Here's How Amazon Took The Lead In The Billion-Dollar EBook Market -- And Why They'll Dominate

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Photo: AP

The most interesting thing about last night’s report that the ebook market will reach $1 billion this year wasn’t so much that number — through it’s impressive, especially considering the growth rate — but that Amazon has a full 50% marketshare there thanks to its Kindle platform.When Apple announced the iPad with its iBookstore many people thought the inferior Kindle would be toast, but by letting people read Kindle books on any device, Amazon has preserved, and even arguably gained, marketshare. Today, most of the people who read books on iPad do it on the Kindle app.

The ebook market is a battle of the titans. It’s Amazon versus Apple versus Barnes & Noble versus Sony. It also crucially involves all the big publishers, who are scared of going digital but know they must embrace it lest they go the way of the music industry, and so have been taking two steps forward and one step back.

But Amazon played beautifully every step of the game. And now, in a market that is growing very big, very fast, and probably has strong network effects, it has an early lead which makes us think it will end up dominating it. In fact, we think Amazon’s marketshare will end up closer to 90%.

Came Into The Market At The Right Time

In business, timing is often everything. The so-called first-mover advantage can be an illusion. First-movers can spend a lot of money educating the market about a new product or service, and watch a fast follower capitalise on that and take the market.

Ebook readers had been around for several years when Amazon came out with the Kindle. Sony had several well-received but ho-hum readers. We don't doubt that Amazon watched them carefully before deciding when to jump.

Built The Right Product For The Right Audience

Amazon didn't try to reinvent computing with its tablet the way Apple did. They just decided to reinvent books.

Unlike Sony's ebook reader, Amazon's Kindle was designed from the ground up with the serious reader in mind. E-paper doesn't just mean it's easier to read on the Kindle, but also that its battery can last for a very long time. You don't think of your Kindle as an electronic device, you think of it as a book.

And crucially, the Kindle includes a wireless telephony link and a 'buy' button (with your credit card on file at Amazon). Amazon pays for the wireless bandwidth to download those books, you don't have to worry about it. It's magical.

What does that mean from a strategic perspective?

It means that even though the Kindle is useless for general computing, it is great for heavy readers. Let's face it, most people don't read for pleasure, especially not long form content. But those who do, love it. By designing their Kindle for this market, and not a more general audience, Amazon locked up very important early adopters.

More importantly for the market and its strategy, because buying books on the Kindle is so easy and painless, and because most Kindle owners were heavy readers already, sales of Kindle books went on fire. This validated the market in an important way, because it showed that even though prices of ebooks would be lower than for paper books, easier impulse buying meant that sales could hold steady. This is important to bring and keep publishers on board.

Set Price Expectations

Publishers want ebooks to sell for the same price as paper books, which is ridiculous. The marginal cost of selling an ebook is basically zero, whereas you have to actually print paper books.

But Amazon knew that this wouldn't fly with consumers. If they wanted readers to adopt the Kindle and ebooks, they needed to price them lower, especially to make impulse buys more attractive.

To get around that, Amazon bought the ebooks 'in bulk' from publishers and then sold back the books, eating a loss every time. It was a very gutsy move, but it was a necessary investment to make ebooks take off. Now Amazon has set price expectations for ebooks for the consumers, and although publishers can still wrangle higher prices now and then, it's going to be much harder for them to do that over the long run.

It also protects Amazon from new entrants -- anybody else who wants to set up a rival bookstore has to match Amazon's price and potentially eat a loss with every sale, or have more expensive books, especially to placate publishers, and therefore an inferior offering.

We should also point out that Amazon probably did a huge favour to the publishers by setting price expectations where they are. Because the marginal cost of an ebook is zero, absent the Kindle their price might very well have ended up being, well, zero. The fact that most consumers don't want to pay for music because they just expect it to be free is what's currently eating the music industry alive. The Kindle didn't just set price expectations for ebooks below those of paper books, it also set them at a level above zero, which is much more important for publishers over the long run as they navigate the transition to digital.

Wrangled Publishers

Of course, for Amazon to dominate the ebook industry, it needs to keep publishers on board. And publishers don't like Amazon very much.

They don't like Amazon very much because they already know them from its being their biggest sales channel for paper books and, like all successful retailers, Amazon is not known for its kindness to suppliers. So from the start, there was a situation where trust was low. More importantly, publishers have seen what happened to the music industry.

