I am a firm believer that the historical knock on the social sciences is unwarranted and that many of the theories, frameworks, and concepts found in the various disciplines are widely applicable in the real world, business in particular.  So when I read about the Amazon-Macmillan dispute I was struck at how a number of social science concepts shed quite a bit of light on these developments; namely Albert Hirschman’s concepts of exit, voice, and loyalty as well as signaling and the indirect use of force.

So what do these concepts have to do with e-books?  Glad you asked.

In his classic Exit, Voice, and Loyalty, political economist Albert Hirschman provided an elegant framework for analyzing the options available to individuals when they become displeased with actions of an organization. According to Hirschman, individuals have three options: they can be loyal to the organization, they can exercise voice (e.g. protest, negotiation), or they can exit the organization (e.g. join a new group, shop at a new story, etc). The framework is quite elegant and can easily be applied to both explain and predict the behavior of consumers in a market or citizens in a political system.

Apple's iPad includes an e-reader functionality

Since the launch of Amazon’s Kindle, book publishers have tried to exercise their voice vis-a-vis Amazon and their pricing requests, but to little avail. Until now, voice and loyalty seemed the only realistic options. Sure, there are other e-book retailers out there, but success of Amazon’s Kindle and the attractive prices they set for their customers provided the retailer with a huge advantage in terms of a distribution channel. However, with the launch of Apple’s iPad, book publishers now have a more realistic exit option. Not only is Apple a potentially powerful sales channel, but they have agreed to pricing terms that are more favorable to publishers than Amazon (Apple will take 30% of whatever price publishers choose to charge, leaving the price point up to individual publishers).

When individuals have the option of exit, we should see typical market dynamics at work–i.e. customers can shop around to various suppliers to find the products they want at the price they want, with competition among those suppliers driving the quality of products higher and the price for goods lower. This is why we generally abhor monopolies, since by nature they stifle market dynamics and leave customers with only the options of loyalty or voice, meaning they lack much leverage. With the launch of a new and potentially powerful sales channel, publishers now have a more realistic exit option that can be brought to the table in negotiations with Amazon.

However, rather than alter the current pricing terms with Macmillan as a result of this new exit option, Amazon stopped distributing Macmillan’s e-books altogether. The question, of course, is why? I would posit that Amazon was trying to send a signal to dissuade other publishers from also trying to renegotiate terms. Now I have no information as to what Sargent may have proposed and if any ultimatums were given, so what follows is purely an intellectual exercise.

We can view Amazon’s move as a deterrent threat to other publishers who, emboldened by Apple’s entry into the market, may attempt a similar renegotiation. By harshly punishing one actor (i.e. refusing Macmillan access to a valuable and dominant sales channel) that attempted to change the status quo (Amazon’s preferred pricing structure), Amazon hopes to send a signal to other potential actors to not attempt something similar. This is a great example of signaling and the indirect use of force, two related concepts that economists (such as Michael Spence and Thomas Schelling) and political scientists (such as Robert Jervis and James Fearon) have fleshed out over the past 40+ years. Rather than having to expend resources forcing every potential adversary to either change their behavior or maintain the status quo, an actor can choose to send a signal to all potential adversaries by making an example of one of them. Not only can an actor make a threat to punish their adversaries, but they can also demonstrate that they have both the capability and the will to do so by carrying out such a punishment on one adversary.

This dynamic is accentuated in systems where one actor faces challenges from many potential actors versus just one. Barbara Walter has looked at why some states decided to deal with separatist groups and factions in a violent manner versus through negotiations. The key variable: the number of potential separatist groups that may also seek self-determination. As the number of potential adversaries increases the probability of solving these disputes through negotiation decreases. When faced will many potential challengers, governments will choose to demonstrate their willingness and ability to put down rebellions in order to deter other separatists groups from similar challenges. In other words, having reputation for resolve when dealing with adversaries becomes more important when you face many potential threats than just one.

In the case of Amazon, it could be that seeing the potential for many actors to attempt to renegotiate the current pricing structure it was decided that they should send a signal to the rest of the publishing world that attempts to change the status quo would not only fail, but would result in sever punishment (i.e. the loss of a popular sales and marketing channel).  My guess is that this likely won’t work for two reasons: 1) as mentioned earlier, the publishers actually have someplace else to go–they can exit the current relationship and cast their lot with Apple; and 2) Amazon is heavily reliant on the book publishers.  Without their titles the allure of a Kindle decreases.  The threat may not be credible, or at least sustainable for long.

Thoughts?

