Opinion, Software, Technology

Opinion: What Amazon’s E-book Strategy Means (Guest Post)


Image: Steacie Library, licenced creative commonsThis is a re-post of What Amazon’s ebook strategy means by Scottish sci-fi author, blogger and commentator Charlie Stross. All rights remain with the author. Do check out his blog, Charlies Diary.

It seems to me that a lot of folks in the previous discussion don’t really understand quite what makes Amazon so interesting—and threatening, for that matter—to the publishing industry.

So I’m going to take a stab at explaining.

Amazon was founded in 1994 by Jeff Bezos. And today it’s the world’s largest on-line retailer.

I submit that, as with all other large corporations, you cannot judge Amazon by the public statements of its executives; they are at best uttered with an eye for strategic propaganda effects, and at worst they’re deeply self-serving and deceptive. Rather, you need to examine their underlying ideology and then the steps they take—and the actions they consider legitimate—in order to achieve their goals.

Now, first, I’d like to introduce three keywords that need defining before you can understand Amazon:

“Disintermediation: is the removal of intermediaries in a supply chain: “cutting out the middleman”. Instead of going through traditional distribution channels, which had some type of intermediate (such as a distributor, wholesaler, broker, or agent), companies may now deal with every customer directly, for example via the Internet. One important factor is a drop in the cost of servicing customers directly.

Disintermediation initiated by consumers is often the result of high market transparency, in that buyers are aware of supply prices direct from the manufacturer. Buyers bypass the middlemen (wholesalers and retailers) in order to buy directly from the manufacturer and thereby pay less. Buyers can alternatively elect to purchase from wholesalers.

It should be fairly obvious by now that the Internet is an intrinsically disruptive force in traditional distribution channels because it makes disintermediation very easy.”

Jeff Bezos recognized this very early on, and designed Amazon to be a disruptive disintermediary: to buy wholesale and sell retail, using the internet as a tool to reach remote customers directly. Initially Amazon relied on large warehouses, but as its database expanded they moved to just-in-time ordering, whereby obscure items would be listed as available but only ordered from the supplier when a customer requested one.

(So far, so good.)

But there are two other key aspects of Amazon that we need to understand.

Firstly, it’s not an accident that Bezos’ start-up targeted the book trade. Bookselling in 1994 was a notoriously backward-looking, inefficient, and old-fashioned area of the retail sector. There are structural reasons for this. A bookshop that relies on walk-in customers needs to have a wide range of items in stock because books are not fungible; a copy of the King James Version Bible is not an acceptable substitute for “REAMDE” by Neal Stephenson or “Inside the Puzzle Palace: A History of the NSA” by James Bamford. But books are bulky—a metre wide galley with books stacked spine-out can hold maybe 200 books on its shelves. It takes a lot of floor space to hold one copy of everything a reader might want to buy. Even a big box store may only have room to stock 20-50,000 different titles. In contrast, Amazon’s database can hold millions of titles without Amazon having to hold them as physical stock.

Moreover, a big bookstore that stocks 20,000 trade books has to either sell them or return them undamaged for credit within 90 or 120 days. Someone is paying for that credit: either the wholesaler who bought them from the publisher, or the publisher themselves. (Or the bookstore may take a gamble and pay for the books, then keep them on the shelves until they sell—but this doesn’t generally happen because bookstore owners aren’t suicidal.) And the availability of that credit is limited by the retailer’s plausible ability to pay. Amazon doesn’t need to run on rolling credit. They can list everything in print as if it’s available, and order it only when they have a confirmed sale. Neat, huh?

As noted, Bezos targeted book selling because it was ripe for disintermediation. By purchasing from the publisher directly when a customer had already bought a copy, his company could keep its overheads down—and in particular, minimize its warehouse space (never mind the cost of running premium retail outlets and paying shop sales staff). This allowed him to buy wholesale and sell retail, at a big discount compared to the regular retail trade (with their higher overheads).

So. What’s wrong with this?

