1Amazon Kindle: Revolutionizing the way we read

Amazon
October 15
Kindle:
Revolutionizin
g the way we
read
2009
The market leader in the eBook industry, Amazon’s
Kindle, has made long strides in a very short amount of
time. However, since this is a relatively new industry the
future is unpredictable. This report addresses key
strategic elements that Amazon will need to consider as
competition surges and market conditions change, in
order to achieve and maintain sustainable and renewable
advantage
2Amazon Kindle: Revolutionizing the way we read

Introduction
The Electronic book (eBook) industry is currently positioned at an interesting
stage in its life cycle. Established in its current form in September 2006 with
the creation of the PRS-500 by Sony, the eBook industry is trying to
challenge and change one of the most popular activities in the world: reading
books. The reading habit dates back more than 500 years and was prevalent
across almost all civilizations around the world. Reading was embedded
even more across different cultures in the 20th century, when the rate of
publishing increased rapidly, often referred to as information explosion.

Today, the three dominant players in the eBook industry are Amazon.com
with its Kindle series; Sony with its E-reader PRS-500 family; and Bookeen
with the Cybook. Amazon’s Kindle is a market leader with approximately
60% of the eBook market share.

The Kindle is a software and hardware platform developed by an

Amazon.com subsidiary, Lab126, for reading eBooks and other digital forms
of media. Three hardware devices, known as Kindle (introduced in
November 2007), Kindle 2 (introduced in February 2009), and Kindle DX
(introduced in May 2009) support this platform. The Kindle DX is the most
advanced eBook device by Amazon. It is the first Kindle model with an
accelerometer, automatically rotating pages between landscape and portrait
orientations if the device is turned on its side. In addition, Amazon
established an iPhone application called "Kindle for iPhone".

In second place is Sony’s E-Reader, which has 35% of the eBook market
share. There have been six E-Reader models to date. The PRS-500 was
made available in the US in September 2006. The PRS-700, with touch
screen and built in lighting was introduced in October 2008 (and has since
been discontinued). On August 2009 Sony announced two new readers, the
3Amazon Kindle: Revolutionizing the way we read

budget PRS-300 Pocket Edition and the more advanced PRS-600 Touch
Edition. Also in August 2009, Sony announced the Reader’s PRS-900 Daily
Edition. This features a 7" diagonal screen to compete with the Amazon
Kindle DX. It is also the first to feature free 3G wireless via AT&T to access
the Sony eBookstore in the absence of a computer.

The Red Queen effect

The Red Queen's Hypothesis1, Red Queen's race or Red Queen Effect is an
evolutionary hypothesis. The term is taken from the Red Queen's race in
Lewis Carroll's Through the Looking-Glass. The Red Queen Principle can be
stated as: "For an evolutionary system, continuing development is needed
just in order to maintain its fitness relative to the systems it is co-evolving
with."

With respect to the eBook industry, The Red Queen Effect indicates that
corporations and other organizations can run faster, but fall behind because
others are running too. The ongoing interest and rising demands in the
eBook industry (estimates predict that the number of e-readers sold in the
US will increase from 3 million in 2009 to 13 million in 2013)2 will lead to
more competitors entering this industry with more technologically advanced
devices, and thus could potentially take over Amazon & Sony’s market
positions.

Around the world, at least 17 e-readers are in development or are already on

the market. Among the better-known entrants is Asustek, the Taiwanese
company which owns ASUS Eee-PC, and is now working on a product called
the Eee-reader. South Korea's two powerhouse consumer-electronics
companies, Samsung and LG Electronics, are joining in too. Samsung earlier
this year introduced a reader called the Papyrus in South Korea; LG is

1Definition per http://en.wikipedia.org/wiki/Red_queen_effect

2www.readwriteweb.com/archives/ebook
4Amazon Kindle: Revolutionizing the way we read

developing a prototype with a large flexible screen. Additionally, Japan's

Fujitsu has released the world's first dedicated e-reader with a color screen.3

Amazon's 60% market share in the U.S. could shrink due to evolving
competitor technologies and changing consumer needs. A current consumer
trend is to read eBooks on smart phones rather than on dedicated devices
like e-readers.

