Z/Web

You may have heard the news about the fight between etailer Amazon and publisher MacMillan. If you’re not an author or publisher, this may not seem important, but I am telling you right now, the outcome of this battle will define the future of the publishing industry.

Basically, the two disagree on the pricing of ebooks, and Amazon used their nuclear weapon: on Friday they pulled all MacMillan products from their store. We’re talking paper books, not just ebooks. (You can still buy some MacMillan products via third parties, i.e. used books, but not from Amazon itself.)

I find this decision by Amazon shocking and I believe it will backfire and cost them dearly.

Amazon sees the writing on the wall and is terrified. They know that the future is all about the distribution of electronic content. Within the next decade, we are going to see a trend where physical media goes away. It’s already pretty much happened with music, and is starting to happen with video and text. It’s inevitable. People who are most opposed to electronic media are old and are literally dying off. The new generation is actually more comfortable with emedia than paper and that trend is accelerating. Many kids today have never even heard of an audio CD, let alone cassette tapes, 8-track, or records. It’s a digital world for them.

For Amazon, this presents a problem. With physical products, they have a competitive edge: huge warehouses and a distribution system that can’t be easily duplicated and they gain huge efficiencies in scale. But digital is easy: anyone can whip up a web store and beam electrons to customers and there is little difference from the customer’s perspective between an outfit in a garage and Fortune 500 behemoth. Amazon’s worry is that they’ll become nothing more than a dumb pipe. They want to be more valuable than that, because dumb pipes are easily replaced.

Amazon’s solution was to create the Kindle ereader hardware device and software platform in the hopes of building up a monopoly. That has been modestly successful. But Apple’s upcoming iPad threatens to dwarf and obsolete Amazon’s efforts. Apple’s device is very different from a Kindle: for some hardcore readers it’s a different category of product, but most people, who only read a few books a year, the more multi-functional iPad is all the ereader they need. In truth, far more people already read Kindle books on Apple devices than anything Amazon makes. Amazon has never stated Kindle sales numbers, because by their own admission the product doesn’t make enough money to bother, but estimates are that Amazon has sold as many as 2.5 million Kindles after years on the market. Contrast that with Apple which has sold 75 million iPhones and iPod touches. With estimates of the iPad selling between 4 and 10 million in its first year on the market, the Kindle hardware is pretty much extinct and Amazon knows it. (If they were smart, they’d ship a $99 Kindle next week. Take out the cellular modem and ugly keyboard and sell it paperback cheap.)

That means Amazon can only make money off of content. With its iTunes and App Stores, Apple has set a pricing precedent: Apple keeps 30% and the publisher/author keeps 70%. It was logical Apple would do the same with their ebook store (which they did when it was announced last week). I recently put one of my novels up for sale in Kindle format and I was dismayed to see the paltry percentage Amazon would pay me: for simply selling my digital book they would pretty much give me the 30% and keep the rest! (This is, unfortunately, quite similar to the revenue of physical books, where the bookstore often makes more on the sale than the publisher and author.) Obviously Apple’s store is a lot more attractive to me as a publisher/author.

To compete with Apple, Amazon must change its ebook terms to match. Yet if Amazon does that, Amazon becomes nothing but a dumb pipe. That’s where it gets hairy, for Apple is delighted being a dumb pipe. All of Apple’s digital stores are dumb pipes: they don’t exist to make Apple a profit (Apple has stated their goal is just to “break even”) but as a method of selling hardware. People are attracted to Apple devices because of the digital stores: iTunes makes it easy to buy songs for your iPod and Apps for your iPhone or iPod touch.

But Amazon doesn’t have Apple’s hardware sales to fall back on (Kindles probably don’t make money already and if sales drop off because of the iPad, that’s even less revenue). If Amazon competes with Apple’s “break even” business as a dumb pipe, how will they make any money?

The solution is dangerously clear. There’s a fixed amount of money on the table. Amazon can either raise prices to the customer, which would probably result in customers choosing to keep their money in their wallets, or Amazon can rape the publisher/author.

Amazon has chosen to do the latter.

