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In this blog, I will give an outline of how the Amazon Kindle publishing model works, especially its pricing model, and how it is designed to manipulate the authors who publish direct and how it seeks to dominate the suppliers who are their life blood. (Alasdair White October 2011)

In the US market, Amazon is thought to have around 54% of the ebook market (Barnes & Noble are thought to have 26% and the others, Kobo, Apple, Smashwords and so on, are thought to have 20% between them) while in the UK it has perhaps 75% and in Europe at the moment (a small but growing market) it is the dominant player confronted really only by Apple and Kobo. Amazon is, there can be no doubt, a dominant market operator, a highly effective and efficiency business, and rapidly becoming ubiquitous.

The Amazon Kindle ebook reader, a first-to-market product with all the advantages that that brings, is now aging. It uses a file type called a ‘mobi’ and is now the only major e-reader to use this file – all the newer e-readers use the industry standard format of ‘ePub’ and they can all download a small application called a MobiPocket Reader that allows them to read mobi files. The Kindle has, therefore had its competitive advantage eroded. As a response to new entrants, Amazon decided to release the Kindle outside the US (having previously refused to make it available anywhere else) but they premium priced it at a significantly higher price than it sold for in the USA. In this, they were merely doing what Apple does with its products – there is a premium price to pay if the product is bought outside the US. This is effectively, a tax on consumers for wanting to use a US product!

The problem for Amazon, if they were to stay ahead and were to attract buyers for their Kindle machines, was that they needed to have content. Given the high profit margins on the e-reader itself and the very low profit margins on books in any format, Amazon needed people to buy the e-reader and so the provision of content had to be done free or as near as possible to free. The rationale being that if the content was free or nearly free, then the huge premium on the e-reader would be amortised more quickly. But there is a problem: the average reader buys and reads perhaps eight books a year and since the e-reader is obsolete in around three years, that means the reader will have read perhaps 24 ebooks. That makes the cost of each ebook extortionate since the cost of replacement of the reader was around $200 dollars so each book read cost the equivalent of $8.33 plus the cost of buying the book – and since the very price sensitive and competitive paperback market had caused many mass-market paperbacks to be priced at well under $9.99, this meant that the ebooks would have to be priced at under $1.66 if the reader was to receive value for money. Amazon, therefore, aimed to set their ebook price at around $1 (actually $0.99) to attract buyers. This issue is still basically the same now.

Fortunately, the publishers (the main suppliers to Amazon) made them realise that prices would have to be higher and so Amazon embarked on a vertical integration strategy and started to turn itself into a publisher. The offer they made to desperate ‘wannabe’ authors is that Amazon would take their word processed document, publish it for them, and sell it for $0.99 for the Kindle. Amazon would not offer any editorial input, nor layout and design input, they would simply be a production unit. The result was a huge upsurge in sub-standard, poorly written and even more poorly edited fiction.

Then, as discussed in my previous blog, Amazon and the publishers colluded to engage in price fixing via the ‘agency model’. This caused a change of tack and Amazon trumpeted that this new deal meant that authors and publishers would receive 70% of the sales price on every sale … only that was not quite the case!

Let’s see what the Kindle Direct publisher’s platform actually offers. The 70% option works only for sales to a limited number of countries around the world and although the list is growing, it is basically, the US, UK, Canada, Germany, Austria, Switzerland, Luxembourg and Liechtenstein. If an ebook is sold to a country not on the list, then Amazon will only pay 35%. Further more, if the ebook is sold to a person in the European Union, then 15% is withheld as VAT and Amazon then returns either 70% or 35% of the VAT-exclusive price.

But that is not all Amazon deducts – on a normal-sized ebook they also deduct $0.15, £0.10, or €0.12 (depending on which Amazon site you order from) as … wait for it … a delivery charge! So, in the end, Amazon actually pays 70% (or 35%) of the list price – delivery charge – VAT. Whichever way one looks at it, to say they are paying 70% of the sale price is being very economical with the truth!