Not only will internet and technology companies threaten the dominance of
Amazon and Sony in the e-book industry business, but also a bricks-and-
mortar bookseller, like Barnes & Noble, which in the U.S. offers access to
750,000 e-books on its website, is rumored to be developing its own e-
reader to compete with the Kindle (The retailer already has a partnership to
sell e-readers made by IREX, a spin-off of Holland's Philips Electronics). This
could be a potential threat for Amazon and we believe that Amazon should
be ready to dynamically align in the case of a change in the future market
conditions.

Understanding “Economic Time” for eBook Industry

The concept of Economic Time is critical for any company in order to
understand the strategies it may adopt in order to continually add value to
the industry while realizing the benefits of this value addition in terms of
profit maximization. It is our hypothesis that the eBook industry, in general,
and Amazon’s Kindle products, in particular, operate in the Fast-Cycle
framework. This section attempts to prove or disprove the above
hypothesis. Based on our evaluation, we intend to identify strategies and
management paradigms which we believe would sustain Amazon as a
market leader in this space.

3 http://www.time.com/time/business/article/0,8599,1929387,00.html
5Amazon Kindle: Revolutionizing the way we read

In order to understand which Economic Time cycle this industry operates in,
we propose to evaluate the products along multiple economic cycle-speed
descriptors such as source of value, isolating mechanisms, impact of
innovation on incremental value addition, lifetime sustainability of
competitive advantage, pricing patterns, competitive dynamics, & value of
Brand loyalty.

Innovation as a Source of Value

Consistent with the dynamics of fast-cycle companies, e-reader products,
once commercialized, do not require complex organizational structures or
processes to support them. In fact, Amazon’s Kindle, in itself, gains its value
from informational content, which we believe can be readily copied. A quick
analysis of Kindle’s technology allows us to understand that the product can
be quickly assembled using components that are simple and readily
available (See Appendix-2).

According to a dissection conducted by iSuppli Corp.’s Teardown Analysis

Service, Amazon.com Inc.’s Kindle-2 eBook carries $185.49 in materials and
manufacturing costs. As pointed out by the analysis in the appendix
(references included), the components that go into this device are really
simple. So which attribute of this device really justifies the hefty $359.00
price tag? We believe that innovation or at least capturing the imagination
of customers with an innovative concept allows companies like Amazon &
Sony to demand such price points. Hence, unlike purely time-based
management that focuses on wait-time reduction, this industry (at least
currently) sees innovation as the primary source of value addition. So,
originating from uncontrolled innovation, we foresee that technology
spillovers will keep any single company from dominating4 this market in the

4 Renewable Advantage Chapter 3: The Children Eaters, Author: Prof. Jeffrey Williams
6Amazon Kindle: Revolutionizing the way we read

long-run if the value addition comes purely from the physical gadget. These
attributes, along with the cultural neutrality & innate globalist features of the
product with few physical, regulatory, or geographic barriers4 position it in a
typical fast-cycle model – case-in-point being Sony e-Reader’s launch in the
UK in summer of 2009 (@ $249.99) & Amazon’s quick response in UK
markets with an “International Edition” in October, 2009 (@ $279.00).

Isolating Mechanisms (or the lack thereof)

Consistent with our analysis of simple components that go into making the
Kindle product is an implicit assumption that any competitor can quickly
observe these features and copy the innovator’s work at lower cost
structures. We emphasize lower cost structures because such transparent
transfer of technology allows competitors to glean only the successful
features and start at a lower point on the experience curve, thereby,
accelerating their gains in cost reduction by volume.

