How Amazon Can Compete with Apple
At the moment, Amazon's best selling Kindle is the king of the eBook readers. But the impending launch of Apple's iPad means that unless Amazon changes its direction and its mindset, the Kindle is kindling.
Amazon CEO Jeff Bezos has a tough habit to break. It started when he built the Kindle and he deliberately copied Apple's approach to the iPod.
- He integrated the Kindle tightly with his website. Just as iPods can only play music bought on iTunes and music bought on iTunes would only play on an iPod, Kindles only handle books bought on Amazon (Bezos did not try for a double lock: you can read Amazon eBooks on iPhones, Macs, and PCs).
- He subsidized the hardware and the content to build momentum, knowing that with volume, costs would drop and competitive barriers would grow. Steve Jobs had done the same with music.
- He set the selling price. Jobs was hated by the music labels for insisting on $.99/track pricing and Bezos is equally despised by publishers for selling nearly all eBooks at $9.99 or less. Both men had the same agenda: to accelerate the adoption of digital media.
Publishers howled. But Bezos stuck to his guns and refused to compromise, just as Jobs had done. Bezos even made the same arguments to publishers that Jobs did to labels: "you will make more money this way because we will sell more units".
So when Steve Jobs decided to sell eBooks, he tossed his old play book. Instead, he offered publishers something that they had long been unable to bargain from Amazon: agency model pricing.
This is worth understanding. The key question for publishers is who sets the retail price of the product. Traditionally a publisher suggests a list price but the actual retail price is set by the retailer. A retailer is free to mark products down according to their strategy and in the book market, large discounters like Walmart and Costco as well as virtually all websites sell books at a discount to the list price suggested by publishers. Amazon has always treated best-selling print books as loss leaders and today sells virtually all e-Books below cost.
But in an agency model, Amazon and Apple are not retailers -- they are agents of the publisher, who dictates the retail price and pays them an "agency fee" (a commission). Amazon has successfully resisted pressure to allow agency model pricing for the past two years.
A table clarifies just how odd this is. This table illustrates (imperfectly because some costs are essentially fixed) the variable economics of a newly published mid list hardback trade book. The economics of best-sellers, backlisted books, paperbacks, and textbooks are materially different but the conclusions are not.
Notes: (1) Editing and marketing $1 each -- fixed costs that diminish with volume. Author royalties shown at 15% of list price -- it can be less -- or for franchise authors, a lot more. (2) Varies because of returns. Best sellers have very low unit costs here because returns are low and print runs are high, but 99% of all books are not best sellers. (3) 50% of publisher's list price for ebooks or print books. 70% for agency model sales. See today's NYT for a similar take. What the heck is going on here?
What is Apple trying to do?
Agency pricing helps the eBook strategy because it means that Amazon (whose Kindle will run on the iPad) cannot underprice Apple. (Agency pricing also keeps Apple's margins up by allowing them to book as revenue only the commission, not the product). This new pricing structure gives Apple instant credibility with publishers, something they never had with record labels. But Apple does not want to simply sell books, they want to reinvent them. Armed with a Jesus tablet, Apple wants to create, control, and sell premium books. Textbooks would come with embedded videos, tutorials, study guides, sample tests, forums and tutoring services. Children's books would shake, rattle, and roll. Novels would include guides for reading groups, author interviews, alternative endings, suggested next books, film clips, sample chapters from the sequel, and dedicated social networks for fans. Science texts would contain myriad links, video demos, and discussion forums. Travel books would geo-locate and tie to restaurant and shopping recommendations, events, etc. Not incidentally, none of these things are possible on the Kindle. This week Penguin demonstrated that publishers fully understand the potential of high quality tablets like the iPad. They know that the game is not simply getting rid of printing presses -- it is to explode what we think of as a book. The following video (produced within a month of the iPad's debut and well before its launch) gives you a glimpse of their thinking: Penguin also predicted that eBooks will go from 4% to 10% of the book market in one year. Translation: books are precisely ten years behind music. The iPod was announced the week that the twin towers fell and in late 2001 music was sold overwhelmingly on CDs. The fastest growing music retailer was Amazon. The book market is stagnant. It only grows most years because publishers raise prices, not because Americans buy more books. If eBooks replace printed books at the same rate that digital music replaced CDs, the number of printed books sold each year will decline at first 10%, then 20% and more annually. Publishers will be forced to limit returns from retailers (an appalling cost, but necessary for small retailers to afford high selection). Brick and mortar bookstores will disappear at least as quickly as music retailers did. Chains like Borders and Barnes and Noble, long the bane of your local bookstore, will be out of the book business in five years. Investors understand this: they value Borders today at less than its break-up value. Amazon understands this as well: after all, they led the first revolution (when the iPod was released, Barnes and Noble was worth more than Amazon. Today, Amazon is 50 times more valuable than BN). Amazon knows that once the iPad launches, the Kindle will start to look like the Garmin GPS, a dedicated device threatened by multifunction smart phones. The slow black and white Kindle will not fare well against a blazing color iPad. The contrast will be larger than a Mac vs a PC. Apple won't even have to run goofy commercials to make the point. Said another way, for the first time in its history, Amazon faces real competition for online book sales. Apple has sold 12 billion downloads to their base of 125 million customers -- and they did much of it from within iTunes, an vastly inferior retail experience to Amazon's. Amazon's response has been unusually clumsy. First, they decided to compete with publishers. Just before the iPad announcement, Amazon reached out to unpublished authors and announced that they would offer them 70% of the selling price of a book if they would publish directly to the Kindle. If publishers hated Amazon as an arrogant retailer, they hate them even more as a competing publisher. Second, Amazon announced that it is building an app store for the Kindle. An app store for a black and white device with a leisurely screen refresh rate? An app store for a device engineered to do only one thing? An app store for a device with no known SDK or programming language? Let me know how that works out.
How Should Amazon Respond? Amazon needs to stop copying Apple. They should realize that the value of the Kindle is as software, not hardware. If they need to copy anybody, start with their Seattle neighbors. Microsoft has out competed Apple for three decades. To take a page from their book, Amazon should:
Bill Gates inadvertently created an industry of hundreds of hardware and software companies. His system software was less elegant and his applications integrated less seamlessly with the hardware and operating system, but the Windows ecosystem adapted quickly enough and it outpaced Apple everywhere. Windows took 97% of the market and left Apple with a boutique 3%. Apple nearly died. Kindle software needs to run on dozens of general purpose devices. Some of these devices will be phones, some tablets, some netbooks, some desktops. Some will be fancy, some cheap, some specialized, some general purpose. They will focus on every demographic: tablets for teens with games and tablets for gramps with big buttons and big type. They will sell to every vertical: tablets for teachers, repairmen, and doctors. And every one of these devices should come with a Kindle reader tied to Amazon. Amazon does not win by copying Apple. Amazon wins by turning Apple's coolest features into commodities, just as Bill Gates did when he copied the Apple user interface again and again. Google and Adobe are Amazon's natural allies in this endeavor. | |||||||||||||||||||||||||||||||||
If you enjoyed this post, please subscribe to the feed and get future articles delivered to your feed reader.
