What if the price war that broke out this week among e-book readers is a race to zero?
Dennis Kneale, CNBC's media and technology editor, proposed yesterday that Amazon.com (Nasdaq: AMZN) give away its Kindle as a way to populate the country with its e-book readers.
It's a noble idea. If Amazon could find a way to eat the hardware costs, knowing that it could make up the difference in digital downloads, why not let free Kindles rain on down?
But there are more than a few roadblocks on the bumpy path to Nil City. For starters, there's the iffy assumption that Amazon's Kindle is a razor-and-blades model.
A novel plan
Video-game consoles, satellite-television receivers, and smartphones are subsidized because the parties taking the hit know they can make it up in video-game royalties, monthly programming packages, and wireless plans, respectively. It remains to be seen whether Amazon can cash in when it comes to digital books.
There's a misconception out there that digital delivery is high-margin, by default. It's not. When Apple (Nasdaq: AAPL) sells a song for $0.99 through iTunes, the lion's share goes to the music label. Fulfillment costs largely consume the leftover sliver.
"The iPod makes money," Apple executive Phil Schiller said in a CNET interview several years ago. "The iTunes Music Store doesn't."
Economies of scale have improved since then, but music downloads are unlikely to ever be a major part of Apple's bottom line. The blades in this particular case are the sacrificial lambs for the razors.
Amazon's pricing is equally aggressive. It was never going to convince the first wave of Kindle owners to pay $399 for a device that reads digital books at the same prices as the online discounter commands for print editions, so the $9.99 price point was born. Amazon would pay publishers a set price and then mark the books up or down to achieve its desired price point.
The agency model is changing that situation, as Apple and Amazon are agreeing to higher price points of $12.99 and $14.99 and take 30% of the sale. However, the agency-model math shows how little Amazon was making on $9.99 books -- if it was making anything at all.
Higher prices will benefit Amazon's model, but they will also slow the flow of digital converts.
The $185 line in the sand
An iSuppli study last year on Kindle components pegged the gadget's cost at $185.49. This doesn't mean Amazon is making a profit at the new $189 price point. We have steep marketing costs to consider, and Amazon even subsidizes the shipping. However, it's also realistic to assume that component prices have gotten cheaper over the past year.
Let's go with $185 as the breakeven point, even though reality is probably a bit more or less than that.
How many digital books would Amazon need to move to cover that sizeable nut? It's quite the stack. But Kindle is also offering paid subscriptions to digital newspapers, magazines, and blogs.
Let's be blunt about the blogs. As e-reader devices improve their Web-browsing features, few will pay for blog fees that are freely available online. That leaves us with newspapers and magazines -- and there may be something there.
"Daily papers aren't enough to justify the ideal catalyst: newspaper companies that offer fully subsidized Kindles in exchange for long-term subscriptions," I wrote when Amazon shaved its Kindle to $259 last year. "Even an aggressive book of the month concept would have to lock a publisher into a multiyear commitment to pay off. However, as Kindle prices get cheaper, the subsidized math will get easier to swallow."
CNBC's Kneale and I appear to be on the same page in suggesting book clubs and digital newspaper subscriptions as a way to offer "free" Kindles.
New York Times' (NYSE: NYT) namesake publication is the bestselling newspaper on the Kindle. Subscribers pay $19.99, a price that the paper set, for a month's worth of their daily Kindle editions.
Perfect! If an avid New York Times reader is willing to pay $240 a year, why can't he or she get a free $189 Kindle?
Not so fast, my friends with ink-stained fingers. We don't know how much of that $240 goes to Amazon, though it's not likely to be much. The math doesn't work unless the publishers are willing to subsidize the offer.
Will they? The cost benefits of digital over print are obvious, but newspaper giants may not want to be on the hook for annual hardware hits. We may have to stretch user commitments to two years, which is standard in the wireless realm, but will that fly? Consumers may not warm up to $480 in digital subscriptions to save $189 on a Kindle.
Learning from the subsidized-netbook mistakes
We've seen this happen with netbooks. RadioShack (NYSE: RSH) turned heads two holiday seasons ago, when it offered Acer netbooks for $100 -- hundreds of dollars less than they retail for -- as long as buyers ponied up for two years of mobile broadband connectivity.
Best Buy (NYSE: BBY) followed suit with a $0.99 netbook for a spell last summer, but did it fly off the shelves? Probably not. Getting a $390 Hewlett-Packard (NYSE: HPQ) netbook for a buck sounds like a great deal, but moving value-priced portable computers tethered to $1,441 in wireless fees over two years isn't going to fly.
Amazon is in a better place. Newspaper subscriptions and book clubs would clock in at substantially lower price points. It's also reasonable to think that e-book readers are marketed at a more affluent audience than folks looking for a dirt-cheap laptop.
Amazon also is in a healthier position than a retailer making a one-time transaction. If someone has a daily subscription on a Kindle, that person is going to be carrying it around everywhere. I would bet you a dollar -- or a subsidized Kindle -- that folks who have daily newspaper subscriptions are also more active buyers of e-books and e-magazines than those who do not.
If New York Times balks, Amazon should turn its attention to all of its newspaper partners. Surely there must be one in the lot that is more desperate than the others.
Gannett's (NYSE: GCI) USA Today is the third most popular newspaper in Kindle format. It's cheaper at $11.99 a month, but some print dinosaur is going to jump at this -- especially if Amazon offers exclusivity for a few months or a year to the partner that helps it make "free" Kindles a reality.
It's going to happen. And Amazon had better hope that it gets there before a rival arrives first.
Will subsidized Kindles fly? Share your thoughts in the comments box below.
