Perhaps the biggest secret of great success in the digital age is to create a market ecosystem in which other participants provide great value at low prices—or better yet, for free—while you sell your stuff at high margins. This strategy is fundamental in the tech business.
Examples? How about Microsoft, Apple, and Google?
Microsoft sells its software at crazy high margins (yes, still!) while the manufacturers of the PCs it runs on—HP, Dell, etc.—beat each other up on price. IBM, the originator of the PC, got out of the business long ago.
Apple flipped the hardware/software equation around and, beginning with the iPod, started selling hardware at high margins while purveying other people’s music at 99 cents a cut on iTunes—the same price I paid for my 45 of The Little Old Lady From Pasadena in 1964. Now it is reportedly pushing music labels to agree to terms that enable $5 per month all-you-can-eat subscriptions on its Beats streaming service, down from $9.99. Why push down the price? To keep the Apple music ecosystem competitive in the face of rapidly growing streaming services like Spotify, so that high-margin Apple hardware sales continue to grow.
Google aggregates other peoples’ content—including high quality, expensively-obtained reporting from old-line news organizations—pays them nothing, and sells readers’ eyeballs and stealthily obtained personal information at really nice margins to advertisers, because we want to read the news for free.
In each of these cases, the margins of willing or unwilling trading partners (PC makers, the music industry, and old-line news organizations) are sacrificed to benefit the dominant partners (Microsoft, Apple, and Google).
Amazon doesn’t appear to fit the model because it doesn’t make any money: it sells other people’s stuff at low prices, even at a loss, but its own overall margins are abysmal. Even Amazon’s cloud services (Amazon Web Services, or AWS), which Wall Street thought was Amazon’s secret killer app, are becoming commodified with increasing competition from Google, IBM, and others. But there actually is one thing that Amazon sells at high margins: its stock. So far, Wall Street has provided almost unlimited capital, while the company makes no profit and Jeff Bezos has made $30 billion. Amazon supporters say that the lack of profitability is justified, given the even more gargantuan opportunities in which Bezos is investing.
Whether Amazon is a bubble stock, or whether its continued lack of profitability is a rational strategy that will ultimately result in total domination of the market, the result of that strategy for book publishers is the same: continued squeezing of their margins. On the eBook front, Amazon’s ongoing pressure on publishers to lower eBook prices is well known. Now, with the Kindle Unlimited service, Amazon has entered the eBook subscription business. For the authors who willingly signed up, the result has so far been the same as with the music business: royalty deflation.
There’s another way for a new business to benefit by selling stuff cheaply or giving it away, which is to shrink an entire industry but wind up the dominant party in what remains. Perhaps the best example of this is Craigslist, which has contributed to the huge collapse of newspaper revenues by providing free classified ads, and made Craig Newmark a fortune in the process. This could be the trajectory Spotify follows: shrinking music industry revenues by 75 percent, but winding up with a dominant market position. With eBooks, it could be Scribd or Oyster that benefits from slashing author and publishers revenues—if, of course, Amazon doesn’t come to dominate eBook subscriptions as it does with eBook downloads.
What does it take to be king of such an ecosystem? Sure, it takes smarts and capital, but having trading partners who don’t understand the terms of the game is critical too. For Microsoft, Apple, and Amazon, there were early inflection points where they made deals critical to their subsequent success in which their counterparties misunderstood the nature of digital marketplaces.
When secret IBM emissaries went to the west coast to find an operating system for their new PC in 1980, they thought that the profits in the PC business were going to be in making hardware. They didn’t understand they were handing a software empire to Bill Gates and Microsoft when they made MSDOS the PC standard.
In the case of Apple, the music labels grievously underestimated the potential of iTunes when Steve Jobs came looking for rights to sell tracks for 99 cents. Music labels viewed iTunes as incremental revenue, and as a counterweight to illegal downloading. As former chairman of Warner Music Edgar Bronfman has admitted, Jobs outfoxed them.
When Amazon launched as a bookseller in the 1990s, people inside the industry completely misunderstood its modus operandi. I saw a positive report on Amazon from Deutschebank analysts torn apart by savvy book industry people, who said that there was no way that Amazon was ever going to make tons of money in the book business. They were right, and the fact that they were right was irrelevant: the role of publishers was to be the willing but unwitting low-margin trading partner, as Brad Stone amply documented in The Everything Store.
The industry is at another inflection point now with eBook subscriptions. The question is: are publishers going to misread the current situation and acquiesce to innocuous-seeming deals with eBook subscription services, or are they going to learn from tech history and create author- and publisher-friendly paths to a digital future? What might those paths even look like? A topic for another post.