On Free Kindle

It appears, at least to Farhad Manjoo, Kindle is going to be free. He writes in recent Slate colum,

I can’t tell you when this will happen. But it will happen. Mark my words: The Kindle will be free.

Let us not delve into how he arrived at such a certainty couched as a measured statement with uncertainties.  Let us take his word for it and look at what it would mean to Amazon’s profits. According to Manjoo, who seems to have a window into Amazon decision maker’s mind and their business strategy,

First, why? Well, that’s easy—because Amazon’s long-term goal is to make money from selling content and general merchandise, not by peddling its own devices.

The case in point is the low-end $79 Kindle that will be free. So what kind of money should Amazon make by selling content and general merchandise by not peddling its device? Let us be aggressive and assume that this low-end Kindle is going to be great to sell general merchandise and not just content.

Again according to Manjoo, Amazon makes no profit on these devices or may be even losing money. Let us say they are indeed selling $79 Kindles at their marginal cost.

Say by making the Kindle free, they sell 20 million of them.

Cost? $1.58B for 20 million units. Just to stay where there are with current gross margin, they have to gain gross margin(not sales) of $1.58B from content and merchandise sales.  To put that in perspective, Amazon’s 2011 gross margin is $10.8B from sales of $48B. At its 22.4% gross margin, this $1.58B means $7B in sales.

And this $7B  sales will all have to be incremental new sales, sales that are made possible only because of the free Kindles. Sales that would have any way happened, because customers do shop even without free Kindle, cannot be counted towards these numbers.

On a per Kindle basis that means every free Kindle user must spend additional $350, above and beyond what they are already spending with Amazon. How likely is that scenario? Say amazon now has 100 million shoppers, its current revenue of $47B means, each shopper spends an average of $470 per year. Can a free kindle somehow add $175 per year (assuming device lifetime of 2 years) to this $470?

Now this is just the simplest of the math. You can see how unfavorable it gets when you add in lost profit from those who buy other Kindle models and Kindle Fire switching to free version.

On the flip side, say if Amazon were able to sell 5 million of the $79 Kindles. As per our marginal cost assumption they are no costs. If Amazon were able to generate the same $175/y in incremental sales from these 5 million customers that is $875 million in new sales and $196 million in new profit – not just the profit they had to make stay at same place but something that actually moves the needle.

Why wouldn’t they do that? If somehow a free Kindle buyer could be coaxed to spend $350 more why is not possible with the one that bought Kindle for $79?

I don’t have the window into Amazon’s strategic mind or the data they are looking at.May be you should ask Manjoo.  Amazon has said before, “economics don’t work for a free Kindle”. That appears as a bluff to Manjoo.

What appears like a bluff to us outsiders may really be the result of strategy guys doing their job – evaluating all possible paths ahead of them and making choices with constraints.

That is the difference between writing something based on one’s wishful thinking and having to make decisions that affects shareholder value.

 

There is something about Kindle and $150 Sunglasses – Results from Conjoint Analysis

Let me start by stating that my previous article about Kindle positioning is most likely wrong and Amazon product managers have definitely done their marketing research well.  There is something about the segment that prefers $150 sunglasses and Kindle.

I will discuss only part of the results from my recently conducted conjoint analysis. I will not be providing here the detailed results, differences across gender and other analysis.

When Amazon introduced Wifi version of their Kindle (priced at $139), Mr. Bezos said,

“At $139, if you’re going to read by the pool, some people might spend more than that on a swimsuit and sunglasses,”

Amazon also ran TV Ads that talked specifically about $139 Kindle being cheaper than Sunglasses.

I did not believe that was a valid positioning, I believed (and wrote),

What job will these segments hire the e-Reader for? The same job they hire their $150 sunglasses for – to make a statement about themselves. For that job, they might be more inclined to hire an iPad than a Kindle.

I recently conducted a conjoint analysis by surveying the Haas Berkeley, MBA class of 2011 (thanks to Hrishika, MBA 2011 for providing access). I did not get enough samples from my twitter followers so I ignored all those samples.

A key finding of the study is, those who preferred $150 sunglasses also preferred Kindle more than they preferred iPad, nook or a $99 Generic eBook reader.

Among those who preferred $30 sunglasses, Kindle had 26% market share – tied for second place with generic eBook reader.

