Why Advertising Could Become Amazon's Knockout Punch

It all started harmlessly enough with Amazon's Kindle with Special Offers. That's the cheaper Kindle that displays ads when the device is in sleep mode or at the bottom of the screen when paging through the owner's catalog of books. It is very unobtrusive and, since it lowered the price of the device, has made that Kindle an extremely popular device.

Now there are rumors that Amazon is selling ad space on the Kindle Fire's welcome screen. That sounds pretty reasonable too as it's a simple way for Amazon to drive a bit of additional income that's pure profit for them.

Given that Amazon's goal is to offer customers the lowest prices on everything, what's the next logical step? How about even lower prices on ebooks where Amazon starts making money on in-book ads? Think Google AdWords, built right into the book. Of course Amazon won't want to use Google's platform. They'll use their own so they keep 100% of the revenue.

The changes the DoJ is requiring for the agency model means a retailer can't sell ebooks at a loss but they can still sell them for no profit, or breakeven. IOW, the 30% the retailer would keep on an agency ebook sale can be passed along to the customer as a 30% discount on the list price, but that's as deep a discount as that retailer can offer.

The rules are different with the wholesale model. Amazon already loses money on sales of many wholesale model ebooks. Let's talk about a hypothetical wholesale model title with a digital list price of $25. Amazon is required to pay the publisher roughly half that price, or about $12.50 for every copy sold, but that ebook might be one of the many that are listed at $9.99 for the Kindle. So every time Amazon sells a copy they lose $2.51 ($12.50 minus $9.99). Amazon has deep enough pockets to continue doing this though, so they're quite comfortable losing money and building market share.

So what's preventing Amazon from taking an even bigger loss and selling that ebook for $4.99 or 99-cents instead? In the wholesale model world, the answer to that question is "nothing is preventing them from doing that." And if selling ebooks at a loss for $9.99 makes sense, especially when it comes to building market share, why doesn't it also make sense to sell them at $4.99, 99-cents or even zero for some period of time? It probably depends on how much pain Amazon wants to inflict on other retailers and how much attention they're willing to call to themselves for predatory pricing.

Make no mistake about the fact that Amazon would love to see ebook pricing approach zero. That's right. Zero. That might seem outlandish but isn't that exactly what they're doing with their Kindle Owner's Lending Library program? Now you can read ebooks for free as part of your Prime membership. The cost of Prime didn't go up, so they've essentially made the consumer price of those ebooks zero.

Why wouldn't they take the same approach with in-book advertising?

At some point in the not too distant future I believe we'll see ebooks on Amazon at fire sale prices. I'm not just talking about self-published titles or books nobody wants. I'll bet this happens with some bestsellers and midlist titles too. Amazon will make a big deal out of it and note how these cheaper prices are only available thru Amazon's in-book advertising program. Maybe they'll still offer the ad-free editions at the higher price, but you can bet they'll make the ad-subsidized editions irresistable.

Remember that they can only do this for books in the wholesale model. But quite a few publishers use the wholesale model, so the list opportunities are enormous. And as Amazon builds momentum with this they'll also build a very strong advertising platform. One that could conceivably compete with Google AdWords outside of ebooks too.

As long as Amazon still has to pay the full wholesale discount price publishers and authors won't suffer. Other ebook retailers will though. Imgaine B&N trying to compete if a large portion of Amazon's ebook list drops from $9.99 to $4.99 or less. Even with Microsoft's cash injection B&N simply doesn't have deep enough pockets to compete on losses like this, at least not for very long.

At the same time Amazon will likely tell publishers they only way they can compete is by significantly lowering their ebook list prices. They'll have the data to show how sales went up dramatically when consumer prices dropped to $4.99 or less. I wouldn't be surprised if Amazon would give preferential treatment to publishers who agree to lower their list prices (e.g., more promotions, better visibility, etc.)

By the time all that happens Amazon probably has more than 90% of the ebook market and a nice chunk of their ebook list that no longer has to be sold at a loss. And oh, let's not forget about the wonderful in-book advertising platform they'll have built buy then. That's an advertising revenue stream that Amazon would not have to share with publishers or authors, btw, and that might be the most important point of all.

