33% of total Group sales

Visual (DVD & Blu-ray), remains the Group's leading product category, providing over 45% of HMV sales. During 2008/09, the UK market grew by 2%, including the effect of retail capacity withdrawal, with the total market worth over £2bn. For HMV, this remained an important growth category, with UK volumes up 7%, reflecting strong market share gains.

In the medium term, the visual packaged media market is anticipated to remain stable, with growth of high-definition Blu-ray offsetting a decline in the mature DVD market. Over and above this, the total market is expected to benefit from growth in the currently underdeveloped paid-for online delivery channels.

21% of total Group sales

As reflected in the Group's medium-term and long-term plan, sales of music via physical media are in structural decline. However, the physical market remains significant, worth over £1bn, which is approximately 85% of the total UK retail market. Furthermore, 2008/09 market performance was robust, with market volumes down 3% for the year, although down 10% in the last four months as retail capacity withdrawal impacted. The Group continues to plan for over 10% per annum declines in the packaged music market, offset in part by growth in digital distribution. Music, however, remains core to the HMV brand, whether through the sale of product and merchandise or via the new investments in venue management and ticketing.

18% of total Group sales

The UK market for games hardware and software surpassed expectation in 2008, with strong hardware growth contributing to the UK games software market reaching £2bn. Whilst growth in 2009 has slowed, the installed console base (excluding handheld units) is still expected to reach 18 million during the year, with the Nintendo Wii in particular driving a broadening demographic. Consequently, continued games software growth is anticipated, with the market forecast to exceed £3bn by 2012. A particular characteristic of the games market is the importance of used or 'pre-played' games. During the year HMV UK developed a strong pre-played games offer, and rolled this out across the store estate. Technology products, predominantly MP3/MP4 players and related accessories, have also developed into an important component of the HMV offer, representing almost 5% of HMV UK & Ireland sales for the year.

28% of total Group sales

The total UK book market has a history of steady but modest growth, although 2008/09 proved challenging, with a total market decline of 2% after adjusting for the prior year publication of Harry Potter and the Deathly Hallows. The outlook remains for a stable, yet highly competitive and promotional market, inclusive of continued growth from online channels, which are anticipated to account for a quarter of the market by 2012. An embryonic market for digital books developed also during 2008/09, with Waterstone's successfully launching the Sony Reader for e-books. Although this new market is currently constrained by a limited catalogue of digital books, the market has potential to become up to 10% of online sales by 2012.

Stores and online

The Group has an attractive portfolio of 722 stores, all of which are:

• leasehold and located in prime retail locations
• tailored in size to meet the requirements of local markets, but always provide the widest available ranges in core categories
• inspiring environments in which to shop, supported by knowledgeable service and advice.

As online continues to develop as a key channel to market for our product categories, the Group is making the necessary investments to compete by replicating its specialist brand credentials via transactional websites. Recent developments include:

• 55 million visits to hmv.com and 18 million to waterstones.com during 2008/09
• integration of MP3 music downloads into the hmv.com offer, and launch of streaming service to access over 4 million digital music tracks on subscription
• waterstones.com migrated to in-house fulfilment for enhanced customer service
• early entry into emerging market for e-books for download via waterstones.com

Economic environment

During the year under review, the Group has faced challenging economic conditions in all of the geographical territories in which it operates. The Group is not immune to macro economic trends: a significant proportion of our sales are made on impulse, meaning footfall on the high street is an important driver; and the products we sell can be deemed to be 'discretionary'. However, our businesses and product markets exhibit the following characteristics:

• the products we sell are relatively low ticket items to purchase
• music, filmed entertainment, games and books are attractive gifts. Typically, 40% of the Group's sales and the majority of the operating profit are made in its third financial quarter (November, December, January), which includes the key Christmas season
• many of our customers, as with our colleagues, are passionate about, and committed to our markets, whether music, video, games or books. Consequently, sales of our products are often more resilient than other consumer items.

Competition

The product markets in which we operate are structurally changing and, therefore, in the Group's opinion, market leadership is critical. In all the territories and markets in which we operate we face competition from supermarkets, particularly in the segment defined as new release, chart or bestsellers, and from online players, which provide an extensive range.

In entertainment, the market in which there is the most profound structural change, specialist retailing capacity has been withdrawing from the market. Here, there are opportunities for us to maximise our leading market position. In books, Waterstone's remains the market leader on the high street, though independent bookselling remains a more vibrant part of the market than is the case in entertainment. Online, Amazon.co.uk is an established and clear market leader of our product categories. As a specialist retailer, both through our stores and websites, we seek to differentiate HMV and Waterstone's by:

• providing the widest ranges and availabilities, driven by best-in-class inventory management systems
• offering customers superior product campaigns utilising high-quality merchandising skills, direct supplier relationships and range expertise
• the authoritative product knowledge and advice offered by our employees
• provision to our customers of added value experiences, including special events to meet artists and authors and to attend live performances at our stores
• innovative CRM to drive and maintain customer loyalty, including in HMV UK access to rewards which are not usually available for purchase.