Amazon E-Book Sales to Hit $2.5B in 2012?(Hear that Steve?)

Last month at Book Expo America, I heard Jeff Bezos say that Amazon had been selling e-books for nearly ten years and that they needed an electron microscope to find the sales figures. Well they may not need one much longer, if Pacific Crest analyst Steve Weinstein’s projections are valid. He estimates that global sales of e-book sales at Amazon could reach $2.5 billion by 2012, based on the following analysis:

To figure this, Weinstein starts with the handiest analogue: iPod and MP3 player sales. He notes that between 2003 and 2008, digital music sales grew from 2 percent of the US market to 33 percent, largely on the back of Apple’s (NSDQ: AAPL) twin offerings. He doesn’t expect the Kindle/e-books to track as fast, but he does think the market is off to a strong start already, and that the cycle will pick up steam as the Kindle comes down in price (that’s already started) and the ecosystem matures. He also suspects the consumers will be drawn to the instant gratification aspect of Kindle titles, as well as the lower price per book. Based on an operating margin of 4% to 5% for physical books (comparable to operating margins for brick-and-mortar stores) and 15% to 20% for e-books (comparable to other forms of digital media), we estimate that e-books could add as much as $330 million to operating income.

The key figure in this analysis is not the total sales projection, but the margin ratios. If the e-book business generates an operating margin that’s 4X that of the dead tree type, you need no further evidence that Amazon will over time make this the foundation of their business model. Any innovation that offers you the opportunity to carve out two of your largest cost components – warehousing and shipping – (not to mention improving on the customer’s instant gratification experience), is clearly going to be a key component of the company’s strategy. In fact, one wonders why they aren’t giving Kindles away, in order to “iPod-ize” the market, and begin to reap the benefits of the overall growth of the ecosystem. The most logical explanation is that the capital markets still regard Amazon’s investments in digital media with a high degree of skepticism, which tends to temper the rate of spending on this type of technology. This somewhat cautious approach could end up backfiring however. If Steve Jobs chooses to enter the e-book market (despite his dismissal of the book business last year), Apple could quickly come to dominate the market for e-books, since consumers are becoming more accustomed to using their iPhones for reading along with browsing the web. The infrastructure is already in place (iTunes store), and the platform has the dominant market share, and the lure of 20% margins on $10 price points (compared with the few pennies they currently earn per song download) may just be enough to entice Apple to change course and start selling e-books.

All these developments are good news, of course, for the reading public. The outcome of this creative destruction process will be lower costs for content, as well as for the devices to read it on. I might however, have some concern for my career path if I was an assistant editor in a large publishing company.


Unbound, undone, and unplugged: Publishing in America

You can always count on The Economist for a cogent and succinct analysis of an important trend or development that promises to change the way either producers or consumers act. In last week’s issue, they turned their attention to the U.S. book publishing industry, with a piece covering Jeff Bezo’s announcement at BEA that Kindle sales now account for 6% of sales of the 125,000 titles available in both print and electronic versions.

None of the handful of e-book manufacturers will divulge sales figures. First-quarter sales of mass-market e-books in America have tripled since the same period in 2005, but they were worth just $10m. But Kindle and its kind are merely the first generation of a product that is sure to evolve quickly in the coming years. Eventually, e-books point the way towards a cleavage of content from platform, threatening publishing with the wholesale change that has hit the music industry. It is a familiar story: fearing piracy, publishers are already adopting various mutually incompatible security technologies that are sure to annoy readers—although ePub, a new standard backed by many big publishers, may clarify things.

This paragraph zeroes in directly on the essence of the threats and opportunities facing the publishing business. First, until recently, miniscule sales, a fact which is largely explainable by the myriad of confusing and conflicting formats to present the content, and by the fact that:

Unlike digital music or video, digital books require consumers to change their consumption habits.

This is a pivotal distinction: except for consumption of live music or performance, consumers have used some sort of electronic device (albeit not necessarily a digital one) to enjoy their music and video for decades. But the book, as we all know, has survived in a very analog format for more than 500 years. As Bezos himself remarked: “It’s hard to out-book the book”. So there is naturally a fair amount of resistance to changing one’s ingrained habits to adapt to a piece of new technology. The benefits must far outweigh the costs of switching and breaking old habits. Convenience is one compelling feature: downloading almost any book you can think of in under a minute is one that comes to mind – but only if you’re a voracious reader. (just as having 500 channels to watch is not a strong attraction to someone who never watches TV.)

Just as with all new technology, the early adopters pay the premium for what’s essentially a beta release. Prices must drop significantly for the device to reach mass acceptance.  And mass acceptance is what it will take in order for Amazon to be successful with the Kindle. That’s what will drive demand for e-books, which is really what they’re after. Let’s face it: Amazon is not a hardware company; they sell content, and high volumes of consumption of content drive their margins higher. How sane would it be for a company like CBS to start manufacturing TV sets to facilitate distribution of their programming content? Shareholders would shout “Stick to your knitting-let someone else provide the hardware.” But Bezos recognized that no one had come up with the ideal device to consume digital books on, so he created one.

By offering the Kindle, Amazon has jumpstarted the whole e-book market, and shaken up the moribund publishing industry yet again. But in order for this effort to be successful, they will need to get the price point down to a level where it’s a no-risk proposition for the late-adopter. That means around $99 or so. Bezos might think about the approach another tech visionary is taking with his game-changing gadget. Just this week Steve Jobs announced the new and improved version of the iPhone will drop in price from $399 to $199.  This strategy is no doubt a recognition of the benefits of subsidizing the development of the overall ecosystem, which drives greater overall demand for content offered on the device, (see iTunes) or for other, much higher margin products, like Macbooks.

If some Taiwanese manufacturer came up with a sub-$100 e-book reader with color touch screens and a Gig of storage, I predict Amazon would cede the device business to them. Then they could concentrate on selling more e-books, and continuing their gradual domination of the book selling business.