Further, like fast-cycle markets, we observe that being a first-mover doesn’t

really translate to an advantage over the competition. Sony was the first to
enter this market with the PRS-500 as early as September 2006, when the
readers went on display and for sale at Borders bookstores throughout the
US. Amazon, a fast follower, launched its 1st Generation Kindle in November
2007, when the device was sold out in five and half hours from the online
store and remained out of stock for 5 months until late April 20085. Today
Amazon.com Inc and its Kindle reader are expected to dominate the
category with a 60% market share, followed by Sony Corp's Reader line with
a 35% share6. The breakup of majority share between two dominant players

5 Patel, Nilay (November 21, 2007). "Kindle Sells Out in 5.5 Hours". Engadget.com
http://www.engadget.com/2007/11/21/kindle-sells-out-in-two-days/

6 Forrester Research Inc. estimates:

http://www.reuters.com/article/rbssConsumerGoodsAndRetailNews/idUSN064429992009100
6
7Amazon Kindle: Revolutionizing the way we read

should not be confused with a standard cycle oligopolistic market because

this industry is still in its incipient stages where the target customer is the
early-adopter predisposed to paying a premium for the “cool” new gadgets.

Next, we find a complete lack of effective patents in this industry, fairly

intuitive given the simplicity of internal components. Among the few patents
that Amazon has for its Kindle products are the “ornamental design” patents
for the 1st Generation Kindle (not the latest Kindle DX) and its “slip-cover”7.

All these aspects point to the fact that isolating mechanism based purely on
the e-reader physical product can at best be described as weak. What
potentially can become an isolating mechanism for the Kindle is Amazon’s e-
book business. If Amazon can successfully leverage its vast relationship with
publishers and harness its powerful customer recommendation engine to
offer compelling service features, only then can it add a level of stickiness to
its e-reader product. For example, the Kindle is demanding 70% of the
profits from magazine and newspaper subscriptions, and Amazon maintains
republishing right on other devices like the iPhone8. Whether or not Amazon
should open up its e-books business to other readers or try to maintain
exclusivity in so far as the formats, store access, or future Kindle applications
are concerned, we believe it’s a bit too early to comment on but it is
certainly a source of strong isolating mechanisms.

Schumpeterian Gale of Creative Destruction

We find the Schumpeterian theory to apply well to the e-reader industry
where being an industry leader at any point, in terms of market share, does

7 D-601,559 & D-600,699: http://patft.uspto.gov/netacgi/nph-Parser?

Sect1=PTO2&Sect2=HITOFF&u=%2Fnetahtml%2FPTO%2Fsearch-
adv.htm&r=2&p=1&f=G&l=50&d=PTXT&S1=Amazon.ASNM.&OS=AN/Amazon&RS=AN/Ama
zon

8 Epaper Central, May 06, 2009: http://www.epapercentral.com/amazon-debuts-new-kindle-

dx.htm
8Amazon Kindle: Revolutionizing the way we read

not guarantee long-term success. Players must necessarily innovate faster

than competitors to remain on top but even the number of “new” releases
does not guarantee market leadership.

Sony e-Readers Amazon Kindle family

September, 2006 – PRS 500 November, 2007 – 1st Generation

(discontinued) Kindle (discontinued)
October, 2007 – PRS 505 February, 2009 – 2nd Generation
(discontinued) Kindle
October, 2008 – PRS 700 May, 2009 – Kindle DX
(discontinued) October, 2009 – Kindle 2
August, 2009 – PRS 300 “Pocket “International Edition”
Edition”
August, 2009 – PRS 600 “Touch
Edition”
August, 2009 – PRS 900 “Daily
Edition”

As the e-Reader market catches the fancy of a larger audience, we believe

this cycle of convergence and renewal will accelerate to unforeseen heights.
Hence, the competitive advantage gained by every new wave of e-Reader
models will be short-lived and temporary, reinforcing the theory of fast-cycle
markets.

