Barnes & Noble has just launched its ebook store and its ereader software (Mac, Windows, iPhone, Blackberry). Give credit to Barnes & Noble for (re-)entering the market. They’re certainly not quitters.

The company does a lot of things right. Its built in note taking feature is excellent. Click on the corner icon and up pops a note taking window that keeps track of all notes and their locations. Its bookmarking feature is just as good. It is all very intuitive.

But it’s not all good news. The Mac version has no way of downloading books or organizing your library. To purchase any content, Mac users will need to leave the B&N software and launch a browser. Now, this forced use of a browser doesn’t ruin the purchasing experience; but, the incoherent website does. After purchasing a book, Mac users must go to an entirely different part of the website in order to download that new book. Sound confusing? It is.

Once the book is downloaded and opened, the individual software is good. But, the overall ecosystem is incomplete. Barnes & Noble has received a lot of attention for allowing users to access their content on multiple screens. You can have your book on your home computer, your laptop, and your phone. This makes sense as I don’t want to drag my laptop onto the subway or cuddle up with it on my couch. I’d rather pull out my phone (or the soon to be released Plastic Logic device). The problem? In the B&N ecosystem, devices do not communicate with each other. If you’ve read a couple of chapters on your laptop, your other devices have no idea. When you pull out your phone, before you can begin reading, you’ll need to flick your way through the book to find the exact place you left off. Reading should not be that hard. Whatever benefit they hoped to achieve with its multiple screen capabilities is not worth the frustration caused by local-only copies of content.

Overall, it’s a decent start. The software and the store will work well for single device users. But, if the company hopes to grow an ebook business and compete with Amazon and Sony, it needs to provide a comparable experience surrounding all the devices its consumers use.

In Part I of this post, I discussed the nature of two-sided networks and how network effects leads to the success of a small number of companies in ebook distribution. Part II of this post analyzes how the use of DRM in ebook distribution magnifies these network effects.

There has been a lot of discussion as of late regarding the role of DRM in the ebook industry. Many publishing companies have pushed for strong DRM in order to protect their rights as copyright holders. Because replication of digital files is so easy, many fear that unprotected ebooks will lead the proliferation of pirated copies. While publishing companies’ desire to protect their content (and their source of profit) is understandable, the current use of DRM carries unintended consequences.

Ebook aggregators and distributors have responded to publishing companies’ concerns largely with proprietary file formats and DRM techniques. Amazon’s format and DRM are different than Sony’s which are different from Barnes & Noble’s. By allowing these competing formats, publishers have given up considerable power in the value chain. Why? Because proprietary formats and DRM increase switching costs for users and can eventually lead to winner-take-all platforms.

Consider a new ebook consumer who wishes to purchases a dedicated ebook reader. Currently, the individual can choose from Amazon’s Kindle, Sony’s eReader, several small brands, and soon the Plastic Logic device. The individual will consider many factors in making the final decision. However, one of the most important considerations will be the future of the device and the library of titles it is connected to and compatible with. If a consumer chooses a device (or simply buys ebooks) from a distributor that exits the industry in the future, that device and its files could become all but worthless (witness the Fictionwise debacle in January 2009). With proprietary file formats and DRM, it is very costly for a consumer to pick a loser.

So, how does a consumer sort out the winners from the losers? There’s no full-proof method. But the danger for publishers comes when individuals employ the following simple logic: The company with the most users is least likely to exit the business. Strictly speaking, that makes sense. And, the logic becomes self validating as time goes on and additional consumers employ it. Economists have a name for this -- they call it same-side network effects. Any given ebook platform is more valuable (in this case because it carries less risk) when additional users join it.

This can eventually lead to significant control over the market by a single company. Because of this, the current method of ebook DRM does not benefit the publishing industry. If current DRM practices continue, growth in the ebook market will likely lead to increased power among ebook distributors in the supply chain.

A couple of weeks ago, I, along with the rest of the ebook community, was trying to digest all of the news related to Amazon’s deletion of George Orwell books from a number of Kindle devices. There was (and still is) a flood of articles related to the decision and the subsequent actions by Amazon executives and Kindle consumers. One of these articles, published by the New York Times, interviews Jonathan Zittrain who lays out briefly why Amazon’s actions are troubling. Intrigued, I decided to buy his book “The Future of the Internet: And How to Stop It” and have since had a hard time putting it down.