Not only is the music industry dying because of digital, but they're also increasingly dominated by Apple, which has the biggest marketshare in selling electronic music. When Apple was a minor player in the industry and the iPod didn't have much marketshare, joining the iTunes Music Store didn't seem like such a big deal -- an experiment, at worse. But now that Apple's market cap exceeds the total supply of money in the universe and that the iTunes Music Store has 4500% marketshare, labels simply have to go through Apple.

Amazon's wrangling of the publishers hasn't been uneventful. They have had to yield to publishers on several occasions. They've had to raise book prices. In an embarrassing incident, Amazon blocked Macmillan from their site for a day during a dispute over Kindle terms -- and had to bow because they couldn't hold their customers hostage.

But on the whole, the Kindle platform is largely where Amazon needs it to be: huge selection, volume, and mostly low prices. That's because they've succeeded at all the things we've pointed out: because Kindle owners are so many, and are such voracious readers, that's a big, fast-growing market that publishers simply have to be in. And for that, they need to go through Amazon.

As is the nature of such markets, there will always be friction between Amazon and publishers, but right now, Amazon's got the upper hand.

Turned The Kindle Into A Platform

Many people have expected the iPad to be the death of Kindle. Because the tablet is such a superior product (at least for doing everything except reading). And because Apple launched it with an iBookstore with major publisher to compete head on with Amazon.

But the Kindle isn't just about the Kindle device. It's about the platform. At the end of the day the Kindle is a marketplace, with a lot of sellers (publishers, and increasingly authors) and a lot of buyers. The device is secondary.

Amazon realised that, and so they've opened the Kindle platform way beyond the actual device. They bought a company called Stanza that let people read books on their iPhone and turned that into the springboard for a Kindle iPhone app. You can even read Kindle books on the web. And of course they have an extremely successful iPad app. In fact, even though Apple has its iBookstore and promotes it heavily, most people who read books on the iPad do it through the Kindle app.

Amazon smartly realised that if the Kindle sells, it wins, but if the iPad crushes the Kindle but iPad owners read books on their Kindle apps, they still win. At the end of the day, they need the highest numbers of readers to keep publishers on board.

Used Their Heft Smartly

At the end of the day, Amazon is a giant company. This makes it bad at some things, like being very nimble in selling diapers, but that gives it a lot of weight, and Amazon has used its weight smartly.

Because of its size, Amazon could sell the Kindle through its website, probably for a low margin or even a loss, eat a loss on every ebook, and still dominate the industry. It can step up marketing for the Kindle, advertise it on TV, and it can even play hardball with publishers -- but not too much. Amazon decided to pull Macmillan from their store, but they only did it very briefly, because they realise it would piss off customers who would blame them (rightly or wrongly).

They mostly don't bully anyone into being in the Kindle platform, as many big companies do when they try to impose a new standard. They just promote it aggressively and make it a must-have for publishers.

So Here's Why We Think Amazon Will Dominate

Why is this so important?

After all, the ebook market is only a few years old and sure, Amazon has played their cards right so far, but it's only the start. Apple or someone else might still eat their lunch.

That's true.

But the reason why we don't think that will happen is because we believe the ebook market has strong network effects. Network effects are the idea that some products get more useful the more people use it. When a given product or service has strong network effects, what usually happens is that one company takes all the market, because its product grows more useful the more people use it. Think Microsoft and Windows, or Facebook today, which has crushed all other social networks.

When it comes to selling ebooks, the more people there are on one platform to buy ebooks, the more publishers and increasingly authors will have to be on there. The more publishers and authors, the more consumers will go to that platform. The more consumers, the more publishers and authors. And so on ad infinitum.

This makes Amazon's 50% marketshare very important. In markets with network effects, once one company has even a small lead, network effects kick in and they crush everyone else. That's how the digital music market played out with Apple.

We probably think it won't happen overnight, because publishers will want to hedge their bets and give content to other platforms like the iBookstore and Barnes & Noble's Nook. But at the end of the day, we think Amazon will end up with 90%+ marketshare in ebooks.

Of course, anything could yet happen. Amazon could screw up in a major way, or someone else could come up with a novel way to distribute their platform, or something. But on current trends, given the market and given how Amazon has executed, we think they'll end up with 90% marketshare.

BONUS: Amazon's Pretty Funny Kindle Ad

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