In the absence of strong isolating mechanisms, players will find themselves

in product life-cycles that give them very little time to grow and adapt.
Hence, growth or hyper-growth, rather than creating the perfect alignment
with loyal customers, would distinguish the winners from the laggards.
9Amazon Kindle: Revolutionizing the way we read

As seen above, the slew of new product introductions in the market creates a
high level of uncertainty and hence the focus must be on recouping profits as
quickly as possible. The clear message for companies looking to enter this
space would be to not wait for the emergence of standardization or a
dominant design because market conditions and target customer segments
are bound to change rapidly. Any delay in coming to a “go/no-go” decision
about market entry, product specification, product placement or promotion
would only result in loss of potential profits to competitors who possess a
greater bias for action. The key for Amazon would be to encourage
investment in alternatives or complementary assets that build better
isolating mechanisms or allow Amazon to quickly adapt to changing needs
while capitalizing on as much profit from Kindle’s success as possible. For
e.g. the e-book business could be one such alternative which would allow
Amazon to compete in the e-Reader space regardless of which physical
reader wins the innovation race.

Tenets of Dynamic Pricing

Validating the concept of recouping profits as quickly as possible, we believe
dynamic pricing to be central to the success of any player in this market.
First, determining an introductory price for the products is difficult because
there are no precedents. This is clearly evident from the early hefty prices
for both Amazon Kindle & Sony’s e-Reader series. Second, demand for the
product is very sensitive to prices and as price declines, volume demand
increases significantly (See Appendix-3).

Even in its early stages, the e-Reader industry shows clear trends. When
faced by absence of precedents or uncertain demand, both Amazon & Sony
err on the side of setting prices high rather than appeal to a larger audience
by pricing low. This is because it is easier to reduce prices in future as
10Amazon Kindle: Revolutionizing the way we read

continuous innovation phases out older models than it is to increase prices

based on the perceived value of an innovation.

In July, 2009 Amazon slashed prices for its 2nd Generation Kindle (released in
February, 2009) from $359.00 to $299.00 – a 17% price drop. On October
06, 2009, the prices were slashed again to $259.00 – a 28% price drop from
the original release price within 6 months. Amazon CEO Jeff Bezos, in an
interview, said "the company can now afford to reduce the price because of
the increased number of Kindles the company is making - and selling"9. We
believe that, consistent with the theory of “Fast-Shifting Strategies” in fast-
cycle markets, dropping prices on older versions significantly shortens
competitor’s profit cycles. Dominant players introduce newer versions with
more capabilities and charge higher price points. In effect, most competitors
are restricted to playing “catch-up” with the market leader.

As prices fall quickly and new global competitors move in, the focus of
competition passes quickly from early adopters, who are predisposed to
paying a premium, to price-sensitive fast followers and finally to late-
adopters waiting for a low-price commodity (see Appendix-3). A marketplace
where thousands of idea-driven, well-financed companies have quick access
to millions of customers with fairly high disposable income is the building
block of a fast-cycle market4.

Fleeting Brand Loyalty

Even as companies enter the market with newer and jazzier models, neither
of the existing players, Amazon or Sony, offer any incentives to early
adopters or loyal customers in terms of upgradable options. If an early
adopter of Kindle-2, who paid $359.00 for the same wishes to acquire the

9 Source: NY Times - http://www.nydailynews.com/money/2009/10/07/2009-10-

07_finally_amazon_cuts_price_of_kindle.html
11Amazon Kindle: Revolutionizing the way we read

brand new Kindle DX, he/she must pay the full $489.00 for the new machine.
During the launch of Kindle DX, when asked how Jeff Bezos would reward
early adopters of 1st & 2nd Generation Kindles, the quick response was –
“allow them to be first in line for Kindle DX pre-orders”.