There are other catches as well. To get a book accepted for the 70% band the price has to be set at between $2.99 and $9.99 if offered on Amazon.com, £1.49 and £6.99 inclusive of 15% VAT if offered in the UK and €2.60 and €8.69 inclusive of 15% VAT if offered on the German site. So, if you offer the book at €0.99, then your payment from Amazon will be in the 35% bracket. In addition, the price set must be NO HIGHER than the list price at non-Kindle ebook stores and no higher than 80% of the printed book price.

Finally, if world rights are offered, then the correct 70% bracket price has to be set for each site to ensure that Amazon doesn’t arbitrarily modify the price inline with whatever FX value they have chosen – something they are entitled to do without informing you. If this fate does befall you, they won’t even discuss it and will pay only in the 35% bracket.

And if you think the problems end there, then think again! No matter what price is actually set, this can appear radically different depending on where the buyer is in the world. For example, let’s take an ebook that is priced at $3.95 on the Amazon US site – this will appear as $3.95 to a US-based buyer, as $6.42 to a UK buyer, $6.84 to a European buyer and $5.95 to a Hong Kong buyer. On the other hand, the same book offered on the UK site at £3.98 and the German site at €4.99 appears at that price no matter where the buyer is based. And if a UK or European buyer has the temerity to try to buy from the US site they will be advised to return to the UK or German site while a US-based buyer trying to buy from the UK or German site will be actively blocked from doing so. And just in case you are wondering, the publisher/author will only receive 70% (or 35%) of the $3.95 even if the buyer ended up paying $5.95 or higher.

In the mean time, they are about to release the Kindle Fire, an ePub reader and tablet computer, using the same pricing approach as they used before in the hope that they can develop a significant market position in the computer market. Whichever way you look at it, Amazon is positioning itself as a vertically integrated electronic content provider and it is abandoning its current positioning as an online book retailer.

In reality, the Amazon operating and pricing model puts all the control in their hands, is generally disadvantageous to is suppliers (publishers and authors) but is generally supported by is customers – who have very little option since Amazon dominates the online book and ebook market. It would not surprise me to find Amazon’s position challenged by new entrants and for Amazon itself to be the subject of an anti-trust or competition investigation in the near future.

In this series of blogs on Amazon I have looked at the fact it is not really a bookstore, that it is operating an ‘agency model’ pricing model in a way that reflects its corporate and national culture but does nothing for its suppliers, and that its Kindle Direct publishing system is being presented inaccurately and operated arbitrarily. Indeed, Amazon may not be in the best interests of the book trade at all – now there’s a thought!

In this second blog on the subject of Amazon, I am interested in the company’s behaviour as exhibited by its pricing model. (Alasdair White, September 2011)

The objective of all business is to generate revenue and, by controlling costs, to make a profit. To do this they have to sell products to end users at a sufficient price to generate a margin (net revenue) – this is derived by taking the selling price and deducting the cost of purchase or manufacture. In any value chain, each party makes the same set of calculations and they ‘set’ the selling price – usually by taking the their cost price and adding a margin. The next party in the value chain then takes this as the ‘cost price’ to which they add a margin and so on.

In the case of books (in any format), the producer of the book (‘the publisher’) is generally expected to establish an end-user price – often called the Recommended Retail Price, or the Recommended Sale Price. This will be based on market research to determine what similar books are selling at and is thus market-driven. The bookseller then negotiates a ‘trade discount’, this is deducted from the RRP, and the result becomes the price at which the bookseller buys the book. This is, technically, a ‘wholesale pricing model’ and leaves the retailer with the flexibility of setting the final sale price to suit their market. In a robust and diversified retail market, this encourages competitive behaviour and is good for all parties.

However, in a new and fragile market, such as that for ebooks, which represents under 7% of the total book market in the US and is estimated to be under 0.5% of the world market, the current model is thought to distort by allowing dominant retailers – especially Amazon – to sell ebooks at huge discounts in an effort to capture or protect their market share, but such very heavy discounting can be seen as anti-competitive behaviour by a market-dominant party. Publishers claim that this undermines their ability to sell their books through ‘normal’ bookselling channels. (By which, I assume, they mean that sales of books in other formats are being under-mined – especially if the ebook is also offered in a print format.) This sort of thing was, of course, a potential contributory factor to the demise of Borders as a high street bookseller. And let’s be absolutely clear about this – this problem is not confined to the USA, it is becoming an issue in Europe as well.

