Value of a Book, its Price and Cost

How do you measure the value of a book, or more specifically its content? How much are you willing to pay?

The answers lie in what the reference price. For people like me who wait for the book to come to public library and read it, the reference price is $0.00. For those who wait for the paperback, the reference price is somewhere in the $6-$12 range. For those who frequently buy hardcover books when there are published the reference price is what they typically for their purchases.

All these three segments may very well derive a high value from the books be it entertainment or education, but their willingness to pay is decoupled from the value due to reference price.

Now Amazon is trying to shape this reference price among frequent book buyers to be $9.99, the price they charge for Kindle books. Before Kindle, Amazon was a price taker. The publishers set a price and Amazon decided its retail price based on its cost. Now with Kindle Amazon can become the price setter  and gain upper hand in the value chain. The first step is training the customers to expect a fixed price of $9.99 on books.

(As an aside, I think Kindle is a great device and provides an easy way to read books. I would love to get a Kindle and hope someone will give this to me as a gift.)
Amazon argues that the cost structure of physical books and Kindle books are different and hence the Kindle books should be sold at a lower price than paper books. The New York Times quoted Mr. Jeff Bezos, CEO of Amazon, saying

“E-books should be cheaper than physical books. Readers are going to demand that, and they are right because there are so many supply chain efficiencies relative to printing a paper book,”

How does the cost matter when the value people get from a book is the same? A reader derives same vaue from the information content of the books regardless of the format. There are differences in convenience factors but Kindle’s advanced featurs like highlighting and  notes taking etc makes it superior to paper books. It does not because customers do not care how much it costs to produce a book.

But Amazon is happy to talk about cost here for two reasons. First it stands to gain from switch to electronic format from logistical savings and second its price to customers is based purely a markup on prices publishers sell their books to Amazon. Furthermore talking about costs only helps to build a reference price in the minds of customers that Amazon can use to negotiate better prices with publishers. As I said before I still believe Amazon’s strategy is to be THE distribution channel for books by owning the format and the medium. Training the customers and shaping their reference price is the first step.

How Does Kindle Fit In Amazon’s Strategy

Amazon.com sells its Kindle books below costs, at a flat $9.99 even though the publishers charge amazon.com the same price for their hardcover books.  While the devices are still not priced for the mass market, probably due to high costs, amazon.com is trying to encourage higher adoption for its eBooks. It is my theory that Amazon may not want to be in the Kindle business. There are several reasons:

  1. It is a low margin business except for Apple which found a way to sell at premium price
  2. The customers are fickle minded and hard to satisfy with designs, many a hits like Palm and iPaq have lost their traction now.
  3. The current design,  despite being a very well crafted one, is still rudimentary. There are many possibilities. This is just a start. This is a carefully chosen strategy by amazon.com, no one know how the most popular eBook reader is going to look like.
  4. amazon.com is subsidizing the Kindle books for two reasons. One to reduce total cost of ownership of Kindle devices to customers, second to increase the footprint for the Kindle format.
In the value chain of authors, publishers, distributers (amazon.com), and customers the power is shifting and the medium used for books is changing.  amazon.com, as it had always done,  is shaping its own future and not waiting for it. It is driving the new format, reduce the value captured by publishers and position itself to be the distribution medium of choice. The goal is to capture the format market and control the value chain and not the devices market. Since no one else s making such devices amazon.com took this on itself.  
If the above thesis is correct, then the logical next step is for amazon.com license the reading format and publish the reference design to have others compete in the devices market. Kindle proved the point, now it is time for it to become the “Kindle Inside”.

Selling Kindle Books Below Cost

The New York Times reports on the eBook for Kindle pricing by Amazon.com. Most books go for $9.99 According to the report, most books are sold below cost, because the publishers sell the books at the same cost of print books.

Amazon sells most Kindle books for $9.99 or less. Publishers say that they generally sell electronic books to Amazon for the same price as physical books, or about 45 percent to 50 percent of the cover price.

The Kindle itself goes for $399, while the books are sold at a a lower price than print books. A model that very much resembles the iPod and iTunes songs pricing model. But Apple’s strategy was to sell more iPods and the iTunes was just part of the ecosystem. Amazon on the other hand sated the change in the way books will be read in the future and made Kindle as part of its strategy to lead the next version of books. If Amazon wants to dominate the format it should have priced the Kindle at a lower price and charged a higher price (at least above the cost) to grab market share.

So why would Amazon price below cost? Conversely why would the publishers charge the same for eBook when they do not incur the same cost of physical books, like materials, labor , warehousing and distribution costs? The questions are related but the answers are not.

First the publishers see a very small uptake for eBooks while there are 100 million people who still buy physical books. The do not need Amazon’s Kindle, but Amazon needs them. So they do not need to give a price rent to Amazon. They may be uncertain about DRM protection. Any sale they make on Kindle comes at the expense of the physical book sales (cannibalization), so they want Kindle sale to pay the same margin. They also do not want to discount the eBook for fear of the low price expectation creeping into physical books market.

For Amazon, I do not know why they do not do the Razor-Blade pricing. If they want to gain upper hand in the channel relation they should have priced Kindle lower than $399. The books on Kindle also provide value added features that are not available on a physical book, like search, font magnification for easy reading, convenience etc. So they should charge higher than $9.99 for Kindle books. The possible reason is that their margin on Kindle is already low and they can’ cut further. On the other hand, they must be thinking that eventually they can convince publishers to cut their prices.

By some measures there are 10,000 Kindles in consumer hands. The next move will depend on how the Kindle’s customer base will grow over the next 12 months.

Amazon Prime Numbers

amazon.com offers Prime, a shipping program that offers unlimited second day shipping for a cost of $79 a year. This plan, like Costco membership is considered to increase the sales, as customers enticed by the free second day shipping, shift more of their purchases to amazon and buy more often than they would normally.

How much revenue do these subscribers bring to amazon.com from their annual purchases to take advantage of free shipping? But we do not know how many subscribers are enrolled currently. amazon.com does not break out the number of subscribers to its $79 a year amazon.com Prime shipping program. amazon.com’s 10-K does not spell out the exact revenue from the Prime program, the revenues streams are combined together in a line item “Shipping Revenue”.

Here is an attempt to estimate the number of amazon.com Prime subscribers. The program was introduced in 2005. I computed the jump in shipping revenues year over year from 2002 to 2007. I cannot say much about the increase in revenue excluding Prime. The shipping revenue as a percentage of net sales is also decreasing, an indication of shift to Prime away from single unit shipping revenues. In the first year of introduction, the shipping revenue jumped by $91 million, in the previous year it jumped by $48 million. Since the uptake is bound to be lower in the first year, we can assume that the non-prime shipping revenue grew by the same $48 million in 2005 leaving $43 million to revenue from Prime.

In 2006 and 2007, if we assume the other shipping revenue remained the same, then we can attribute all the increase to Prime subscription growth. All this leads us to conclude that amazon.com has about 3.44 million Prime subscribers.

If we assume a $1000 revenue from each of them (based on shipping cost of 7.5% of total purchase), that is $3.44 billion just from these Prime subscribers. That is 25% of total sales.