Goodbye to Discs and Pages?

This article, although related specifically to Apple and Amazon, the larger story is the fast movement to digital content for books/textbooks. 

Amazon vs. Apple: Battle of the books

With its new iPad, Apple is taking aim at Amazon's core business and its Kindle book reader. Can the 'e-tail' pioneer keep up as books, music and movies go all-download?

By Michael Brush (AMZN, news, msgs) has come out on top in the digital revolution that's moving sales of books -- as well as compact discs, DVDs and lots of other products -- online.

But there's a second digital uprising afoot, and some experts think Amazon won't fare as well -- and could lose a sizable chunk of its core bookselling business.

Any Amazon losses would likely be gains for Apple (AAPL, news, msgs), which could do to its "e-tail" rival what Amazon has been doing to brick-and-mortar competitors.Apple's chief weapon in this battle of online giants -- the iPad -- will be rolled out April 3, with preorders starting March 12. Among the many things people will be able to do with these flat touch-screen computers: download and read digital books from Apple's new iBookstore.

Amazon has its own successful book reader, the Kindle. But Apple dominates in music downloads, so there's good reason to think it will take a big share of the market for downloadable books. "In music, Apple is the dominant player. Now Apple wants to do the same in books," says Jeffrey Liebenson an attorney with Herrick, Feinstein who was involved in some of the early music industry negotiations with Apple. And the iPad threat is part of a bigger-picture "digital transition" risk to Amazon that has led many investors to head for the exits.

The worry? Books are joining music in a broad shift to entertainment via digital download, and that's a game Apple tends to win.

Goodbye discs and pages

Think how this second digital revolution has changed the way we get entertainment:

  • When was the last time you bought a CD? Sales of CDs declined to 301 million last year from 712 million in their peak year of 2001, according to Nielsen SoundScan. Instead, people download music -- and Apple, with its iTunes store, dominates with a 70% market share. Amazon has 8% of the music sales market.
  • The same thing is happening to DVD sales. Video stores such as Blockbuster (BBI, news, msgs) are already hurting. Consumers will soon wonder why they should buy a DVD anywhere when they can get a movie online -- instantly.
E-Book price wars

Amazon hasn't ignored these changes. You can download music at the online retailer -- and from many other places, of course -- but Apple simply rules this game.

You can also get movies over the Internet from Amazon. Here Apple isn't dominant, but the field is crowded with strong rivals: cable companies, Netflix (NFLX, news, msgs), Hulu and Vudu, which was recently purchased by Wal-Mart Stores (WMT, news, msgs).

Books are next, and Amazon is certainly a major player in the digital book market with the Kindle. But imagine that Apple does to the book market what it's done in music. How much will be left for Amazon or anyone else?

The risk to Amazon's business is real, and it is one of the main reasons Credit Suisse analyst Spencer Wang is telling investors to avoid buying Amazon stock now. He has a "hold" rating on the online retailer and a 12-month price target of $130 a share, around where the stock sells today.

Because of these worries, investors sold out of Amazon stock earlier this year when it became clear Apple was entering the e-book market, analysts say. The stock is down from a 52-week-high at $146, though, like the market as a whole, it's way up from its lows.

Among those selling has been Amazon founder and CEO Jeff Bezos. In February, he sold 2 million shares of Amazon stock at prices between $116 and $120, according to Thomson Reuters. He sold 7 million shares in 2008-09, after selling no stock at all during 2005-07.

The strong side of Amazon

Mind you, this is a battle of giants.

Amazon's stock is up 50% since I wrote in August 2008 about a different battle for online sales ("How Amazon is beating up eBay"). The Standard & Poor's 500 Index ($INX) is down more than 10% from where it was then, and eBay (EBAY, news, msgs) is down slightly.

Amazon revenue grew an impressive 37% in the fourth quarter of 2009. It owns 22% of the North American book market, according to a Credit Suisse estimate. And it can continue to grow by doing what it does best: taking market share from brick-and-mortar retailers.

It sold an estimated 2 million Kindle book readers last year, and 3.1 million are expected to be sold this year, according to estimates by Barclays Capital analyst Douglas Anmuth. Amazon's stated goal of having every book ever printed in any language available on Kindle in less than 60 seconds is a bold one -- and however realistic, it means Kindle owners should eventually be able to get virtually any book they want.

The Apple advantages

Apple, though, is a fierce competitor, which is what makes the battle intriguing. And it has two big advantages as it goes after book sales.

Advantage No. 1: Apple has eager allies in the publishers.

To promote Kindle, Amazon has been offering great deals on new and best-selling e-books, a 55% discount off a typical $22 list price to $9.99. It's selling many e-books at a loss, says Wang, the Credit Suisse analyst.