Among those who preferred $150 sunglasses, Kindle had 37% market share – the highest with a RMS of 1.34.

Better yet, my past claim that those who buy $150 sunglasses will also buy iPad is wrong. iPad had the lowest market share of 17% for this segment.

Clearly Kindle has a better chance among this segment and Amazon’s marketing campaign is capitalizing on that. That said, the Kindle Ads take on iPad on readability. It is likely that nook is the bigger competitor to Kindle for this segment than iPad.

The two types of specialized single task devices

In the NYTimes article on Kindle, Mr. Russ Grandinetti, Amazon’s vice president for Kindle content make his case for Kindle thusly,

“If I’m going on a 10-mile run,” he says, “I want a really well-designed pair of running shoes instead of Converse high-tops.”

Another example is cameras.“As good as the technology in my phone camera is, when my son has his third birthday party, I’ll use my 35mm S.L.R.,”

Both are valid examples but do not apply to the case of Kindle. A specialized, really well designed pair of running shoes is a premium product, targeting a small segment and is offered at premium priced. Same goes for a premium SLR camera. The one thing that Kindle does really well is not marketed as a premium feature and is definitely not priced as such.  Kindle isn’t the only single task device either – it is competing in a crowded field of eBook readers all using the same technology (and even the same manufacturer).

There are two types of specialized single task devices that appeal to different customer segments that are willing to trade-off price for benefits from these devices (you can find the segments and the trade-off function using Conjoint analysis):

  1. One that does the task extremely well and appeals only to a small segment that value the benefits more than they value the frills and hence are willing to pay a price premium for it. It stands relatively alone in its category and is not easily copyable. It adds little or no value to the rest of segments.
  2. One that does the task extremely well but nothing else  but is so inexpensive that customers do not mind buying them (like a mobile phone that can only make calls – not even SMS, alarms , camera etc) and do not mind losing them. These are like the dedicated sudoku gaming devices you pick up at Walgreens checkout counter while you are waiting to fill prescription.

Amazon’s CEO, Mr. Bezos stated that Kindle is a dedicated device for avid readers, 10% of the total market. But with the release of $139 Kindle their focus has shifted to making it a mass market device – to make people not think twice to buy Kindle and even make them buy one for each family member. That is not the sign of a premium device, the way it is priced now Kindle resembles the second category.

My hypothesis is, despite selling out Kindle at current prices, we have not seen the last of price cuts before the Holidays.

What if Customers don’t Want to Hire Your Products at Any Price?

Lot will be said and written about the nook and Kindle price war. Success of iPad will be quoted as the reason for the price cuts. Comparisons will be made to razor and blades and why the reader should be free. Will the price cut increase footprint and convince customers who would have bought iPad to buy nook or Kindle instead?

Let us ask the key question on product positioning for nook and Kindle:

What job will the customer hire the product for?

Kindle is applying for the job of, “Easy to read, even in sunlight.  Carry all your books with you.”.   nook is applying for the same job as well. In other words nook and Kindle are paper book replacements. Yes there are social features, and free books in stores (nook) but these are add-ons.

To some segments this is the job they are hiring for. As Mr.Bezos said, this is for serious readers to read without distractions. He also said that less than 10% of reading population are serious readers. For this segment that has decided on the job, they will choose on cost to hire for that job. So the price cut by nook threatened to take away customers who would have bought Kindle hence Amazon had to respond with its own price cut.

Will the price cut make the product attractive to segments that are not looking to hire for the job of easy reading? The answer is mostly likely no.

What job is your customer hiring your product for?

Shining New Light On nook Investment and nooks Sold

Barnes & Noble announced its Q2-FY10 earnings last week. Their balance sheet shines some new light on their cost of nook product development and marketing and the number of nooks they might have produced. nook was so successful that Barnes & Noble cannot anymore deliver one before Christmas nor can it sell through its stores. How many nooks were sold? B&N is silent about the number of nooks they sold, but from their latest balance sheet I estimate they sold about 200K-400K nooks, read on.

12/26/09 Update: Techcrunch says, based on its sources, 60,000 nooks sold but I stand by my 200K-300K estimate unless I get data on cost per unit that is different from the assumptions I made.

