolution would hit the book business was inevitable, but it is coming faster than almost anyone expected, spurred on by the proliferation of devices that carry books, such as's Kindle and Apple Inc.'s iPad. In 2009, Ms. Reisman predicted that low-margin digital book sales would erode 15 per cent of her traditional book business within five years. Now she's predicting it will be 40 per cent.

Indigo, by virtue of its dominant market share in Canada - it has about half the book retailing business - remains healthier than its U.S. counterparts. But sales growth is sluggish and its 62-year-old founder is worried. Like Mr. Schultz, she is setting in motion a new plan.

"In the book industry, when you are in a situation where you know that 40 per cent of your business is going to go digital - you need to change," Ms. Reisman, chief executive officer at Indigo, said in an interview in her office, which she recently cleared of decorative penguin figures and other mementos in a nod to her company's transformation in the digital age.

Her road map for the country's largest book seller takes a detour from physical books. Indigo, like many book retailers worldwide, has a toehold in the digital books business, with a majority stake in Kobo. But in the stores, Ms. Reisman, who had a head start in envisaging Indigo as a "cultural department store," is betting more than ever on other categories. Indigo is stepping up its offerings of tableware, toys and tote bags - even putting comfy chairs back in the stores, in the hope of stemming the tide of consumers abandoning the retailer for Web-based alternatives.

Industry data signal that she has no choice. U.S. e-book sales, which stood at less than $1-billion (U.S.) in 2010, will nearly triple to $2.8-billion by 2015, according to Forrester Research estimates. For book retailers, which are quickly stocking up on non-book products, it means an annual 1.1 per cent drop in revenue over that period, says IBISWorld, another market researcher.

That may seem small, but it means a big hit to the bottom line in a business that already operates on microscopic profit margin. This year, U.S. book sellers' profits before tax will plummet to 1.3 per cent of revenue from 3.5 per cent in 2006, IBISWorld analyst Mary Gotaas projects. Margins are being pinched not only by stiff competition but also by heavy digital investments.

The Canadian book revolution still lags the pace of change south of the border. The penetration of e-books is roughly half that of the U.S., where e-book sales made up more than 8 per cent of the trade book market in 2010, up from 3 per cent a year earlier, estimated Jacqueline Hushion, executive director of the Canadian Publishers Council.

But the trend is clear, and the experience of the music industry showed that when a digital product catches on, it can gain market share quickly. And that throws into question the need for so many big boxes like the 96 Chapters and Indigo superstores, which average about 24,000 square feet.

"As digital becomes more pervasive, you're going to need less bricks-and-mortar stores and less bricks-and-mortar [distribution]centres because digital doesn't need any of that," said Brad Martin, president of Random House of Canada. Last year, for the first time since the non-profit BookNet Canada started monitoring domestic physical book sales in 2005, they posted a decline - 3.2 per cent.

Selling non-books

A big part of the retailers' shakeup - the rapid expansion into non-book products - is underlined by Indigo's appointment of two fashion retailing veterans to key executive positions. Ms. Reisman said she needs merchants who are familiar with the world of non-books because it operates under different rules than book retailing.

Book sellers are in the unusual position of being able to return books they don't sell to publishers, thus putting more risk on the supplier rather than the retailer. But in virtually all other consumer goods, the retailer bears the risk. Now Ms. Reisman is building a new team that understands the dangers of buying general merchandise products that may not sell and need to be cleared out at big discounts, slicing into profits.

Her risk-taking will intensify in the next two the three years as she moves to ramp up non-book sales to 40 per cent of Indigo's business - from 15 per cent today - to replace lost book revenues, she said.

In the past, she felt strong resistance from industry insiders when Indigo branched out into items such as candles and picture frames. But today, she no longer shies away from acknowledging her dramatic shift away from books.

"The only way to stay in the book business is to find the ability to marry our book offerings with other products that our customer would value," she said. "I think of that as affordable items with intrinsic value."

The new Indigo president, Tedford Marlow, is a former executive at U.S.-based fashion chain Urban Outfitters. He had been a member of Indigo's board of directors over the past year and advised Ms. Reisman on purchasing general merchandise. What did she learn? "How much I don't know."

To bolster sales of items other than books, Indigo opened a design studio in New York and hired a creative director who is developing private label products, ranging from reading lamps to decorative dishes. Profit margins on these products can be 10 to 20 per cent higher than those of books, industry insiders said. Ms. Reisman is testing a photo studio in two superstores, which she plans to expand to other outlets.

And last fall, she ramped up the array of toys and games in her stores, a strategy aimed at drawing in families who can roam the book aisles at the same time. The toys are now stocked in 57 of the 96 superstores and will be in all of them in the next couple of years, a tactic that both Barnes & Noble and Borders have seized upon.

Borders, which is a partner with Indigo in Kobo, is taking cues from Ms. Reisman's playbook in expanding into non-books. Borders is trying to shift its sales mix to just 40 to 45 per cent books in five years from about 70 per cent today, president Mike Edwards said in a telephone interview. He envisages Borders morphing into a "community centre," expanding its café and adding other food franchises to bring in traffic.

Still, the road to diversification is not an easy one. Books may be a declining business, but all of Indigo's competitors are small. As it tries to move into affordable home decor, it faces a plethora of tough competitors, including U.S. discounter Target Corp., which is opening its first stores in Canada in 2013.

"Retail is not a game for the faint of heart," Ms. Reisman said. "You need to keep picking up your game ... Now we have to transform for the new reality."

The e-book effect

And e-readers, for all of their promise, are not a route to rich profits for book sellers so far. Kobo, of which Indigo owns roughly 60 per cent, lost $10-million in its latest quarter, an analyst estimated, and Ms. Reisman doesn't expect it to be in the black for another year. The digital investments have been a drain on Indigo and other book sellers.

Priced at about $10 in Canada, e-books yield about less than half the gross profit of traditional hardcover books, industry observers estimate.

"Profitability as the business stands today remains elusive, with few participants covering their cost of capital." Peter Wahlstrom, associate director at Morningstar Equity Research, said in February about the U.S. book-selling landscape.

The shifts are pushing publishers to change their ways, too. Random House, for instance, started in late 2009 to produce all new books in both physical and digital form. By the end of this year, all older books will be digitized, up from the current 75 per cent, said Random House of Canada president Mr. Martin.

In 2010, e-books carved out 3.5 per cent of Random House's sales, which will rise to 10 to 12 per cent by the end of this year, he said. By 2012, the publisher will switch to electronic from print catalogues, generating about a 5 per cent cost saving, he said.

"Every part of our business has been re-examined," Mr. Martin said. "We do everything differently except how we process returns."

At Indigo, Ms. Reisman is setting the stage for its transformation. This includes not only reading Howard Schultz but speaking to him about an expanded role for the coffee shop at Indigo.

In an interview, Mr. Schultz said that he's eager to work with Ms. Reisman, and understands the challenges she faces. "You can't embrace the status quo as an operating principle, whether you're selling books or coffee or tea," Mr. Schultz said. "We all have to recognize that the way in which the consumer is responding and making decisions is rapidly changing."

In some ways Ms. Reisman is going back to the future. Several years ago, she stirred a controversy by ditching sofas to stop people from loitering, replacing them with hard chairs. Now she is reversing that move and bringing back the soft chairs to help re-establish the retailer as a place to hang out - and make purchases.

"It's a defining moment in physical book retailing, just as I think we're in some ways in a defining period for physical retailing," she said. "If you don't do something, you're not going to be in business."