Is Amazon shifting its Core Value Proposition from price to speed?

Two weeks ago, Amazon announced that it intends to build and open its first distribution center in Illinois. Currently, Amazon fulfills many orders to Illinois, including Chicago, from a distribution center in Indiana and others further away. Having a distribution center in Illinois would enable Amazon to provide next-day or even same-day delivery to Chicago customers. However, Amazon also agreed to collect sales tax from Illinois residents as a condition of opening a local distribution center; that effectively represents a 6.25% to 9.75% price increase, depending on the customer, municipality and product category.

Amazon's decision to open a distribution center near Chicago aligns with its recent decisions to open centers near other big cities, including Boston, Charlotte, Los Angeles, Milwaukee and New York Metro (all of which have been announced since September,) and collect sales taxes in those states. In addition, earlier today, Amazon announced an agreement with Hachette to sell its print books and eBooks, after months of public squabbling. The terms of the deal between the two companies are confidential, but both companies have confirmed that Hachette will have the ability to set its own prices for eBooks. That's in line with the agreement that Amazon reached with Simon & Schuster last month, which also gave that publisher the right to set eBook prices.

One other data point, this one anecdotal, is that I recently purchased some food products from Amazon. The company is moving aggressively into grocery sales and delivery with its AmazonFresh service in San Francisco, metro Los Angeles and Seattle. For customers in other areas, Amazon recently launched a service called Amazon Prime Pantry, which enables Amazon Prime members to order a limited selection of non-perishable items for a flat fee of $5.99 with 3-4 business day delivery. That also represents a price increase for Prime customers, who pay nothing for 2-day delivery of other products. I ordered one of the grocery products that didn't require Prime Pantry shipping, but I paid $17.99 for a product that I subsequently purchased for $4.79 from a local supermarket. You can safely assume that much of the price difference went for the "free" shipping.

So, we have multiple points of evidence that Amazon is willing to let its effective consumer prices increase. If that's true, it's a dramatic shift in the company's strategy, which has been to underprice its competition, much like Walmart's now-abandoned "Always the Low Price" strategy. However, if Amazon is willing to no longer be the low-price vendor, what's the tradeoff? Amazon's recent flurry of announcements suggests that it's speed of delivery, and possibly, the ability to provide same-day grocery delivery to the largest metropolitan markets. Amazon is signalling that it intends to offer next-day delivery to perhaps 90% of the continental U.S., and same-day delivery in as many as the 50 largest cities.

I discussed my hypothesis with one of my former clients, and he made a very important point: Anyone can offer the lowest price as long as they're willing to take losses; price is never an effective long-term differentiator. On the other hand, same-day delivery is a powerful differentiator, because it requires massive capital and labor investments that few competitors are willing or able to make. Amazon is making the investments to give it a long-term competitive advantage over not only brick & mortar retailers, but also quasi-competitors like Google that don't have logistics as a core competency. In summary, Amazon is taking some of the money that it's been using to subsidize below-cost sales to consumers and shifting it to capital investments in and labor costs for distribution centers.

If eBook sales are slowing, is it good news or bad?

Not long ago, it was common for eBook sales to increase by 100% or more year over year. Those days are behind us--last year, the rate of eBook sales growth fell into the 20%-25% range. Barnes & Noble released its holiday 2013 sales figures today, and eBook sales increased 13.1% year-over-year.

Some industry observers are saying that eBook sales growth has reached an inflection point, which means that sales growth has hit zero or gone negative. In reality, eBook sales growth is slowing but still positive, and will most likely remain positive for a while. In addition, both consultants and reporters have been overly quick to minimize the effect of the Justice Department's settlement with Hachette, HarperCollins, Simon & Schuster, and most recently, Penguin. (Random House will join the settlement if and when its merger with Penguin is completed.) The settlements are still being phased in, and unless price has little or no effect on demand, we should see the rate of eBook sales increase in 2013.

However, let's say that even with the price-fixing settlements in the U.S. and Europe, eBook sales increases level off or turn negative. Is that good news for the publishing business, or bad?