  1. Increase in Intangible Assets: Their Intangible assets jumped from $82 million in Q1 to $587 million.  This is surprising for a bookseller. Part of it should have gone towards acquiring rights to digital content and part  to product R&D. The latter cannot be capitalization of their product development costs (3 months is short time),  so I think they bought the design and other patents form outside.
  2. Long-term Debt: There is now long-term debt, to the order of $325 million, showing up in their books. There was no debt in the previous quarter. The long term debt definitely went into their nook product line – for manufacturing and marketing.   B&N does not own the factories, it rents capacity from Prime View International of Taiwan, who also owns the rights to e-Ink technology and makes those displays for all Kindle and Sony as well (source: GigaOm). To guarantee capacity B&N may have had to invest or at least cover part of the assembly line. But I think most of it went into design acquisition (described above).
  3. Increase in Other Long-term Liabilities: Another increase is their “Other long-term liabilities”, by about $240 million. There are no footnotes explaining this. For the purpose of this discussion I would allocate a good part of it towards its increase in Intangible asset (design acquisition).
  4. Cost of R&D: So the total cost to design and manufacture nook is about $500 million – that is going big for a bookseller!
  5. Accounts Payable: Their accounts payable increased by $500 million. It is expected that this would go up as stores build inventories for the Holiday season, but in the previous year it increased by only $200 million from Q1-2008 to Q2-2008. I do not think the other $300 went for stocking more books and merchandise, it must have gone to content suppliers, nook suppliers and for marketing campaigns.  Accounting for the rest, $100- $2o0 million (guesstimate) went to Prime View for making the nook.
  6. COGS for nook: The $100-$2o0 million is possibly allocated for the right to acquire capacity, labor and parts. If we assume half of that $100-$200 million went for parts and if we assume the cost per unit is $250, they made about 200,000 to 400,000 units. Which is what I said they should have manufactured based on the projected market.

If they indeed manufactured 400,000 nooks, given that they are sold out, they must have sold 200,000 to 400,000 nooks in just one month.  That is extremely impressive! B&N has indeed gone really big on nook but still missed the opportunity to price it right!

Footnotes:

The final number is based on the assumptions I made on allocating the step increase accounts payable, the total material costs and cost per unit. Any or all of which can be wrong but at least we have a small range of numbers to work with.

Should Barnes & Noble have Gone Big with nook?

Barnes & Noble received so many pre-orders on its ebook reader nook that it cannot anymore deliver nook for Christmas. With more than a month to go before Christmas, B&N says it can only deliver after January 4th.  It makes me think if they could have done things differently for the launch:

  1. Market size: Forrester says 900,000 eBook readers will be sold just during the holidays. Amazon is the market leader with 65% and Sony the rest. nook is the new entrant, and Barnes & Noble is not saying how many units they sold.  Introduction of this new and better looking and functional device definitely would have grown the market, bringing in new customers who did not want to go with Kindle. B&N should have planned on selling 400K to 500 units during Holidays.
  2. Did they plan on under supply to create buzz? I doubt it, even though brands have previously been accused of doing it to create buzz, Barnes & Noble already had enough buzz going for it with the device and the marketing campaign.  Since they priced it as penetration pricing, shouldn’t they line up the supply chain to meet the volume?
  3. So why did they not plan on selling 400K-500K units? If we assume their margin is so low that nook cost $250 to make, for 500K units the total cost is $125 million. They have no long-term debt in their books (amazing) and could have financed this investment with debt – besides they need not take long-term debt if they could strong-arm their suppliers to delay their account payable until after B&N gets paid. (Update: B&N did take debt but did not have the power to strong arm its supplier because there is only one)
  4. The device looks definitely better than Kindle and they positioned it as such – so why follow Kindle’s price leadership? If they had priced it higher could they have not only handled the lower demand but also delivered more profit?  For instance if they had priced it at $279 with a profit per nook (i am not including book sales) of $29, even if they managed to sell only a third of current sales (which is an unlikely drop) they would make more profit than current price.
  5. Customer Margin: nook profit is about total customer lifetime value, from all those ebooks customers buy, accessories and the 2-3 year refresh cycles. So footprint helps and they do not have to make up all the profit just from the device. But it appears they did not calculate what the demand is going to be and followed Kindle’s lead (which could easily be wrong as well).

Now I waited too long to order a nook and I am not going to gift one for the Holidays.

Update: Here is an estimate of number nook readers Barnes & Noble sold in the early days.