In his book, Zittrain discusses the history of modern technology, focusing on the oppositional forces caused by generative technologies (e.g. the PC and the Internet) and appliancized technologies (e.g. the iPhone and the Kindle). Generative devices, which invite contributions and changes from anyone, offer numerous advantages, most notable of which is increased innovation. Application specific devices (which are closed and centrally managed), on the other hand, give up these benefits in order to be simple and stable.

To achieve this simplicity and stability, however, appliancized technologies must be tightly controlled, often through explicit regulation. Perhaps the most visible example of this today is the iPhone. To develop commercially for the device, developers must submit an application to Apple for approval. Many applications do not make Apple’s cut, often for unknown reasons. While this regulation has many obvious problems, it does result in an enjoyable user experience.

Today, this same issue confronts ebooks and e-readers. To put books on a Kindle (or any other e-reader), publishers and authors must distribute their content in approved formats. To sell in the Kindle store (or many of the other stores tied to a device), publishers and authors have even fewer options -- the proprietary file format and the accompanying DRM are required.

This control, as many Kindle owners discovered, does not end at the point of purchase. Tethered devices and their stored content can be controlled throughout the product’s life. This control is not all bad. Amazon, for example, has used its control to design a better customer experience. (I, for example, love how both my iPhone and Kindle know what page I’m on and update my place in a book automatically). Even Zittrain recognizes that these tethered devices can offer a superior customer experience -- provided that the manufacturer understands what the customer wants both now and in the future. And, this is the real issue. Perfect customer knowledge is unlikely at any point in the product stage -- but the negative ramifications of an appliancized device are greatest in the early stages of a product’s life.

Amazon’s decision to create a closed Kindle ecosystem is grounded in sound business principles. However, this decision comes at a price. By maintaining strict control, the company may be forfeiting opportunities to spur innovation around its device -- innovations that could help grow the ebook market and perhaps even lead to additional demand for its Kindle ebook store.

In her recent article on InfoWorld, Jennifer Kavur asks whether ePub is the next PDF. Kavur claims that since its adoption as a standard in late 2007, ePub has driven ebook sales. This is a bold statement to make, especially given the size of Amazon and Sony. Despite the lack of any exact sales figures, it seems reasonable to guess that most U.S. ebook sales occur in a proprietary format.

Kavur, however, is correct when she states that open standards are good for publishers and consumers. But, those open standards have value only when they are widely adopted. Up to this point, the major ebook distributors have largely ignored the ePub standard. Sony’s device supports it -- but if you buy from its store, you’ll get its proprietary BBEB format. Barnes & Noble has said that it will eventually sell it, but currently offers ebooks only in the protected eReader format and has given few details regarding the eventual DRM it will use. Amazon has the most distance from the standard -- its device won’t even read the file type.

Why has ePub not been more successful? After all, content creators have embraced its use. Carl Shapiro and Hal Varian provide a possible explanation in their book “Information Rules.” According to the authors, those who control the distribution channels can control the standards surrounding those channels. To illustrate their point, they tell the following story:

When [Thomas] Edison opened the first public telephone exchange, his operating manuals prompted “Hello!” as the proper way to answer the phone. . . At the same time, Alexander Graham Bell, the inventor of the telephone, proclaimed that “Ahoy!” was the correct way to answer the telephone.

Edison’s “standard” won out not because it was better or because Edison knew more about the telephone. Today, we answer the telephone saying “Hello” because Edison’s distribution of user manuals gave him greater influence in how voice data should be transmitted.

Currently, a small number of companies control ebook distribution. These companies have recognized that this control gives them an opportunity to exert significant influence over ebook standards. If they can establish their proprietary format as a desired standard in the eyes of consumers, these companies stand to profit considerably.

UPDATE: Since publishing this post, Sony has announced that it will abandon its proprietary BBEB file format and DRM technology and instead use ePub and Adobe DRM.