Accelerating Market Reception

Over and above pre-emptive pricing maneuvers, intelligent players in fast-
cycle markets effectively leverage timely media releases to undercut
competition’s gain of market share. With its summer release & its discounted
e-newspaper subscriptions10, the Kindle DX was positioned to beat the large
screen e-Readers, including Plastic Logic, to market by a few months. This
spelt bad news for a lot of the competition, who hoped to rely on larger
screen and newspaper subscriptions as a counter point to the small Kindle 2
and Sony PRS series of e-Readers. The only way they could beat the Kindle
DX now is through a price war, which might not be possible since 40% of any
e-Reader’s price is in the cost of the e-paper itself10.

In a similar move, on August 25 2009, Sony took a page from Apple’s

playbook, waiting until the end of a press conference to unveil the latest PRS
900 wireless e-Reader, "Daily Edition", that will be available in December
200911. We believe that such moves serve twin-purposes: 1. Encourage
customers to postpone purchases until new products are available & 2.
Encourage 3rd party developers to work on products that complement the
innovator’s products.

10 E-paper Central, May 06 2009: http://www.epapercentral.com/amazon-debuts-new-

kindle-dx.htm

11 WSJ Technology Blogs, Aug 25, 2009: http://blogs.wsj.com/digits/2009/08/25/sony-

unveils-400-wireless-reader/
12Amazon Kindle: Revolutionizing the way we read

Conclusion
While Amazon’s Kindle is currently the strongest player in the market, in
order to gain sustainable advantage, the company needs to be prepared to
deal with an unpredictable future. Keeping in mind the fact that only 30% of
the value of the company is determined by the profits and 70% is
determined by the expectations of the future, Amazon will only be a winner if
it is able to create value in the future. Further, Amazon will need to adapt to
market changes and meet consumer needs in order to maintain a
competitive position. More specifically, if all the competition in the eBooks
industry turns towards an open file format (namely, the ePub format), there
will be no place left for Amazon’s Kindle (proprietary format) in the
marketplace as consumers would want to buy eBooks that are compatible
across different e-readers. This could turn into a tipping point/winner takes
it all situation, as seen in the case of Betamax in the 1970’s, which was
thrown off the market as all the competitors offered the alternative VHS
standard.12

Lastly, Amazon should keep in mind that at the end of the day, a focus on
core competencies is more crucial than a focus on the product alone, in
order to maintain sustainable and renewable advantage in our fast-paced
and constantly-changing world.

Appendix
Appendix 1: Kindle Family with Features & Prices

12 http://www.marketwatch.com/story/kindle-in-danger-of-becoming-ebooks-betamax-2009-
08-10
13Amazon Kindle: Revolutionizing the way we read

Appendix 2: iSuppli’s Analysis of Kindle 2

14Amazon Kindle: Revolutionizing the way we read

Amazon.com Inc.’s new Kindle-2 eBook carries $185.49 in materials and

manufacturing costs, according to a dissection conducted by iSuppli Corp.’s
Teardown Analysis Service.

The direct material cost of the Kindle-2, consisting of all parts used to make
the product, amounts to $176.83. When adding in the conversion costs—i.e.,
manufacturing expenses and the battery—the total rises by $8.66 to
$185.49.

The total materials and manufacturing costs reported in iSuppli’s teardown

analysis of the Kindle 2 reflect only the costs for direct materials,
manufacturing and basic tests. Not included in this analysis are costs above
and beyond the material manufacturing of the core device itself—i.e., the
cost of intellectual property, royalties and licensing fees; those not already
included into the per component price—software, software loading and test,
shipping, logistics marketing; and other channel costs. These costs are not
included because teardowns cannot reveal this type of information.

The combined manufacturing and materials costs represent 51% of

the Kindle-2’s $359 retail price.

Complete analysis can be found @

http://www.isuppli.com/News/Pages/Amazon-s-Kindle-2-Costs-185-49-to-
Build-iSuppli-Teardown-Reveals.aspx.
15Amazon Kindle: Revolutionizing the way we read

Appendix 3: Dynamic Pricing & Demand Sensitivity

16Amazon Kindle: Revolutionizing the way we read