Our article from two weeks ago, Publishing’s Ecosystem on the Brink: The Backstory, and similar articles spur frequent comments online that Amazon is simply reaping the rewards of its innovation, that its growing dominance of book publishing is merely a demonstration that the free market is functioning as it should. This isn’t really what’s been happening.
Useful innovation should of course be rewarded, but we've long had laws in place (limits on the duration and scope of patent protections, antitrust laws, stricter regulation of industries considered natural monopolies) that aim to prevent innovators and others from capturing a market or an industry. There's good reason for this: those who capture a market tend to be a bit rough on other participants in the market. They also tend to stop innovating.
Amazon's first Kindle, released in November 2007, was certainly innovative, but its key breakthrough wasn't any particular piece of technology. Sony had already commercialized e-ink display screens for handheld e-books in September 2006. (E Ink, a Cambridge company co-founded by MIT Media Lab professor Joseph Jacobson developed the displays used by both companies.) Amazon's leap was to marry e-ink displays to another existing technology, wireless connectivity, to bring e-book shopping and downloading right to the handheld device.
Amazon's innovation, in other words, was to untether the Sony device and put a virtual store inside it. This is no small achievement, and Jeff Bezos's particular genius seems to be his ability to grasp the transformative potential of this sort of thing long before others do, just as he saw the potential of databases and the Internet to facilitate shopping for books and the potential for one-click shopping to ramp up online sales before most others had caught on.
Amazon's reward for developing the wireless e-reader should have been that it would become a significant vendor of e-books and earn a profit commensurate with the value it added to the publishing ecosystem. Whether it would then continue to be a significant e-book vendor should have depended on whether it continued to innovate and provide good service to its customers. Amazon's reward should not have included being able to combine its wireless e-reader, deep pockets, and an existing dominant position in a related, but separate, market -- the online market for physical books -- to prevent other vendors from entering the e-book market. Amazon's reward as an innovator, in other words, shouldn't be getting to wall itself off from competition.
By all appearances, this is precisely what Amazon was trying to pull off two years ago, when it removed the buy buttons from nearly every Macmillan book. Amazon removed the buy buttons for both e-books and, stunningly, print books, even though its disagreement with Macmillan was confined to the sales terms for e-books. Amazon had about 90% of the market for e-books at the time, but that market was then quite small: Macmillan could handle Amazon's e-book blackout indefinitely. Amazon's 75% of the online print book market, on the other hand, provided real leverage on Macmillan, and Amazon chose to use that leverage. By using its print book dominance to dictate terms in the nascent e-book market, Amazon crossed a clear, anticompetitive line.
One anticompetitive tactic in service of another
But it was even worse than that. Amazon had deployed its buy-button removal weapon before, but never so publicly, never on such a massive scale, and never (to our knowledge) as a means of shielding its ability to use a separate anticompetitive tactic: its practice of routinely selling e-books at a loss. Such practices, commonly known as predatory pricing, are a means of using superior capital resources not to innovate nor to provide better service, but to weaken or eliminate competition.
In Amazon’s hands, predatory pricing can be a particularly potent weapon. Surely no retailer in American history has had anything approaching Amazon’s database of deep, detailed, real-time market knowledge. This database eliminates the guesswork from marketing, as Amazon can run countless pricing experiments and immediately analyze the results. With this information, predatory prices can become smart bombs that are precisely targeted to maximize the sales of the latest Kindle to the most desirable categories of consumers, for example, or to maximize the losses of an incipient competitor.
… in service of a third
Predatory pricing could, in turn, help Amazon buttress its other critical barrier to entry into the e-book marketplace: its use of a proprietary e-book format, rather than the industry-standard epub format. Kindle owners would naturally be reluctant to switch to incompatible devices after they had sunk money into a personal e-library of Kindle editions. Viewed this way, Amazon’s costs incurred in selling e-books at a loss amounted to an investment in erecting walls around its young, booming e-book marketplace. The more Amazon succeeded in locking customers in to Kindle’s device and format, the less rewarding the market for any potential competitor. Amazon’s investment could pay off handsomely as the e-book market took off.
Amazon’s blackout of Macmillan’s titles came at a critical moment. Barnes & Noble, Amazon’s most significant bookselling rival, had just begun shipping its Nook e-reader the month before the blackout. The Nook was the first direct threat to Amazon’s e-book dominance, the first wireless e-ink challenger to the Kindle. Though sales of the Nook were reportedly brisk, Barnes & Noble could never hope to win a war of financial attrition with Amazon. If Amazon could compel publishers to fall in line with its predatory pricing of e-books, it could eliminate a thinly capitalized but potent (because of its physical, brick-and-mortar presence) competitor from the e-book market. It could smother Barnes & Noble’s Nook before it could pose a genuine challenge.
Amazon backed down -- though not before decrying Macmillan’s “monopoly” over its books -- and restored the print and e-book buy buttons. Macmillan and its thousands of authors regained access to the marketplace where 75% of online book buying transpires. The buy-button removal tactic had, for once, backfired on Amazon; the publicity over the blackout had taken a decidedly negative turn before the company changed course. Barnes & Noble would get a toehold in the e-book market, and, as we described in our last post, would turn out to be a surprisingly nimble and innovative competitor in the e-book market.
That rare setback for Amazon may yet prove to have been but a speed bump: through creative use of its capital and ever-growing market power, by compelling publishers to participate in its free book-of-the-month club for Kindle owners, by requiring public libraries to redirect their patrons to Amazon’s commercial website to borrow books for their Kindles, by starting an imprint to compete for authors now published by the largest commercial houses, and, no doubt, by countless uses of its powerful database of consumer behavior, Amazon continues to tighten its grip on the book industry. Its ambitions haven’t scaled back, and Barnes & Noble, still in the game (in no small part because of its success with the Nook), remains its most significant impediment.
We aren’t Barnes & Noble’s champions, or at least we aren’t their champions by choice. We’d favor a far more diverse and robust retail landscape for books, and we encourage all readers to patronize their local bookstores as they would their farmers’ markets or any other businesses that enrich the quality of life in their towns and neighborhoods. But here’s where we are: Barnes & Noble is book publishing’s sole remaining substantial firewall. Without it, browsing in a bookstore would become a thing of the past for much of the country, and we would largely lose the most important means for new literary voices to be discovered.
A truly competitive, open market has no indispensable player that can call the shots. The book publishing industry has such a player, and Amazon is poised and by all appearances eager to use its muscle to rip up the remaining physical infrastructure of book retailing and the vital book-browsing ecosystem it supports.
If Amazon succeeds, the free market will have had little to do with it.