• Some observers believe that it's good news, because they think that those customers will buy print books instead of eBooks. However, there's no evidence that a slowdown in eBook sales will mean an increase in print sales. In fact, print sales continue to decline, even as eBook sales growth slows down. (Update, January 4, 2014: According to Nielsen BookScan, U.S. print book sales (in units) fell 9.3% for all of 2012. Print book sales fell just under 16% between 2010 and 2012. In the U.K., print book sales (in units) fell 3.4% in 2012.)
• eBooks are the only source of growth for the book publishing business. If eBooks stop growing, we'll see even more consolidation and shutdown of publishers, since cost control will be the primary way to improve publishers' bottom lines.

I don't believe that eBooks' sales growth is going to go to zero, but 20%-30% annual growth may well be the ceiling for the next couple of years. Let's be clear--eBooks (and, to a lesser extent, audiobooks) are the only parts of the book publishing and retailing business that are growing. Everything else is stagnant or declining. If eBooks become stagnant, that's bad news for everyone.

Obama's victory spells bad news for Apple, Macmillan and Pearson

Historically, Republican administrations have been far less aggressive in prosecuting antitrust cases than Democratic ones. Had Mitt Romney won last night, it's likely that the eBook price-fixing case against Apple, Macmillan and Pearson would have been settled on terms far more favorable to the companies, or would have been dropped altogether. That may have been one reason why the three companies refused to settle with the U.S. Justice Department--they thought that they could get far better terms by waiting a few months for a Romney administration. However, with President Obama's reelection, the Justice Department will continue to pursue its case, and will almost certainly make settlement on the same or similar terms as Hachette, HarperCollins and Simon & Schuster a condition for approval of the Penguin-Random House merger. All of this makes a settlement by Macmillan much more likely. At that point, Apple won't matter, because all of the Big 6 will be prohibited from accepting Apple's terms.

Major publishers launch and expand digital imprints

Publishers Weekly writes that Big 6 and other major publishers are stepping up their launches of digital imprints. Some are digital-first, while others are digital-only. Here's a list:

• Penguin is reviving Dutton Guilt Edged Mysteries, which started as a pulp imprint that released 82 noir detective titles from 1947 to 1956, as a digital-only imprint. In addition, its InterMix imprint will serialize titles, starting with the original erotic romance Because You Are Mine, which will be released in eight parts, with one part released each week.
• HarperCollins will double the output of its Impulse digital-first imprint from one title per week to two, and will add William Morrow and Harper Voyager to Impulse.
• Random House's Loveswept is focusing on eBook reissues of Bantam, Ballantine and Dell paperbacks that haven't previously been released as eBooks.
• Hachette's Forever Yours digital imprint does eBooks first, with Print on Demand versions one to two months later; the company plans to have simultaneous eBook and POD releases by the end of this year.
• Harlequin's digital-only Carina Press imprint allows Harlequin's international divisions to release its titles as both print and eBooks.
• Kensington has launched eKensington as a digital-only imprint.
• F+W Media is taking its Crimson Romance eBook imprint from beta test to full release, concurrent with the rollout of a new eBook subscription site for romance titles. In addition, the company's Prologue Books imprint has reprinted eBook versions of 300 pulp fiction titles from the 1940's, 50's and 60's, and will release 30 titles per month.

Google settles some French book scanning lawsuits

Bloomberg reports that Google has settled the remaining lawsuits with the Syndicat National de l'Edition (SNE, the French Publishers Association) and the SGDL Society of Authors (it previously settled with Hachette Livre and La Martiniere Group.) The settlements will allow Google to begin to sell out-of-print titles in France, although no financial terms were released. Google will also sponsor a school-reading program run by the SNE, and will financially support development of a database of book authors and rights-owners by the SGDL Society of Authors.

Did Apple and the book publishers get what they wanted?

With all the Sturm und Drang surrounding the eBook price-fixing charges against Apple, Hachette, HarperCollins, Macmillan, Penguin and Simon & Schuster, and the counter-charges that their actions prevented Amazon from establishing an eBook monopoly, a fair question to ask is: Did Apple and the publishers get what they were after? The short answers are "no," "yes" and "don't forget the Law of Unintended Consequences."

Apple: It may have hoped to become a major bookseller by getting the publishers to force all its competitors to sell eBooks at the same price, but if that was its hope, so far it's failed. Apple's eBook market share in the U.S. is, at best, in single digits, while Amazon still controls around 60% of the market and Barnes & Noble has approximately 25% market share.