What do you think? Why wouldn't Amazon follow this strategy, especially since it helps eliminate competitors, leads to market dominance and fixes the loss leader problem they currently have with many ebook sales?

Comments

[Leah Thompson]

I've been thinking for a while that Amazon's biggest advantage (in terms of direct revenue) over regular bookstores is advertising and other B2B activities. Unlike brick and mortar stores, which only have so much space for co-op deals, Amazon can sell an almost infinite amount in co-op like advantages: extra content for each book on the site, search campaign advertisements, email blasts, and more. I think maybe advertising is already their knockout punch-- and they will continue to explore new ways to leverage their space and bring down product costs for the end consumer.

[SullivanStPress]

I agree that this is part of the Amazon strategy--to be as predatory as possible so that they capture 100% or as close to that number as they can get in the capture the publishing industry. Most people don't want to believe that this can happen or that this is their intention. The short sighted among us who just see their own or their company's sales reflected on the positive side now are ostriches waiting for their ship to come in. (Excuse the mixed metaphor, but that is about as misguided as these folks are as well.)

Anyone who believes that Amazon hasn't been working those algorigthms to find the best possible way to take the whole pot has also been hiding their head in the sand.

And that agency model anti-trust case? Where did that idea come from? Who set up the Feds to look into that? Yes, I do see the very wicked hand of Amazon in most things these days. We all should be ashamed of ourselves and stop hitting that buy button without asking ourselves some real questions like who is packing those boxes for us? What are they being paid? What are their benefits? Who is worried about them? Not their states or Amazon. We too are way too greedy for cheap goods at any cost to others.

Truly this is a situation of buyer beware.

Deborah Emin, Sullivan Street Press
www.sullivanstpress.com

[Jim Jefferson]

It's a strategy to enhance their industry. Discounts can attract many potential consumers and it will use it to show them that it is more practical to buy books in Amazon than in bookstores. But the truth is, its sales has increased.

[Brian]

I sure hope this plan is for a NEW version of the Fire with "Special Offers," which people will buy with the understanding that the ads will subsidize the purchase price, because this is NOT the deal I signed up for when I bought MY (currently ad-free) Fire.

[Evan Perriello]

The problem with the idea that ad-revenue wouldn't hurt publishers or authors unfortunately evaporates as we get further into your scenario. As you say, "I wouldn't be surprised if Amazon would give preferential treatment to publishers who agree to lower their list prices (e.g., more promotions, better visibility, etc.)"

The problem is, Amazon is going to be able to dictate what "preferential treatment" means as they gain more market share. It may begin with publishers getting their books featured on the homepage of the Kindle if they drop to $7 instead of $10. Well, that's great and may really push sales--well worth it for the publisher. But once that model becomes standard and Amazon is the only ebook retailer of any import, why wouldn't they start making books findable by keyword search only if you agree to their pricing of $7 and then you get homepage status if you drop to $5. Rinse and repeat.

They're not above that sort of bullying--they've proved it again and again in the world of print publishing. And the end result is that Amazon is making tons of money on ads--money they don't have to share with authors or publishing houses--while the books themselves become completely devalued, the publishing houses lose their profit margins in the constant fight to just keep getting some sales, and authors soon find themselves getting nothing for their books.

Amazon has also shown that they want to cut out the middle-man wherever possible (everyone in publishing, essentially) for their own gain. While no other publisher will be able to offer monetary gains to authors, Amazon will be able to offer boatloads of money to prominent writers to be published through Amazon.

So, we have Amazon as both the only retailer and the only meaningful producer of books in this country (and soon the UK, Australia, EU, etc.)

If things go the way you've suggested, the only question becomes, how evil will Bezos be when there are no checks placed on his monopoly at all? Are we thinking very evil, because I'm thinking very evil? And has anyone noticed that over the years, his appearance has progressed from goofy-looking nerdy type to full-on Bond-villain? Just saying.