Well, there’s nothing intrinsically wrong with this way of doing business—if that’s all that was going on. But it isn’t. So now we come to our two new words:

“Monopoly: exists when a specific person or enterprise is the only supplier of a particular commodity … Monopolies are thus characterized by a lack of economic competition to produce the good or service and a lack of viable substitute goods.”

Monopolies suck for their customers because they don’t have to give a shit about product quality or price: they have you, the customer, over a barrel with nowhere else to go.

A monopoly is a consumer-side problem. In contrast, there is a less-well-known corresponding supplier-side problem …

“Monopsony: is a market form in which only one buyer faces many sellers. It is an example of imperfect competition, similar to a monopoly, in which only one seller faces many buyers. As the only or majority purchaser of a good or service, the “monopsonist” may dictate terms to its suppliers in the same manner that a monopolist controls the market for its buyers.”

Monopsonies suck for their suppliers because the suppliers are systematically starved of profits by the middle-men running the monopsony. Which can lead to suppliers going bust, and a reduction in the diversity and quality of goods available (via the monopsony) to consumers.

(It’s kind of like inflation and deflation in economics. Inflation is bad; deflation, its opposite, is not good, it’s simply differently bad. Similarly, both monopolies and monopsonies are bad.)

And the peculiar evil genius of Amazon is that Amazon seems to be trying to simultaneously establish a wholesale monopsony and a retail monopoly in the ebook sector.

You’re probably familiar with predatory pricing. A big box retailer moves into a small town with a variety of local grocery and supermarket stores. They stock a huge range of products and hold constant promotions, often dumping goods at or below their wholesale price. This draws customers away from the local incumbents, who can’t compete and who go bust. Of course the big box retailer can’t keep up the dumping forever, but if losing a few million dollars is the price of driving all the local competitors out of business, then they will have many years of profits drawn from a captive market to recoup the investment. (Meanwhile, helpful laws allow them to write down the losses on this store as a loss against tax, but that’s just the icing on the cake.) Once the big box store has killed off every competiting mom’n’pop store within a 50-mile radius, where else are people going to shop?

Amazon has the potential to be like that predatory big box retailer on a global scale. And it’s well on the way to doing so in the ebook sector.

Until 2008, the ebook side of publishing was a vestigial, if not irrelevant, irritation from the point of view of the major publishers—at less than 1% of their turnover it was lost in the line noise. However, as subsidiaries of large media conglomerates, the executives who ran the big six had all been given their marching orders about the internet: DRM restrictions would be mandatory on all ebook sales, lest rampant piracy cannibalize their sales of paper books.

(This fear is of course an idiotic shibboleth—we’ve had studies since 2000 proving that Napster users back in the bad old days spent more money on CDs than their non-pirate peers. The real driver for piracy is the lack of convenient access to desirable content at a competitive price. But if your boss is a 70 year old billionaire who also owns a movie studio and listens to the MPAA, you don’t get a vote. Speaking out against DRM was, as more than one editor told me over the past decade, potentially a career-limiting move.)

But publishers aren’t software companies. They just want to sell books. And so they outsourced the DRM to the ebook resellers. Including Amazon.

Amazon has a history of investing hundreds of millions of dollars in loss-leading products and ventures solely to build market share. For AMZN, the big six insistence on DRM on ebooks was a windfall: it made the huge investment in the Kindle platform worthwhile, and by 2010 Amazon had come close to an 85% market share in the ebook sector (which was growing at a dizzying compound rate of 100-200% per annum, albeit from a small base). And now we get to 2012, and ebooks are likely to hit 40% of total publishing sales by the end of this year, and are on the way to 60% within five years (per Tim Hely Hutchinson, CEO of Hachette UK). In five years, we’ve gone from <1% to >40%. That’s disruption for you!