The publishers: They wrested pricing control for their eBooks away from Amazon and were successful in getting Amazon to raise its prices. They also, at least in part, enabled Barnes & Noble to become a viable competitor to Amazon in the eBook market (although a good part of the credit should also be given to B&N's own strategies, including selling and supporting its Nook tablets and eReaders in its stores.)

The unintended consequences:

1. Amazon moved quickly to develop a supply of titles that are beyond the control of the Big 6 publishers, first by strengthening its self-publishing efforts with the Kindle Direct Publishing program, and then by entering the publishing business itself with Amazon Publishing. Amazon is now competing directly with the Big 6 for contracts with top authors and licenses for popular backlist titles. Had the publishers not taken away Amazon's pricing power, the company probably would have gone much slower in building up its own publishing business.
   
2. Price-fixing lawsuits have been filed in the U.S. by the Federal government, 16 state governments and private individuals, and in Canada by private individuals. Lawsuits are being considered by the European Commission and Australia. These lawsuits have the potential to cost Apple and the publishers hundreds of millions of dollars in damages and legal costs, not to mention years of management distraction, reputational damage and constraints on how they do business. Hundreds of millions of dollars may be negligible to Apple, which has $110 billion in cash and equivalents, but the cost is much more significant to the publishers. 

Given Apple's inability to turn the deal into significant market share and the publishers' inability to keep Amazon from maintaining control of a majority of the U.S. eBook market, it's hard to argue that Apple's and the publishers' actions were worth the cost.

David vs. Goliath? How about Goliath vs. Goliath?

In the U.S. Federal, state, and private eBook price-fixing lawsuits against Apple and five of the Big 6 publishers, some observers have equated the battle to David vs. Goliath. The defendants are David and Goliath is Amazon, which, they argue, would have monopolized eBooks and wiped out the publishers if they hadn't imposed agency pricing. The problem with both the analogy and the rationalization is that most of the Davids are actually Goliaths. Here's a rundown:

• Apple: Until recently, it was the most valuable company in the world, with $100 billion of cash and equivalents on its balance sheet and profit margins that Amazon, and the other defendants, would kill for. 2011 revenues: $108.25 billion.
• Hachette: The second-largest publisher in the world, and a division of Lagardère Group, which owns magazines including ELLE and Paris Match, a variety of television broadcasters in Europe, a network of duty-free shops, and 7.5% of EADS, which is the parent company of Airbus. Parent company 2011 revenues: $10.02 billion.
• HarperCollins: A division of News Corporation, which owns Fox, The Wall Street Journal (which has been one of the most vocal critics of the Justice Department's lawsuit,) the New York Post, a bunch of newspapers in the U.K. (which are embroiled in an ever-widening phone hacking scandal,) newspapers and broadcasters in Australia, 39.1% of British Sky Broadcasting, and a lot more. Parent company 2011 revenues: $33.4 billion.
• Macmillan: A division of Georg von Holtzbrinck Publishing Group, owner of Macmillan Education, Nature, Scientific American, several German publishers and the newspaper Die Zeit. Privately held; parent company 2010 revenues: $2.98 billion.
• Penguin: A division of Pearson PLC, the world's largest education and trade book publisher; owns Pearson Education, the Financial Times and 50% of The Economist. Parent company 2011 revenues: $9.45 billion.
• Simon & Schuster: A division of CBS Corporation, which owns the CBS television network, multiple television and radio stations in the U.S., Showtime, CBS Television Distribution (which used to syndicate Oprah and still syndicates Dr. Phil and other shows,) and CBS Interactive (which owns CNET among other Internet properties.) Parent company 2011 revenues: $14.2 billion.

Amazon is certainly no slouch; its 2011 revenues were $48 billion. However, that compares to total revenues of the defendants of $178.3 billion. Even if you leave Apple out of the comparison, the parents of the five publishers had revenues of $70 billion. You can argue that publishing is only a small portion of the revenues of some of the parent companies, but books only represent a small portion of Amazon's revenues as well. In 2011, Amazon's media sales, which include books. music and video, were $6.01 billion--12.5% of the company's total revenues.

In short, the conflicts between the five publishers and Amazon aren't David vs. Goliath--they're actually Goliath vs. Goliath. When Apple is added into the mix, it's Amazon that could justifiably be called David.