[Ross]

I really do not think readers will stand still for in-book ads. They barely stand still for commercial television in-show ads. If Amazon introduces in-book ads, they will get far less response than they expect. If they force in-book ads (by dropping any support of adless ebooks), they will lose huge amounts of market share. It's just not what people who enjoy reading WANT. They want a book, not a web page.

[Mike Shatzkin]

Joe, I don't think you have the limitation on discount control that is in the settlement agreement right. A retailer may apply their aggregate margin to discounting; it isn't managed on a book-by-book basis. So Amazon (or any retailer) can sell the books of Hachette, S&S, and HarperCollins (assuming the settlement goes through) at any price they want, down to a penny, as long as the cumulative discount doesn't exceed their cumulative margin.

Which I guess makes your overall case stronger, not weaker.

This also creates a monitoring and enforcement nightmare, which was my point in my letter to DoJ.

http://www.idealog.com/blog/letter-to-the-doj-about-the-collusion-lawsuit-and-settlement/

[Dick Hartzell]

The major problem I have with Joe's scenario is his reliance on the Kindle Lending Library to illustrate Amazon's interest in getting ebook prices down to zero. I have a Kindle Fire, and while it's been a while since I explored the offerings in the Kindle Lending Library (my borrowing privileges expired after a month because I chose not to sign up for Amazon Prime) when I did I found the selection seriously underwhelming. I recall scouring a dozen or more pages of listings and coming across only two titles I'd heard of -- Howard Jacobson's The Finkler Question, which I read, and Jared Diamond's Guns, Germs, and Steel, which I didn't get around to before my free Prime membership trial (and borrowing privileges) ended.

Publishers are clearly reticent to make their titles available in the Kindle Lending Library and I see no reason why that should change if presented with the option to make their ebooks available at very low prices with ads. Sure, Amazon could sweeten the pot by offering publishers a cut of the ad revenue, but apparently Joe doesn't think they need to do that. Amazon could also allow a cooperating publisher a share of ad time to promote their own titles, but that also seems to go against Joe's idea.

Of course, if Amazon's the only game in town the scenario changes dramatically -- but Joe's prediction suggests Amazon will *become* the only game in town by following this low-cost-ebook ad strategy ... and I don't see publishers playing ball unless they're promised something Joe doesn't seem to think Amazon will feel compelled to offer.

[Joe Wikert]

Mike, I get your point but I still figure there are more limitations overall for retailer discounting with agency than wholesaler. You're right to say that a retailer could sell one book at a deeper discount than their agency cut but then they'll have to make that up by not going deep on the discount for another book. In the end, yes, it's all about the total. But in the wholesale world that same retailer could sell every publisher's book for a penny and not be forced to offer lesser discounts on other portions of the list.

[Joe Wikert]

Dick, I'm not basing my point on the lending library alone. From day one it's clear Amazon has been pushing for lower and lower prices. That's great for consumers and as long as they are forced to pay publishers the full net price it doesn't harm the publisher or author either. But the fact that Amazon has been willing to sell all these books at a loss for several years now is one data point. Another data point is the simple fact that Jeff Bezos has said time and again that one of Amazon's goals is to offer the lowest prices. There's nothing wrong with that...unless your objective is to sell at a loss till your competitors are gone. You're also right that Amazon may not be the only game in town when it comes to in-book ads. The problem right now though is that I don't see any other retailer heading in that direction like Amazon has already with their Kindle Touch "with special offers" and soon, apparently, a Fire to match.

[Arthur Biblioteka]

Sometimes Amazon policy is weird. But they are strong player on the market so I don't know if someone can be threat for theirs current position.

[Lucgross]

do you think literature based advertisements are possible? e.g the ad is about the shoes someone in the plot is wearing? and as the reactive moment - authors start to write with this in mind to generate more revenue? just thinking about it, as it is the first time in history of advertisements something like this would technically no problem at all. how about the copyrights on using those shoes outside a plot? wouldn't this be the ultimate "special offer"?

[Joe Wikert]

Yes, I definitely think literature-based ads will be possible. Think of Gmail, where those ads appear to the right, away from your inbox, but with the book's content in that main frame instead.