There is currently an interesting debate occurring between Mike Shatzkin and Paul Biba over the possible benefits of an agency pricing model in publishing. If you have not read each individual's blog recently, I recommend doing so. Both individuals make some interesting points. However, I ultimately agree with Mike and believe that the introduction of an agency model in pricing and distribution of ebooks is a net positive.

It goes without saying that any given business would prefer a highly competitive downstream market. A single downstream player that dominates the distribution of a product poses a significant threat to the long-term profitability of a business. While Amazon does not release any sales figures, it is widely known that it controls the ebook distribution market (with some estimating its market share today between 70-90%).

There are those who dismiss this concern (as it relates to the current pricing debate) by noting that publishers were actually earning more under the previous model (where Amazon subsidized consumers’ purchase of ebooks and sold the content at a loss). However, the subsidization of a product should never be seen as a permanent aspect of any relationship, especially when that subsidization is undertaken in order to gain and secure market share through increasingly strong network effects.

If one accepts the premise that a business should strive for a competitive downstream market in order to protect the long term viability of its business, the question then becomes how best to achieve this end. Creating a competitive downstream market for ebooks has been difficult for publishers, due in no small part to the fact that the ebook market is governed by the above mentioned network effects. Up to this point, publishers’ efforts have centered around creating file format standards that would promote competition across platforms and provide consumers the freedom to move purchased content from one device to another. While the logic of this strategy is sound, it has failed to seriously dent Amazon's position as market leader.

The success of this standards-based strategy rests, in large part, on publishers' collective ability to secure compatible downstream partners and to convince consumers to choose this new, more open platform. The benefit of the agency model is that it gives publishers an additional tool in their attempt to increase the degree of downstream competition. By making the final pricing decision (whether there be imposed price maximums or not), publishers can effectively eliminate a large company's ability to subsidize content in the pursuit of growth. This then allows smaller aggregators and even companies not previously in the ebook distribution business to enter and be viable. (Mike's example of ESPN selling relevant sports books to its established user base is but one possibility).

As I have discussed before, one of the goals of a standards-based strategy is a modularization of the downstream market. However, subsidization of content prevents this because losses at the distribution layer must be compensated for by profitably selling product or services elsewhere. Without true and full modularization, the growth of the platform is limited and the specialization that can lead to greater user experience is hindered. An agency model, however, facilitates modularization and allows new players to profitably enter the market and for all players to more effectively specialize. This, in turn, can fuel the growth of an open platform and counter the considerable network effects currently enjoyed by Amazon.

Last week, Jeff Bezos predicted that ebooks will replace print books. Although he did not attach a time frame to the prediction and while many others reject his opinion outright, it is certainly an interesting thought. The end of print books (or even a dramatic reduction in its sales relative to ebooks) would have significant implications for publishing companies. These implications can be seen and understood by looking at the product life cycle.

Product Life Cycle

The product life cycle provides an intuitive framework through which a business can view its products and help to shape its product management approach. The model plots demand for a product (measured in sales) against time.

Products typically go through five stages: Adoption, Growth, Maturity, Decline, and Abandonment. Each stage in the product’s life cycle brings both challenges and opportunities, requiring product managers to understand the implications of the model in order to shape strategy.

Product Life Cycle and New Technologies

During a product’s mature and declining phases, new technologies (that will eventually displace the product) exist, but have yet to be adopted by the majority of consumers. Given this, it is important that companies be aware of these advancements and have a strategy to successfully transition to the new product. This strategy could be one of partnership, investment, or acquisition.

The Product Life Cycle and Complementary Goods

While the product life cycle model provides a useful context for understanding a single product, it does little to help managers understand the relationship between related, complementary products.

A complementary product is any product tha t is used with (and therefore whose demand is based on) another product. Complementary products can be divided into two general categories: those whose demand is highly specific to the primary product and those whose demand is independent of any single product.

The current product life cycle model is able to satisfactorily explain the relationship between primary and complementary products only if those products are specific to one another. If a complementary product is built specifically for its primary product, their demands will be highly correlated and the corresponding life cycle demand chart will be similar. Companies making the complementary good will therefore face similar market dynamics and can likely employ similar product management strategies as its primary product counterpart.

However, the same cannot be said for those complementary products whose demand is independent of its primary product. Information, for example, would fall into this category (where the primary product is the medium in which the information is delivered). This difference presents unique challenges to those companies who create and sell the demand-independent information.

New technologies often (but not always) bring about new cost structures, pricing strategies, and business models for the primary product. Companies providing the demand-independent information, however, have built their business models and have achieved financial success based on the rules and business norms associated with the first primary product. This transition, therefore, represents a period of vulnerability in which new entrants that embrace the new rules in order to develop cost structures and revenue models can displace the incumbents that do not.