It's On: U.S. Justice Department sues Apple and five publishers for eBook price-fixing, settles with three of the publishers

The long-rumored eBook price-fixing lawsuit against Apple and five of the Big 6 publishers (Hachette, HarperCollins, Macmillan, Penguin and Simon & Schuster) was filed in Federal court in New York today by the U.S. Justice Department. In addition, the Attorneys General from Texas, Connecticut, Ohio and Pennsylvania are filing their own lawsuits today in Federal court in Texas. Here's a summary of U.S. Attorney General Eric Holder's remarks:

• Hachette, HarperCollins and Simon & Schuster agreed to a settlement, which must be reviewed by the court, with the following terms: 
• The publishers will go back to the wholesale model and allow retailers to set their own prices for eBooks.  Update: Publishers Lunch Direct has clarified the situation (and given the actual verbiage in the settlement, I use the word "clarified" advisedly.) The three publishers will be allowed to continue to offer agency contracts, and they can use variable commissions and discounts to encourage resellers to limit their discounting of eBooks to consumers. However, they can't prohibit resellers from offering discounts. Publishers Lunch Direct claims that this clause prohibits resellers from selling eBooks below the retail price less commission set by the publishers, but I don't read it that way: Resellers can sell eBooks at any price they choose and take as much of a loss as they want. In addition, resellers can refuse to purchase on agency terms, but publishers can refuse to sell to them.
• They will terminate their "Most Favored Nation" agreements with Apple, Amazon, Barnes & Noble and other eBook retailers. 
• They're prohibited from placing constraints on resellers' ability to offer discounts on eBooks for two years. 
• They're prohibited from conspiring or sharing competitively sensitive information with their competitors for five years. 
• They must implement a strong antitrust compliance program. 
• Justice charges that the defendants held regular, near-quarterly meetings to discuss confidential business and competitive matters as part of a conspiracy to raise, fix and stabilize retail prices. 
• They also mutually agreed to seize pricing authority from resellers, agreed to pay Apple a 30% commission on eBooks sold through the iBookstore (and to impose the same 30% on other resellers,) and used most-favored-nation provisions to guarantee that no reseller could sell their eBooks at a price lower than Apple's. 
• According to the statement, "...one CEO allegedly went so far as to encourage an e-book retailer to punish another publisher for not engaging in these illegal practices." 
• Acting Assistant Attorney General Sharis A. Pozen quoted from the complaint as follows: "One executive said that, 'the goal is less to compete with Amazon as to force it to accept a price level higher than 9.99.' And yet another said, 'we’ve always known that unless other publishers follow us, there’s no chance of success in getting Amazon to change its pricing practices.' Our complaint also quotes Apple’s then-CEO Steve Jobs as saying, 'the customer pays a little more, but that’s what you [he’s referring to the publishers here] want anyway.' As you can see, we allege that these executives knew full well what they were doing. That is, taking steps to make sure the prices consumers paid for e-books were higher." 

Apple: Don Quixote de Cupertino?

Update, April 11, 2012: Bloomberg is reporting that the U.S. Justice Department filed suit this morning against Apple, Hachette, HarperCollins, Macmillan, Penguin and Simon & Schuster for eBook price-fixing; Hachette, HarperCollins and Simon & Schuster settled with the Government.

Bloomberg reported that Apple, Penguin and Macmillan are unlikely to agree to a settlement with the U.S. Justice Department over eBook price-fixing accusations, and are preparing to go to court. The three other publishers in the case, Hachette, HarperCollins and Simon & Schuster, are said to be very close to agreeing to a settlement with the Justice Department.

Regular readers of my blog know my opinion on the subject: There's very strong evidence, even if circumstantial at this point, that the publishers imposed agency terms on all of their resellers at almost exactly the same time, including the exact same commission rate, and that all of them threatened to stop supplying eBooks to any reseller who refused to agree. Apple's precise role in the scheme isn't clear, but it's known from Steve Jobs' own words that Apple proposed the scheme to the publishers and knew that it included the part about refusing to sell eBooks to any reseller (including Amazon) that didn't agree.

Apple may believe that it didn't coordinate the actions of the publishers (or that it's covered its tracks well enough that the Justice Department can't prove that it did coordinate their actions.) It may also not want to agree to a settlement for fear of its impact on the civil price-fixing case underway in New York. However, in my opinion, Apple is taking a huge risk by not settling the case before it goes to court.

