As a consumer,

I’m still not sure whether e-readers will have staying power and become mass-market devices, or whether they’ll be superceded by some more general device, like a netbook or smartbook or tablet, for which reading will be one of many functions.

I happen to own a Sony e-reader, one of the smaller-sized new models, which I like.  I don’t miss the feel of the paper, or the larger size of the pages, or the tactile message of how much of the book I’ve read.  The most striking negative–for me, anyway–is the lack of a backlist (an issue of publication rights and the subject of a later post).  And, of course, I can’t look for better prices from Barnes and Noble or Amazon, nor can I consider buying a used book instead of a new one.

As an investor,

on the other hand, these questions may not be relevant.  The investment issue is whether there’s a way to make money from thinking through the phenomenon of e-readers and figuring out who, if anyone, will profit from them.  It would be an added bonus if the conclusions were not yet widely known.

Let’s start the process by looking at the Kindle from Amazon.

The Kindle

Two perspectives:

1.  as an owner/user

The Kindle seems to me to have a number of distinguishing features, apart from the general attributes of e-readers as a class–

a.  a free, always-on cellphone data connection, which allows you to browse through and order books from Amazon (and only on Amazon) at any time;

b.  that same feature, which allows Amazon to monitor and erase content from your Kindle, as it did in the case of 1984;

c.  text-to-speech (although publishers can apparently turn this feature off for a given book);

d.  free wireless access to Wikipedia;

e.  for $4.99 a week, wireless delivery of periodicals and blog subscriptions;

f.  the ability to buy e-books from Amazon at (for now, anyway) discounted prices.

the cost of a Kindle

The last is the feature that catches my attention.  The Kindle costs $259.  Generally speaking, newly published (“hardcover”) books cost $10 and older (“paperback”) ones cost $8.  To make the calculation easy, let’s say that that’s $2 per book less than having a physical copy.  There’s no shipping cost and you get it right away.

a breakeven point

Suppose you’re an avid reader and go through a book a week.  Buying e-books with a Kindle would save you $2×52 weeks = $104/year.  At that rate, you’d recover the cost of the Kindle in about two and a half years.

It’s possible that you like to read books as soon as they come out and that the best price on average that you can find for physical books is $15.  In this case, the book per week reader would recover the Kindle price in a year.

Finally, if you paid full retail price of $25 and read only hardcovers, using a Kindle would save you $15 per book, meaning at the pace of one book a month, you’d recover your Kindle cost in a year and a half.

The point?  Unlike other e-readers, Amazon’s discount pricing policy means Kindle users can sooner or later “earn back” the cost of the machine.

2.  the seller–Amazon

Amazon has three basic costs, apart from research and development:  the cost of making and distributing the Kindle, the cost of purchasing and selling the e-books, and the cost of maintaining the wireless connection.

a.  the Kindle.  Amazon is not a hardware manufacturer and, compared with cellphones, mp3 players or personal computers, unit volumes are low.  In addition, one would expect Amazon would adopt a razor-razorblade strategy, that is, sell the machine at cost and make money by selling books through it (another example is personal or home office printers–which retail at 10% below manufacturing cost–and the ink/toner cartridges for them, where all the profit is made).  So a good first guess, I think is that Amazon at best breaks even on the Kindle.

Typically when a new electronic device debuts, analysts buy one, take it apart and price out each of the components in it.  This is called the “bill of materials.”   In the case of the Kindle, the bill of materials comes to just under $200.  The bom doesn’t include assembly and shipping.  There’s no reason to think that Amazon will get the same sort of volume discount that, say, a cellphone firm would.  So, particularly if we lump the cost of the wireless connection from Sprint into manufacturing costs, it again seems reasonable to figure that Amazon makes no money on the Kindle machine.

b.  e-books themselves.  Publishers usually sell their books to distributors at about 50% of the list price.  For a $25 hardcover, this would mean $12.50.  For a $10 paperback, this would be $5.  So the sale of an older book would net Amazon $3; the company would lose about the same amount on a new release.

My guess is that by far the majority of amazon’s e-book sales are of new releases.  If this is correct (I’ll explain my reasoning in a later post), we have a case where a company is not only making no money on the razors but losing money on the razor blades as well.

Welcome to the world of Amazon!!!

One more revenue source, periodicals and such.  I’m regarding this as insignificant for the Kindle so far.  One thing to note, though.  Amazon uses an agency model here.  The periodical publisher sets the selling price and Amazon collects a commission.  The initial split was said to be 70%/30%, with Amazon collecting the larger amount.

Just before the debut of the iPad, however, Amazon announced an agency model for e-books, starting in June.  The deal is complicated, but boils down to a 70%/30% split of revenues, with Amazon getting the smaller amount.  No mention is made of periodicals, but I presume something similar is being done for them as well.  (Note, too, that the agency model governing the Kindle Digital Text Platform also provides for self-publishing, with the same 70/30 split.)

It’s déjà vu all over again

Almost every industry has a “heavy half” structure; that is, something like 20% of the product users do 80% of the consumption.   These avid users are worth their weight in gold.  The Kindle may have locked up 2 million of them firmly in the Amazon camp.

Also, Amazon has done this before–started driving at high speed down the road without knowing exactly where it led, but convinced that something good might be just around the next bend.

More in my next post, It’s vintage Amazon, and my third, the Macmillan price dispute.