WH Smith struggles to reinvent itself as an e-commerce stock of the future

Richard Handover, chief executive of WH Smith, feels his company is misunderstood. For months now he has been trying to explain his vision of how Smith's should reinvent itself for the Internet age, but found his audience sceptical.

Richard Handover, chief executive of WH Smith, feels his company is misunderstood. For months now he has been trying to explain his vision of how Smith's should reinvent itself for the Internet age, but found his audience sceptical.

The City gave the thumbs-down to Smith's £185m deal to buy book publisher Hodder Headline and Smith's shares have been on the slide ever since. Next week the group is set to report its annual results and the round of questions and answers will begin again. What is Smith's trying to be, and how can this most traditional of high-street retailers equip itself for the challenge of the electronic age?

Richard Handover says: "Where Smith's should be in five years' time is not where it is now. But you can't extrapolate this company's future just by looking at its current position. You have to start to think differently."

Smith's has no choice but to embrace radical change. As a mass-market seller of books, music and videos it stands directly in the firing line of the "virtual" retailers, such as Internet bookseller Amazon.com, that do not have a costly chain of stores to fund. Books and CDs are already among the most commonly purchased items on the Net. Verdict, the retail consultants, say that of the £1.9bn of books sold in Britain last year, 6.3 per cent were sold on-line. That proportion is forecast to rise to 19 per cent by 2003. Prices of best-sellers are also tumbling all the time.

To his credit, Mr Handover has heeded the warning signs and has started to act. Waterstone's, the bookselling specialist, and Virgin Our Price, the music stores, have been sold. In their place have come a string of deals aimed either at giving Smith's the technical expertise to sell via electronic channels or providing the "content" for sale.

In 1998 Smith's paid £10m for the Internet Bookshop, an online bookseller. In February it paid £5m for Helicon, a small company that digitises material for use online and also owns the rights to the Hutchinson Encyclopedia, which is being made available online. It has launched the inevitable free Net service provider and will release its subscriber numbers next week.

But the big move came in May when it paid £185m for Hodder Headline, the book publishers whose list of authors includes John Le Carré and Stephen King. The idea is to have the capacity to develop books and ranges under the WH Smith name that can either be sold as physical books or made available online. Also, Smith's says, it will be more profitable, as the retailer will be able to take all the profit margin.

Mr Handover is looking to add further deals that will provide "content" that can be sold online. Education and travel are likely to be the two areas of priority. His view is that as Net service provision becomes commoditised, retailers and other service providers will be judged on the quality and exclusivity of their content.

City analysts, who are forecasting profits of £132m, have been holding their heads in their hands regarding the move towards vertical integration. David Jeary at CSFB says: "People didn't like the Hodder deal because it is a move further down the supply chain. The retail sector has not had a happy experience in that regard with companies like MFI and Laura Ashley." His view is that Smith's did not need to buy a publisher outright in order to secure a flow of online material "They could have signed supply agreements," he says.

He also points to the decision earlier this week by Encyclopedia Britannica to make its volumes available online free to everyone. This is likely to undermine the Hutchinson brand acquired by Smith's.

Though Smith's shares have fallen from 782.5p in April to 422.5p, Mr Handover remains adamant that by buying Hodder now he has got in "ahead of the curve". He points to Hodder's "Teach Yourself..." series of educational books as an example of ranges that can be made available online.

His view is that the Smith's name has tremendous trust with parents, schools and students and that this brand strength has great scope for further leverage.

A key part of establishing Smith's as the main destination for educational material is furthering links with the Government's schools policy. Next month, Smith's will start holding maths lessons for pupils in some of its stores after school. The trial is starting in four stores in the Manchester area, and will involve trained WH Smith staff overseeing a game that improves arithmetic skills. Smith's claims professional teaching qualifications are not necessary to take the classes.

Smith's is also in talks with the Government about the possibility of holding parents' evenings at its stores. It is also thinking about paying teachers to come to its shops on Saturdays to provide advice to parents on books and the school syllabus. Though Smith's stresses the educational benefits of these initiatives, it will have its tills open when the children and parents come in, so there is an obvious commercial spin-off.

While Smith's explores the online opportunities and attempts to establish itself as the main retailer for educational products, it is aware that it needs to change its stores to adapt to the digital age. As one analyst says: "They have really got to be more of a lifestyle retailer. They've got to put the fun back into the stores while building on their educational heritage and brand trust."

Smith's is starting to make moves in this direction. It has improved store layouts, but analysts say the product ranges have not kept pace. As one analyst puts it: "Smith's problem is that it doesn't add a huge amount of value to many of the products it sells. It you want a particular book or CD it doesn't really matter where you go to get it."