As it looks now, Hachette, HarperCollins and Simon & Schuster are close to a settlement. If they settle, they'll enter into what's called a consent decree, which doesn't require them to assume guilt for the charges. They'll be required to change their business practices, possibly pay a fine, and agree to court supervision for a limited period of time. The pain and reputational damage will be over quickly. For Apple, Penguin and Macmillan, however, their senior executives are in for months of depositions, they'll be required to provide many thousands of documents as part of the discovery process, and the court trials and appeals will likely take years to play out.

In addition, the Justice Department will be able to compel Hachette, HarperCollins and Simon & Schuster to testify against the other three companies. They'll have immunity as a result of their settlement, and they'll have no reason to protect their competitors or Apple. This is a standard part of most price-fixing cases: One or more defendants cut early deals with the Justice Department and gain immunity, and then they provide evidence against the other players in the price-fixing scheme.

The worst possible outcome for Apple would be for it to lose in court, even if it eventually wins on appeal. All they have to do is look at Microsoft to witness the damage that could be done. That case was eventually settled with a consent decree, but Microsoft was under court supervision for ten years. The company could no longer pursue the aggressive tactics that it had used in the past to suppress competition. Most importantly, it became a convicted monopolist, which changed both the public's perception of the company and the stakes for any future litigation. (When Bill Gates eventually passes away, stories about his philanthropy will have to share time with the videos of his depositions.) The press was no longer afraid of retaliation by Microsoft's public relations department for running negative stories, and Microsoft lost control of its messages.

Apple is unafraid of litigation, as witness its myriad lawsuits against Android licensees. In Walter Isaacson's biography, Steve Jobs clearly saw Android as not only a theft of Apple's intellectual property by Google, but a personal betrayal by Google Chairman Eric Schmidt, who served on Apple's board of directors for years. Jobs swore that he would spend Apple's entire cash horde, if necessary, waging "thermonuclear war" on Google and Android.

Unfortunately for Apple, its cases against Samsung, HTC and Motorola have been far from the "slam-dunks" that Jobs thought they would be. Apple has estranged perhaps the most important component supplier for its mobile products, Samsung, and it's being forced to bring alternative vendors up to its quality and deliverability standards. For example, Apple had planned to launch the new iPad with three LCD vendors, LG, Samsung and Sharp, but only Samsung was able to meet Apple's quality requirements and ship in the necessary quantities in time for the launch. In addition, some of Apple's own patents are being challenged and could be invalidated.

Apple, like Don Quixote in Cervantes' novel, enjoys its battles. Unlike Quixote, however, Apple's opponents fight back, and are likely to hurt Apple much more than Apple hurts them.

Is the $9.99 eBook dead? Not at all

Earlier today, Gizmodo pronounced the $9.99 eBook dead, as a result of an announcement by Hachette that it is joining Macmillan (and probably HarperCollins) in instituting an agency pricing model where resellers such as Amazon and Apple will get a 30% commission on sales of eBooks at prices set by the publishers themselves. (I've learned from a source that Penguin is working on its own agency plan to be announced in a few months.) Of the Big 6 trade publishers, only Random House and Simon & Schuster would be without an agency model for sales of eBooks.

In response, Amazon has a number of tactics that it can execute. First, it can limit distribution of print titles from publishers who impose agency deals. The "nuclear option" that Amazon exercised against Macmillan backfired because the company "capitulated" almost immediately. However, a longer-term strategy of purchasing fewer print copies of Macmillan's titles, letting them go out of stock more often and taking longer to refill inventories would serve the same purpose. If the eBooks are available day-and-date with print versions and in unlimited quantities, while the print versions are often out of stock, it would provide more incentive for readers to move to eBooks.

Amazon could also play one publisher against the other, offering more promotional support and even co-op funds to help pay for newspaper, magazine and television advertising, in return for more pricing flexibility. Those publishers who cooperate would increase their revenues and/or decrease their costs, and would put pressure on other publishers to fall in line.

Finally, I expect Amazon to get even more aggressive in pursuing electronic rights from established authors. Many established authors or their estates have contracts with publishers that predate the eBook era, so they retain their eBook rights. There is a strong body of legal precedents and settlements that favor the authors and estates in cases where their print publishers claimed eBook rights that they had not specifically been granted. Amazon can price these titles at $9.99 or less and still offer extremely attractive financial deals to authors.

In short, the $9.99 eBook is far from dead, and Amazon still has many ways to prevail in the long term.