This annoys publishers. They think Amazon has too much clout in the book business, and they don't want to see that extended to e-books. And they worry that a $10 price will "cheapen" books, training consumers to always expect low prices.

Enter Apple. It has offered publishers better prices than Amazon asks -- as long as the publishers make other vendors (i.e., Amazon) raise the retail price on best-selling e-books to $12.99 to $14.99. Most of the major publishers have signed on. If the alliance sticks, it will hurt Amazon's strategy for taking market share and fueling Kindle growth.

"All the publishers I talk with are hoping the iPad will live up to the hope," says Todd Eckler, the vice president for print and publishing at North Plains, which sells software to help providers put their content online.

Advantage No. 2: Apple is better than almost anyone at making gadgets.

This is key, because the gadgets can be crucial in determining which company eventually controls the content ecosystem, including the all-important formats that can be used to lock out competitors.

One of the main reasons Apple dominates music is the popularity of its iPod players and its music-playing iPhone. Lots of companies make music players, but Apple dominates so thoroughly that "iPod" is nearly a generic term.

Though we won't know for sure until it hits the market, with its smooth interface and bright color screen, the iPad seems sure to be a comfortable way to read books, believes Scott Testa, a professor of business administration at Cabrini College in the Philadelphia area and an avid Kindle user. "The iPad is going to blow the Kindle away as far as ease of use and the quality of the screen," he says.

Amazon's gadget will have the price advantage. The Kindle starts at $250 and is likely to get cheaper soon. Apple's iPad will start at $500; if Apple wins, it will likely be because the iPad does much more.

Though the iPad's features and processing power will be overkill for the simple act of reading a book, they're likely to contribute to an evolution in what constitutes a book that could move that market toward Apple.

A next-generation iPad book could easily include video on "the making of the book" as with DVDs, an author interview or music -- features that will make book reading a richer experience, says Eckler, of North Plains, which sells software that helps publishers do these things.

Beyond books, consider that the many potential customers who already have deep libraries of iTunes music and video can play those on their iPad. They don't work on a Kindle or on other manufacturer's devices. If customers buy only one device, that's an incentive to go with the iPad.

The Google wild card

Amazon also has Google (GOOG, news, msgs) to worry about. The latter is scanning as many books as possible to build up the world's biggest digital book database.

We're still not sure how Google plans to make money off this, but one approach is obvious: Google will likely discount books (or give away books in the public domain, without copyright limits, for free), and make up the difference by charging sponsors for ad words, just as it does for search. Plus industry experts believe that like Amazon and Apple, Google will roll out its own book reader at some point soon.

So what to do with Amazon?

Against this backdrop, what does Amazon's future hold?  

An Amazon spokesman declined to comment for this column. But in a recent conference call with investors, when asked about the emerging book battles, Amazon finance chief Thomas Szkutak responded: "We think we are positioned very nicely from a digital perspective. We think we are focused on the customer, and I think Kindle is certainly a good example of that."

Even without the price advantage, the Kindle would be good enough for many book fans, particularly older readers who will be happy to read books and newspapers on the Kindle's black-and-white screen. "It is a generational thing," says Eckler. "The Kindle is simple. There are not a lot of buttons."

Wang, of Credit Suisse, believes Amazon will continue to see 7.5% annual growth in North American book sales over the next five years, even with Apple entering the market.

There's also a macroeconomic reason Amazon will be OK: Online sales still represent only 3.8% of overall retail sales in the U.S. So there is still plenty of room for Amazon, the leader in the space, to grow as more retail moves online, says Mark Mahaney of Citigroup.

The key takeaway for investors is this: Don't buy Amazon stock expecting the kind of huge gains seen over the past couple of years. Many market players will wait to see how the online retailer manages the all-digital transition, but with savvy competitors such as Apple attacking its core book market, growth will slow.

Apple's stock, on the other hand, just keeps rising. You would be buying today at an all-time high, which can be risky. But citing the iPad, plus continued strength in iPhone and Mac sales, Credit Suisse analyst Bill Shope has an outperform rating and a 12-month price target of $275 on Apple stock, from about $223 today.

For consumers, the book battle could mean higher prices on new and best-selling e-books, as Apple aligns with publishers to raise prices above Amazon's big discounts. But gadget prices should fall quickly as the competition heats up.

And the cool news is that the iPad may open up a whole new world of "words" that brings lots of cool features to the concept of a book. Amazon and others will have to match technologies or lose out. The simple act of reading is changing forever.

At the time of publication, Michael Brush did not own or control shares of any company mentioned in this column.