So, in an effort to protect the print-format market, the publishers and the retailers (mainly Amazon, Barnes & Noble and the other online retailers, including those in the UK) have come up with something called ‘the agency model’ in which the publishers ‘set’ (or ‘fix’) the retail price claiming that this will allow the development of the ebook market in a protected environment. While I can see how this helps publishers who issue the same title in both print and ebook formats (and thus, by extension, the authors), I cannot see how this is in the interests of the retailer or the consumer – it is, plainly and simply, ‘price fixing’ which is an anti-competitive behaviour. By agreeing with the publishers to adopt the ‘agency model’, Amazon, Barnes & Noble and Apple, to name but three, appear guilty of collusion and I am obviously not the only person to think this: the EU’s Competition Directorate and the Office of Fair Trading in the UK have both launched investigations as to the legality of the model.

Why have Amazon and the others agreed to collude with the publishers in the ‘agency model? Well, given that 40% of Amazon’s revenues come from book sales in general, they are rather dependent on the publishers as a source of supply and to get Amazon to agree to their new ‘agency model’ the publishers simply threatened to withdraw all their titles from Amazon’s list! Amazon capitulated in short order – they held out for a week, I believe, but then folded.

Amazon almost certainly decided that since the publishers really only wanted to operate the ‘agency model’ for ebooks, it was in Amazon’s own enlightened self-interest to agree simply because their interest in ebooks was to supply content for their Kindle reader on which there is a far higher margin. (see earlier blog)

Having been forced to concede to the publishers’ demands, Amazon has set about making the best of a bad job and has developed a two pronged approach: to vertically integrate, and to maximise their control over the ‘agency model’. The vertical integration strategy gives them a high level of control over the entire book value chain and psychologically leverages the authors’ desire to be published, while the maximisation of control of the ‘agency model’ is achieved through price banding to ensure that the majority of ebooks are priced at the most advantageous price as determined by Amazon.

Their vertical integration strategy encourages authors to convert their manuscripts to the MOBI format that is used by the Kindle reader (indeed, the only major e-reader to use it). This conversion is either done by the Kindle Direct publisher platform or the file can be converted elsewhere and simply made available to Kindle. The file is then loaded using the Kindle Direct publisher platform and the publisher has to enter various data, including the list prices (as per the ‘agency model’). The publisher then has no further control over the process except to monitor the prices. Kindle pays when it is ready – either by cheque or by bank transfer to a US bank account (no international transfers and no use of PayPal). Kindle will enter into NO discussions about prices, money or exchange rates and their decisions are final – there is no negotiation on anything. In this way, Kindle has virtual control over everything in the value chain except the original creation process (the authoring) – at the same time, Kindle also exerts non-negotiable control over the ‘agency model’. Which ever way this is viewed, the Amazon/Kindle strategy is an attempt to dominate the market and, as such, is broadly anti-competitive – however, Amazon/Kindle is such a dominate player, it is very difficult to see how this can be changed while the collusion with the publishers is still in existence.

In the next blog, I will outline a case study example of Amazon Kindle and its pricing model, which shows clearly how, as ‘elephant in the room’, Amazon/Kindle behaves in a strange, arbitrary, and restrictive manner towards those who supply it with content to sell and it can’t be ignored.

In this first blog on the subject of Amazon, I am interested in seeing whether the company, which started life as a bookseller using a pure online model, can still be classified as a bookseller or whether it has changed and become something else. (Alasdair White, August 2011)

If you go out onto almost any street in the developed world, and many streets elsewhere, and ask people “What is Amazon?” they will tell you that it is an online bookshop (and that Kindle is its online ebook shop). And yet if one looks at Amazon’s own published financials, it becomes clear that consolidated media (books, ebooks, magazines, music, cds, and software etc – in other words, its bookshop activities) account for just 40% of total revenue and so clearly, Amazon is not just an online bookshop but is really something else.