Ebooks, Print Books, and the Period of Vulnerability

If Bezos’ prediction comes true (or if ebooks come to represent a sizable share in the overall trade book market), publishers may now be entering the Period of Vulnerability. New competitors with lower cost structures and different business models (e.g., Lulu) have entered the market, putting pressure on publishing companies to balance print and digital strategies and the cost structure associated with each.

This last week, Barnes & Noble announced its soon-to-be-released Nook e-book reader. While many have seen this as just another entrant into the already crowded market, I believe it represents a potentially significant shift in the industry. Strategists suggest that in order to successfully compete with a company in Amazon’s position, companies must embrace standards. And, in fact, Amazon’s competitors have done this. In August, Sony announced that its library would be converted to ePub, and last week, Barnes & Noble reiterated a similar, previously made commitment. However, despite this common commitment, Sony and Barnes & Noble’s strategies are very different from one another. This difference can be seen in analyzing the industry’s capability stack.

Stack analysis is a representation of the capabilities needed to deliver value to a consumer. At the bottom of this stack are those elements furtherest away from the consumer and those whose technical details the consumer is least concerned with. Additionally, each layer in the stack can use only those below it to transform data and increase overall value.

Within this framework, a company’s primary strategic decision concerns where it will compete in the stack and whether it will focus on a single layer or integrate across multiple. Amazon, for example, has chosen to integrate across multiple layers.

While this strategy of multiple level integration has brought Amazon considerable success, it can be difficult for multiple companies to follow because it often leads to significant network effects and considerable platform lock in. Recognizing this, Sony decided to alter its strategy and is currently operating in the following stack model:

While this strategy of market modularization is logical, it is certainly not the only option. Barnes & Noble, for example, is taking a considerably different approach. The c ompany, with its Nook e-reader, now has a dedicated device, additional e-book software (for the PC, Mac, iPhone, etc.), and its own content library.

However, as the above diagram shows, Barnes & Noble’s involvement in the ebook market does not end here. The company has chosen to compete not only through vertical integration but also within a single layer of the capability stack. The company sells content and makes available its platform to users of IREX and Plastic Logic devices.

Not only does this stack architecture provide Barnes & Noble additional sources of revenue, but it also provides the company options unavailable to Sony, Amazon, and other industry players. By integrating across multiple layers while simultaneously competing within a single capability, Barnes & Noble may be able to provide more value to its consumers. While the device is unproven and the performance of the overall ecosystem is completely unknown, it is possible that this stack architecture will allow Barnes & Noble to provide the benefits of an open format standard (multiple devices with no significant lock in) with those of vertical integration (solid user experience and multiple connected, synchronized devices).

A few days ago, The Atlantic ran an article titled “The Kindle Problem.” In it, author Kevin Maney gives his thoughts on why many consumers have not yet purchased one of Amazon’s e-readers. His basic premise is that when developing products, companies should focus on either providing an excellent experience or being extremely convenient -- but not both. He states:

...in aiming to provide both a great experience and supreme convenience, [the Kindle] has achieved neither. And unless it can be revamped to truly distinguish itself, either as the best reading experience around (superior to the old-fashioned book), or as the cheapest and most convenient reading outlet available, it may be doomed to fail.

Maney continues by stating that Amazon’s pursuit of both elements has required the company to charge a price too high for the majority of consumers. While this has some merit, such a view is far too simplistic to be useful. After all, those companies following Maney’s advice have sold far fewer devices than has Amazon.

This is not to say that price does not matter. It does. Price undoubtedly has an impact on purchase decisions. However, as Everett Rogers describes in his research and in his book “Diffusion of Innovations,” consumers’ adoption of innovation is impacted by numerous factors. According to Rogers, a new innovation’s rate of adoption can largely be explained by five variables: the perceived attributes of the innovation, the type of innovation decision, the communication channels used, the nature of the social system, and the extent of change agents’ efforts.

Within these five variables, Rogers identifies the perceived attributes as being most significant. These attributes -- relative advantage, compatibility, complexity, trailability, and observability -- together tend to explain anywhere form 49 to 87 percent of variation in consumer adoption of a new innovation.

When interpreted through this framework, Maney’s argument centers around the Kindle’s relative advantage, with a heavy focus on economic costs. However, Maney’s focus on these costs does not include proper attention to perceived benefit or to the other sources of relative advantage. Rogers states:

Diffusion scholars have found relative advantage to be one of the strongest predictors of an innovation’s rate of adoption. “Relative advantage” is a ratio of the expected benefits and the costs of adoption of an innovation. Subdimensions of relative advantage include economic profitability, low initial cost, a decrease in discomfort, social prestige, a saving of time and effort, and immediacy of reward.

In other words, consumer behavior cannot be explained through a dichotomous product development strategy of providing experience versus convenience.