Wed, 18 Apr 2012 Apple vs. Amazon: Who Is Really Fixing E-Book Prices?

In the mid-1990s, I ran across what looked like an incredible story: A teenager, dubbed the Whiz Kid, was selling a ton of computers from his parents' home. Newspapers told the story complete with images of the teenager talking on his cell phone-which, at the time, was a big deal.

So I called the teenager and spoke to him and his dad. Turns out, his dad had set up a business to buy computers via a distributor and sell them directly to companies at cost. That's right, no margin. The dad and his son moved lots of computers because they were undercutting everyone's price.

The business wasn't about making money, rather just a publicity stunt for the teenager. While companies could get computers on the cheap, business models with a hidden agenda and no margins aren't good for anyone down the road.

The Whiz Kid story came to mind as I thought about the drama going on with Amazon, Apple, book publishers and the Department of Justice over alleged price fixing of e-books.

In this scenario, Amazon is the teenager with a not-so-hidden agenda.

Amazon set the price of an e-book at $9.99, a low-ball number with a tiny, if any, margin. Critics point out that Amazon overall makes little profit on a whopping $48 billion in revenue. Amazon's goal is to offer e-books at a huge discount and seed the e-book reader market with Kindle devices, which, in turn, will create a monopoly that forces customers to buy e-books only from Amazon.

And it was working: Amazon quickly grabbed 90 percent of the e-book market, writes CIO.com's consumer tech blogger Bill Snyder.

We can thank Apple for putting the kibosh on Amazon's evil monopolistic scheming. With the iPad, book publishers had another e-book distribution option. E-books on Apple's iBookstore rose to the range of $12.99 to $14.99 under Apple's agency pricing model, which allows book publishers to raise the price of an e-book while Apple takes a 30 percent cut. As a result, Amazon's market share fell to 60 percent.

If Amazon is the teenager in the Whiz Kid story, then book publishers are the value-added computer resellers, known as VARs. They are victims but not completely innocent.

In the early days of computer distribution, VARs often did little more than receive a computer from a low-margin mass distributor, slap on a 30 percent markup and push the box to the corporate customer. I doubt VARs got together and fixed the price, but it was an industry standard practice.

If there's any upside to the Whiz Kid story, it's this: A teenager shed light on what VARs contribute to the value chain for that 30 percent markup, which wasn't much. VARs eventually changed their ways and became solutions providers and integrators, often not even taking ownership of hardware and software moving from distributor to the corporate customer.

Book publishers, too, will need to change their ways in the e-book era. Book publishers do not provide as much value with e-books as they do with traditional books, so they can't expect the same margins. On the other hand, Amazon's $9.99 price point cannot support quality e-book production, which is what happens when no one makes money.

I suspect there will be a compromise: E-books will have to be sold for more than Amazon's $9.99 but less than the Apple-publisher's $14.99. To make the new price point work, publishers will have to cut the fat out of the old book publishing model.

Enter the DOJ, the newspapers of the Whiz Kid story.

The DOJ's mission is to protect consumers against monopolies and price fixing, but in this case their approach is flawed. A quick glance at Apple's agency model, and one might jump to the conclusion that consumers faced an e-book price hike from $9.99 to $14.99. This means Apple's agency model is bad for consumers, right?

A quick glance at the Whiz Kid's business, and one might jump to the conclusion that computer-buying companies are making out with the cheap price. So is the Whiz Kid business model good for the computer market?

We know this isn't true in both cases.

Dig a little deeper, and you'll find that the DOJ's thinking doesn't make sense. You simply cannot break Apple's agency model and swing the pendulum back in favor of an Amazon monopoly, all in the name of protecting consumers.

The DOJ can and should penalize book publishers and Apple if it finds price collusion-after all, price fixing is illegal- but not to the benefit of Amazon and its money-losing, monopoly-building enterprise. Apple and book publishers may have to pay a penalty or settle, as some already have. The price of an e-book should be determined by the market, not Amazon.

Too simple? Maybe. But this is how it's supposed to work. I could ask the Whiz Kid what he thinks, but he went out of business a long time ago.