Manufacturers of e-Readers

Why would Amazon price e-books below cost?

Three strategies come to mind that involve below-cost pricing.  The first is Amazon could be using e-books as loss leaders.  Loss leaders are products sold by retailers at less-than-profitable prices.  The very low prices of the loss leaders attract customers to the retailer's store, where the customers may then purchase other, higher-margin products.  However, in the case of e-books, it is unlikely Amazon is using them as a loss leader. Kindle users who are attracted to Amazon by low e-book prices are bound to buy more e-books, rather than other, higher margin books or other Amazon products.  In this case below-cost-pricing would simply generate losses for Amazon.

The second strategy that involves below-cost-pricing is the razor and blades model, now probably better recognized as the printer and ink model.  Applied to the Amazon situation, this would mean Amazon is selling e-books at very low prices in order to encourage sales of high-margin Kindle e-readers, where the high profits generated from sales of e-readers would more than compensate for the losses associated with sales of e-books.  It is doubtful that Amazon is using the razor and blades model, though.  Properly applied, the model would entail losing money on the system component that is purchased by system users one time (that is, the hardware component), while making up for the losses on sales of components that are purchased repeatedly (that is, the consumables component).  In other words, if Amazon were using the razor and blades model, it would sell the e-readers at low prices, and it would sell the e-books at high prices, which is exactly the opposite of what it is doing.

This leaves the low introductory pricing model, which makes perfect sense here.  Applied to the Amazon situation, this entails offering e-books for sale at low prices during some limited initial offering period, so as to encourage user adoption of Amazon’s e-book/e-reader system.  This strategy is particularly effective, since the system being adopted involves network effects: the generation of an initial base of installed Kindle users will attract more suppliers of e-books for the Kindle, which will lead new users to subsequently adopt the Amazon’s e-book/e-reader system.   Once a large enough base of users has committed to Amazon’s system, Amazon will then be able to increase the price of e-books to more “reasonable” levels.  At reasonable e-book prices, the base of Kindle users will still buy e-books at the higher prices, because it will be cheaper than switching to a different e-book/e-reader system (such as an Apple iPad), and the network effects (increasingly large availability of e-books for the increasingly large base of Kindle users) will continue to attract new users to adopt Amazon’s system.

Why would Apple price e-books above Amazon, risking a competitive disadvantage?

A blog entry by Lima Al Azzeh offers this reasoning for Apple’s pricing strategy:

Apple’s decision to introduce variable pricing in the digital books industry was a well-learned lesson they applied from negotiations with major record labels over iTunes prices last year.

In April 2009 Apple announced that they were going to vary the prices of songs, moving away from the 99-cent standard, after negotiations with four major record labels. The price of more popular songs rose to $1.29, while the price of “oldies but goodies” were dropped to 69 cents…

Though Apple agreed to the terms of variable pricing, they did so in exchange for the rights to sell songs that are stripped of copy protection software. Removing DRM (Digital Restrictions Management) from iTunes songs would allow consumers to freely move their songs between PCs and other digital devices. In negotiating this exchange, Apple was able to leverage the strength of their brand to ensure that customers would continue to use iTunes as their primary resource for downloading music, despite rising costs.

Based on the fact that Apple immediately employed the variable pricing strategy when it came to digital books, one can safely assume that they’ve learned their lesson. Not only that, but in agreeing to this system from the beginning, Apple has created an alliance with major book publishers by showing that they too have a vested interest in protecting the interests of, what Scott Westerfeld of The Guardian so elegantly described as, an “ancient industry with many arcane traditions that's in a state of technological flux”.

Virginia Postrel of The Atlantic offers this insight:

As many commentators have noted, Amazon is not just selling e-books. It's also selling the Kindle. To encourage sales of its device, the company has even been willing to sell Kindle editions for less than the wholesale price it pays for them. It's presumably maximizing profit on the whole system, not just each individual title.

Apple, too, is a system seller, and a device company to boot. But it doesn't have to sell a single book for the iPad to succeed. Books are just one app among many... The iPad is exciting not as a way to sell or read books as they currently exist but as a tool for reinventing them as multimedia. The book angle also helps generate good press, since journalists are desperate for any evidence that writing will pay in the future.

Apple doesn't need to maximize book sales. It simply needs to keep publishers happy enough to maintain an impressive sounding inventory of titles while waiting for entirely new forms of publishing to develop. After all, as Steve Jobs famously put it, "people don't read anymore."