One thing is for certain, Amazon is massive: 1^st quarter 2011 revenue was given as $9.86 billion and the expected 2011 figures will probably be in excess of $40 billion. But if only 40% of that revenue comes from its books, ebooks and associated activities, then Amazon is not a bookshop at all but a massive online retail catalogue that allows customers to see what is available, purchase and then have their order fulfilled.

As a catalogue retailer, Amazon does not need to bother with stock, although it carries its most productive lines as stock items, it only needs to make products available and then ensure that its suppliers fulfil the orders promptly. And for that, they, Amazon, will take a significant percentage of the sales value.

Unfortunately, Amazon has developed some rather worrying attitudes towards its suppliers that are reminiscent of the worst practices of the giant supermarkets: a tendency to tell its suppliers the price at which it will buy products, having pricing models that force the supplier to offer products at artificially low prices, discounting goods without advising the suppliers first, being exceptionally slow in paying and having a total inability to make an international bank transfer from the USA. They even insist that certain products are supplied in specific formats so as to support Amazon’s already aging technology.

Without a shadow of doubt, Amazon is a huge success and, as the first major online catalogue, it has massive first-to-market competitive advantage. But like many first-entrants, it is rapidly being challenged by other online retailers who have learned from Amazon’s failures and weaknesses and have come to the market with improved products, improved services, better pricing models and a more cooperative supplier/retailer relationship. The result is that Amazon is losing its competitive advantage in many areas.

Let’s take the ‘media’ section of their business – the part that can be basically taken as being books, ebooks and associated bits and pieces. There is a general assumption that Amazon dominates this market in the USA, and with the recent bankruptcy of Borders, their share was thought to have become stronger but the published figures show Amazon’s media sales as $1.885 bn where as Barnes & Noble (another bookseller that operates a clicks-and-mortar strategy with shops and an online business) had media sales of $1.37 bn – this leaves Amazon at the top but Barnes & Noble are not far behind. And between them, they probably sell around 90% (by value) of all books in the USA. This would give Amazon around 54% of the market by value and Barnes & Noble around 40%.

How does that translate in terms of volume of books sold (unit sales)? The Book Industry Study Group covering the period to the end of 2010 found that in the USA there were 2.57 billion books sold in total of which 80%, or 2.26 billion books were ‘trade publications’ and which excludes educational, professional, and scholarly. The BISG report suggests that 6.4% of all books, or 164 million, were ebooks. Given that the book buying population of the USA (those with discretionary income and thus assumed to be 18 years and above) is 218 million, this means that each person bought 10 books (in any format) in the ‘trade’ category in 2010 of which 0.75 books were ebooks.

Which ever way you look at it, the ebook market is very small at the moment – but it is the fastest growing – which is to be expected given the hype being applied to ebooks and the fact that to publish an ebook does not require a ‘traditional’ publisher and thus it attracts author/publishers (self-publishers). In this sector, Amazon’s first-entrant competitive advantage, derived from their massive marketing effort behind the Kindle, is still there, although it is being eroded strongly by Barnes & Noble. Some notoriously unsubstantiated data suggests that Amazon has around 60% share of the ebook market although Barnes & Noble are gaining ground and are now attributed 26% leaving the ‘other players’ with just 14% of the US market. Interestingly, neither Amazon nor Barnes & Noble choose to provide their ebook revenues separately from their overall ‘bookshop’ activities.

So, whether we take books in general or ebooks in particular, Amazon and Barnes & Noble are ‘the elephants in the room’ and they simply can’t be ignored! But if we go back to the question in the title: “if Amazon is not a bookshop, what is it?” the conclusion has to be that, although a massive player in the book selling market, Amazon is simply an online catalogue.

In the next blog, I will be looking at Amazon’s pricing model as it is applied particularly in the ebook market. (30-08-11)