Now, most ebook customers are not tech-savvy. It is possible to unlock the DRM on a Kindle ebook and transcode it to e-pub format for use on other readers; but it’s non-trivial. (Not to mention being a breach of the Kindle terms and conditions of use. Because you don’t own an e-book; in their short-sighted eagerness to close loopholes the publishers tried to make e-books more like software, where you merely buy a limited license to use the product, rather than actual ownership of an object.) So, because Amazon had shoved a subsidized Kindle reader or a free Kindle iPhone app into their hands, and they’d bought a handful of books using it, the majority of customers found themselves locked in to the platform they’d started out on. Want to move to another platform? That’s hard; you lose all the books you’ve already bought, because you can’t take them with you.

By foolishly insisting on DRM, and then selling to Amazon on a wholesale basis, the publishers handed Amazon a monopoly on their customers—and thereby empowered a predatory monopsony.

I’m not going to comment on the Agency model which has drawn down the current US Department of Justice enquiry into Apple and the big six publishers. Let’s just frame it as a desperate attempt by the publishers to get away from the wholesale model, which was allowing the monopsony incumbent (Amazon) to extort ridiculous discounts from their suppliers. If anything, the agency model simply means selling books the same way they were sold 30 years ago, and the way apps are sold in the iTunes app store or the Android Marketplace. It was unwise to give the appearance of collusion to establish a price-fixing cartel, but whether or not such collusion actually happens is a matter to be decided by a judge in the not too distant future.

I’m not going to lecture you about Jeff Bezos either, although I do want to note that he came out of a hedge fund and he’s ostensibly a libertarian; these aspects of his background make me uneasy, because in my experience they tend to be found in conjunction with a social-darwinist ideology that has no time for social justice, compassion, or charity. (When you hear a libertarian talking about “disruption” and “innovation” what they usually mean is “opportunities to make a quick buck, however damaging the long-term side effects may be”. Watch for the self-serving cant and the shout-outs to abstractions framed in terms of market ideology.)

Anyway, here’s the important take-away:

DRM on ebooks is dead. (Or if not dead, it’s on death row awaiting a date with the executioner.)

It doesn’t matter whether Macmillan wins the price-fixing lawsuit bought by the Department of Justice. The point is, the big six publishers’ Plan B for fighting the emerging Amazon monopsony has failed (insofar as it has been painted as a price-fixing ring, whether or not it was one in fact). This means that they need a Plan C. And the only viable Plan C, for breaking Amazon’s death-grip on the consumers, is to break DRM.

If the major publishers switch to selling ebooks without DRM, then they can enable customers to buy books from a variety of outlets and move away from the walled garden of the Kindle store. They see DRM as a defense against piracy, but piracy is a much less immediate threat than a gigantic multinational with revenue of $48 Billion in 2011 (more than the entire global publishing industry) that has expressed its intention to “disrupt” them, and whose chief executive said recently “even well-meaning gatekeepers slow innovation” (where “innovation” is code-speak for “opportunities for me to turn a profit”).

And so they will deep-six their existing commitment to DRM and use the terms of the DoJ-imposed settlement to wiggle out of the most-favoured-nation terms imposed by Amazon, in order to sell their wares as widely as possible.

If they don’t, they’re doomed. And all of us who like to read (or write) fiction get to live in the Amazon company town.

About Allan J. Smithie

Allan J. Smithie is a journalist and commentator based in Dubai.

Discussion

4 thoughts on “Opinion: What Amazon’s E-book Strategy Means (Guest Post)

  1. I must say; the Kindle is truly an amazing product, but the price of e-books is quite disturbing. Both the kindle store (and many other similar e-book stores) have outrageous prices on their e-books, which most of the time match the price of a paperback.

    I expect the amount of pirating for e-books will increase quite a lot if this pricing strategy continues.

    Posted by Jonny Owlett | April 29, 2012, 12:51 am
  2. Informative article, just what I wanted to find.

    Posted by Justin Bailey | April 29, 2012, 2:51 am
  3. I really like it when people come together and share views.
    Great website, stick with it!

    Posted by Audry Frost | April 29, 2012, 2:58 am
  4. Simple strategy; destroy competition, create total monopoly, gradually raise prices. Done.

    Posted by idlen essuio | May 26, 2012, 12:37 am

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