The feelgood factor has returned to the high-street chain, but is stocking the Kindle like inviting a fox into the henhouse?

In just a few years, Waterstones has gone from being the villain of the book world to the plucky underdog. "When I first worked in publishing everyone hated them, whereas now everyone supports them," says one industry executive.

As hundreds of independent booksellers have shut up shop, publishers are desperate to see a specialised high-street bookseller survive and thrive. But a lot of the goodwill also has to do with James Daunt, Waterstones' managing director, who gave up running his small chain of independent bookshops to turn around the retail giant.

When Daunt arrived two years ago – hired by Alexander Mamut, the Russian billionaire who bought the chain from HMV – Waterstones was in trouble. Sales were dropping through the floor, bookselling staff were disillusioned, while the literati despaired that Waterstones stocked more copies of Jordan's autobiography than Tolstoy or Dickens.

For Daunt, Waterstones had simply lost sight of the old-fashioned art of bookselling: finding out what the customer wants. He tore up Waterstones' rigid centralised directives that meant every shop from Aberdeen to Exeter stocked the same books, as well as the "awful" planograms – photographs of a display table that had to be faithfully recreated in every store.

"That makes sense if you are selling shampoo in Boots, as it makes sense to have all the dandruff shampoos next to each other. It doesn't make sense in a bookshop, if you want interesting bookshops." He also ended the cosy promotional deals that saw publishers handing over £27m a year to get their books in prime locations – putting the latest celebrity memoir smack-bang in the window or including a title in the "cynical" three-for-two offers.

"That was Waterstones' business model," he says. "Now we don't get paid a penny for doing anything; we just do it because we like the books."

It is too soon to say if integrity will pay off. Waterstones reported a £37m loss in its latest accounts, although Daunt was not in charge for the whole period. He is expecting a smaller loss this year, although the chain will have to wait a little longer to swing back into profit – "Next year if we are lucky," Daunt says.

The bottom line might be drenched in red ink, but Daunt is already looking ahead to opening new shops in towns including Lewes and Blackburn. "It is astonishing really how many vibrant places don't have a bookshop."

It is not surprising that Daunt would like to skip ahead to the next chapter. He has just finished a massive reorganisation, during which 200 of Waterstones' 487 store managers left the company – "a brutal and awful process" – but the new and remaining managers should find running a Waterstones shop much more fun.

It is his ambition to make his bookstores enticing places for customers that prompted him to make his boldest move yet – inviting Amazon to sell its e-readers and tablets in Waterstones shops –a move that has been likened to inviting the fox into the henhouse.

Daunt, who denies he ever called Amazon a "money-making devil", says that stocking the Kindle was about giving customers what they want.

He dismisses worries that customers might disappear with their e-readers into the virtual ether – he is convinced only a small minority will abandon paper books altogether. "I have a strong sense we are reaching a sense of equilibrium with e-reading. E-reading works well – really, really well – in particular situations: noticeably when you are travelling, but it has clear deficiencies to the physical book.

"You don't own the thing, effectively you rent it. You can't put it on your shelf … Some people forget what they read on e-readers, because a key element of the personality of the book isn't there."

And it is readers' tactile relationship with the book that makes him optimistic that there is a bright future for shops, where people can squint at the print size and sniff the paper. The pleasure of discovering something unexpected will keep people coming back into his shops, he thinks, even if they can save money on Amazon – although he insists the savings mostly amount to "pennies".

"Amazon is an astonishingly efficient business. It does what it does ruthlessly well. I've never been frightened of Amazon. I've always respected Amazon for what they do. But I think they do something different."

This approach has won him plaudits. "He has shown there is a future for a dedicated high-street bookseller," says Philip Jones, editor of the Bookseller magazine. "Going back two or three years nobody in the trade would have thought that anyone could have pulled it off."

But the story is not over, Jones adds. "What is most needed at Waterstones is investment in shops and staff. So long as the owner is able to afford that, I think people should applaud it rather than worry about the actual bottom line."

For now, Daunt has a bigger preoccupation. A more fundamental danger for booksellers, he thinks, is that in a world dominated by tablets and social media, people have less time to read.

When he got up that morning, the light was leaking out from under his 10-year-old daughter's bedroom door. "She was up at 6am just to shove her nose in a book. That is the pleasure of reading and we lose that, or forget about that, at our peril."

A brief history of Waterstones

Tim Waterstone opened his first shop in 1982 with his £6,000 redundancy from WH Smith. Fed up with schlepping into central London to find a decent bookstore, he hoped to recreate the buzzy, late-night bookshops he had seen in New York. With their knowledgeble staff and literary titles, his stores soon captured book lovers' hearts.

The chain grew rapidly and, giving him the ultimate compliment, his former employer, WH Smith, bought him out in 1993. But this triumph was followed by a long decline in the bookshop's reputation.

Choice on the shelves diminished and publishers complained they were squeezed, especially once the net book agreement that regulated prices was torn up in the late 1990s, paving the way for Tesco and Asda to pile into the market.

Waterstone joined forces with HMV to buy the chain back in 1998, but in the eyes of its literary critics it had not recovered its soul. By the time the economic downturn hit, customers were also turning their backs, drawn to Amazon's knockdown prices.

Rescue came from the Russian billionaire Alexander Mamut, who hired the independent bookseller James Daunt to create "community-orientated" stores. It sounds like a fairytale ending, but many still wonder whether its 300 shops can survive.