They have announced new royalty terms that on the surface sound like they match Apple’s 70/30 split. However, the fine print reveals that publishers must agree to Amazon’s new terms to get that rate, and those new terms are insane. To get the higher royalty, the publisher basically hands over the reins of their business to Amazon, allowing Amazon to set the price of the product (even giving it away for free or dirt cheap if they want). The publisher cannot set a minimum price, and Amazon states that the maximum price will be $9.99. (So my niche-market technical books, which sell for $50 in print form, must sell for an absurdly low $10 in ebook form!) Even more outrageous, publishers agreeing to the terms are forbidden from selling their ebook elsewhere for more than Amazon charges!

That means that Amazon, effectively, would be setting the price of books on Apple’s store. That’s because Amazon sets the price on their store, not the publisher. So if Amazon decides my novel should sell for $2, I guess I have to lower the price to match on the Apple store or else I’m in violation of the agreement!

I do not foresee many publishers taking Amazon up on their offer. I know I won’t. Those are ridiculous terms. Unfortunately for Amazon, their Kindle market is not strong enough for them to dictate them (Kindle ebook sales are still paltry). I’d rather miss out of the Kindle market completely and go with Apple’s new and unknown market than be stuck in such a contract. (Kindle may have the edge today, but I’d be willing to be that by the end of 2010 Apple’s iPad market will be larger.)

I feel sympathy for Amazon. They are caught in a bad position and don’t see a way out. The future is digital and they want to be a part of that, but digital may not be profitable enough for them, at least at the terms Apple has defined. Amazon adds some value over Apple, but as anyone in retail knows, price reigns supreme and no matter how good Amazon’s customer service and website is, they must compete with Apple on price (both on the royalty terms to publishers/authors and to customers). The danger is that Apple can afford to lose money on digital sales if they want. Amazon cannot.

If I was Amazon, I’d just accept that being a dumb pipe is the future and try to be more efficient at selling physical products. I would purchase UPS or FedEx and offer free shipping for all orders. That would give Amazon tremendous clout in the retail market of physical goods. But digital goods, by nature, don’t care what pipe they travel down. Amazon is attempting to control that market by inventing weird contract terms and other artificial controls. (We’re seeing this same battle for control developing in cellular networks and cable/satellite providers.)

Most alarmingly, and a clear sign of Amazon’s panic and the high stakes in this game, Amazon has gone nuclear, dropping the biggest bomb it can on MacMillan by removing all their products. That is huge. I said earlier that it is going to backfire and it will: content makers are terrified of the clout of large sellers like Amazon, Barnes and Noble, and Walmart. They are already wary of Amazon. Instead of Amazon trying to lure them in with more attractive terms than Apple, Amazon is attempting to bully them. The result, I predict, will be droves of publishers lining up to support Apple’s book platform. They fear Amazon and don’t want to be blackmailed. Amazon, by showing that they are willing to go nuclear, has made a horrible mistake. Publishers aren’t going to commit financial suicide by abandoning Amazon in protest, but you can bet that every single one of them is exploring other options, such as Apple’s new store. If Apple’s iPad is even moderately successful as an ereader, you can bet that publishers will flock to it as a way to escape Amazon’s grip.

This is an exciting time. Dangerous, thrilling, and unpredictable. Giant industries such as publishing, TV/film, and cable/satellite, are going to have to change the way they do business. Digital content and distribution is upsetting the old ways of doing business. It’s not going to be an easy transition, but it will happen. It’s inevitable. But in the meantime, there’s going to be pain and adjustment on both sides. The Amazon-MacMillan battle is just the first skirmish of a long war.

[Update: Since I posted this, Amazon has capitulated and given in to MacMillan so this particular battle is done. It’s also of note that Amazon has apparently used this nuclear option before, against UK publisher Hatchette, forcing them to capitulate to Amazon’s terms. However, I don’t think either of those things changes what I’ve said here: Amazon realized their mistake and they have spooked publishers just before a new option for those publishers opens (Apple’s bookstore), and Amazon will regret their decision to go nuclear.]