Apple could very well launch an e-reader of its own, one that vastly improves on Amazon’s market-leading Kindle. Specifically, Apple could develop a reader that utilizes their leading touchscreen technology so that readers can intuitively flip through pages of magazines or books (a feature the Kindle currently lacks), develop their reader so that media is presented in color (the Kindle is gray scale), and provide a larger viewing screen. And while Steve Jobs has previously denied a desire to get into the e-reader market, Apple is apparently full-go towards developing and launching their own tablet computer. Such a device could be a “Kindle-killer”.

After months of speculation, it appears we will get our first look at Apple’s tablet on January 27th which will likely ship in March of this year.  Additionally, the Wall Street Journal is reporting that HarperCollins is in negotiations with Apple to make their titles available in an enhanced electronic format for the release of Apple’s tablet:

Brian Murray, the chief executive of HarperCollins, said in December that e-books enhanced with video, author interviews and social-networking applications could command higher retail prices for publishers than current e-books. Many of the country’s largest publishing houses are worried about the sale of new bestsellers for only $9.99 in the e-book format. New releases of enhanced e-books could sell for $14.99 to $19.99, a person familiar with the situation said.

Apple’s tablet wouldn’t simply be directed towards Amazon and the e-book, e-reader market. But like many of Apple’s products, it will have the potential to disrupt multiple industries at once. With the potential to provide enhanced features, publishers may be able to create some leverage over the 800 lb. gorilla at the moment, who has decided that most e-books need to sell for less than $10.

My initial thought is that while betting against Apple in the device space has not exactly been a good move, I am not convinced that enhanced e-books will be able to attract a high price-point from customers. The practice certainly worked with DVDs, but besides wanting an enhanced graphic display and color interface for many e-books and e-magazines I have not had a gnawing urge for author ‘extras’.

Not exactly the kind of glowing review they were hoping for. But as the article notes, this is version 1.0. We’ll see if they work out the bugs.

Jeff Bezos is trying to do to book publishers what Steve Jobs of Apple did to the music industry. With its iPod and iTunes Store, Apple carved out a largely virgin market so fast that it was able to wrest control of the digital-music distribution system and thus dictate what the record labels could do. With Amazon jamming (its latest earnings are sky-high even as other online retailers are in a state of malaise), Bezos may sense similar opportunity, a moment when he, in true Jobs-like fashion, could colonize this growing niche for the Amazon ecosystem. Should that happen, book publishers would have more to fear than just being squeezed. Amazon could phase them out completely, treating them as the ultimate middlemen orphaned by a new technology.

Essentially, Amazon is looking to bypass traditional publishers through its massive electronic distribution channels (Amazon.com and the Kindle device) as well as its on-demand publishing technology.  Rather than dealing with the publishers, Amazon could strike deals with the largest authors (those that provide the bulk of the revenues from ‘hits’ that traditional publishers require to keep operating) by offering wider distribution and increased royalties.  This could fundamentally alter the publishing industry, if not destroy its current incarnation.

While this is interesting, there is another part of the article that deserves attention: the risk Amazon could face down the road from Apple.

Amazon is faced with a dilemma. While they expend countless resources to create a high-demand e-book market (creating larger consumer demand, testing various designs and functionality in terms of the reading device with those consumers, etc.), Amazon will bear the brunt of creating this massive new market. Ideally, the investment pays off as Amazon then dominates that newly created market. However, the article points out that there could be a disruptive competitor waiting in the wings to take advantage of that market: Apple.

The article speculates that Apple could very well launch an e-reader of its own, one that vastly improves on Amazon’s market-leading Kindle. Specifically, Apple could develop a reader that utilizes their leading touchscreen technology so that readers can intuitively flip through pages of magazines or books (a feature the Kindle currently lacks), develop their reader so that media is presented in color (the Kindle is gray scale), and provide a larger viewing screen. And while Steve Jobs has previously denied a desire to get into the e-reader market, Apple is apparently full-go towards developing and launching their own tablet computer. Such a device could be a “Kindle-killer”.

Apple has made a name for itself as a disruptive innovator, most recently shaking up the digital music player and music industry with the iPod and iTunes as well the cellular market with the iPhone. In both cases, Apple didn’t attack and steal market share at the low end of the market (as Christensen suggests). Rather, they attacked the market with high-performing products set at market-leading price points. In the case of iTunes, Apple did manage to keep prices quite low ($0.99 per song), but the iPhone was a high-priced and high-performing digital music player. With the release of their tablet and a built-in e-reader, Apple would again be attacking a market from the high-end.

Is this unique to Apple? Are they a “luxury disruptor”? They’ve seemingly developed an infrastructure and design team that allows them to pivot into new markets with high-end products and to extract high-prices despite the existence of lower-priced, established competitors. I am wondering if this is replicable, or if Apple is simply an outlier when it comes to innovation and execution.

Curious as to readers’ thoughts.