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).

Amid increasing reports that Amazon continues to dominate the market for e-reader and ebook sales, Sony and other competitors are altering their strategies. Last week, I wrote a post on why Sony had little choice but to give up its proprietary BBEB file format and instead adopt ePub and Adobe DRM. Sony’s new strategy is an attempt to modularize the market and to thereby allow several companies to succeed.

In this respect, Sony’s embrace of ePub was necessary. However, the decision is, in and of itself, insufficient if it wishes to change the market’s overall dynamics. In a recent article on Slate, Farhad Manjoo lays out his suggestions for how Sony (and other Amazon competitors) should proceed if they wish to be successful. The underlying logic of his suggestions comes from the music industry’s transition to digital and Apple’s ability to dominate the new distribution channel. He states:

Anyone looking to beat the Kindle, then, should look to the iPod: Study everything that Apple's rivals did, and do the opposite.

While ebook companies would be well advised to study and understand the history of this market, they should be careful when extrapolating the experiences of Apple’s competitors in order to formulate their own strategies. Digital music is very different than ebooks. Having said this, Sony and others should take the following lessons from the music industry:

It’s all about the experience

As I have said before, consumers do not simply buy products. They do not merely buy content. Consumers buy experiences. With ebooks (as it was with digital music), consumers have paid little attention to the file format or the DRM protection on their content. Now, this is not to say that no one cares about these things. Many consumers do, and these individuals tend to be very vocal about their concerns. But, these individuals are a minority. In fact, according to a recent report done Imran Khan, only 15% of consumers cite Amazon’s proprietary file format when deciding not to buy a Kindle (and only as a 2nd or 3rd reason).

Switching Costs Matter

Manjoo cites the failure (or at least the underwhelming market penetration) of Apple’s competitors as an example of why the overall ecosystem matters. While he is correct, something much more significant is occurring with the Zune and the other device manufacturers that he referenced. By the time the Zune entered the market (in 2006), Apple had solidified its position and had established a large user base. To compete successfully, Zune had to not only provide a better user experience, but it needed to convince users that the Zune experience was so much better than Apple’s that it warranted the incurrence of considerable consumer switching costs. These costs included not only the amount of money invested in music (compatible at that time with only iTunes) but also the time spent learning and becoming comfortable with the iTunes and iPod systems. Consumers like consistency, and comfort with an existing platform represents a considerable obstacle to would-be competitors.

Sony is in a different position today than Microsoft was in 2006. The ebook market is still relatively small. Only 2% of consumers currently own a device and the market is expected to grow significantly. This provides opportunities to Sony that won’t be available if Amazon continues to dominate into the future. However, switching costs are still relevant in the ebook market.

According to Carl Shapiro and Hal Varian, consumers who experience lock-in go through the following cycle:

Lock-in begins when a consumer chooses a brand, begins to sample it, and then invests in it. While we can see that current Kindle consumers have done exactly this, such a view is far too narrow in its scope. The degree of Kindle’s success is due, in large part, to the fact that consumers had previously selected the Amazon brand as their platform for purchasing products. For many, therefore, the purchase of the Kindle is simply a further investment in the platform (and an additional source of overall lock-in). Sony will need to understand this lock-in and be able to address it when it makes marketing and distribution decisions.

Align incentives

Manjoo’s idea of trading ebooks among friends is similar to Microsoft’s idea for social music on the Zune. Individuals could send a friend a song who could then listen to it up to 3 times over the course of 3 days. The concept, despite its uniqueness, did not lead to the level of success Microsoft expected because the feature’s value materialized only if a consumer’s friends also bought into the Zune platform. For these individuals to buy into the system, they would need to incur those considerable switching costs for what was a pretty insignificant benefit. Listening to a song 3 times, after all, could be achieved far more conveniently. Zune’s social media concept failed because the user’s incentives were not aligned.

Manjoo’s idea -- while intriguing -- falls into a similar incentive trap. This time, however, it is the incentives of the content creators that creates an issue. Allowing Zune consumers to listen to a song 3 times for free was allowed because a user’s demand for repeat consumption is high in the music industry. So, giving away the content (while placing certain restrictions on convenience) is effective at increasing purchases. The same cannot be said for books. Once a consumer has read a book, that individual’s demand for the content decreases dramatically. If consumers are allowed to share the full content of an ebook with friends, sharing will in most situations not lead to increased purchases. More importantly, such DRM policies could potentially open the door for third party ebook rental markets that could actually reduce revenue to publishers. The incentives for publishers are simply not aligned with this proposal.

Manjoo’s idea has the correct end goal -- distinguish the ePub platform by increasing consumer options. However, ebook aggregators and device manufacturers must pursue strategies that have incentives aligned for all interested parties.

Consumers have more choice than ever in the book industry. According to Bowker, there were more than 275,000 books published in 2008. That’s approximately 1 book every 2 minutes. With all of these choices, it can be difficult for authors to find new readers. And, while previews of content undoubtedly help, many have discovered that free content works even better. When I checked the Kindle store this afternoon, I counted 4 books in the top 10 that were free. The popularity of these ebooks has received a lot of attention both in the media and among bloggers. But, does free really make sense in the ebook world?

Business models based on free are nothing new and can be seen throughout the economy. These past and current practices offer good lessons to publishing companies and self-published authors trying to navigate the nascent ebook market. These models, despite their many obvious differences to one another and to ebooks, have an important commonality: to be successful, free must lead to paid.

This link can be accomplished in two ways. First, free can overcome the consumption hesitancies caused by purchasing information. Books (and other information products) are considered experience goods -- consumers cannot truly assess their willingness to pay for a book until after they have read it. Companies have traditionally addressed these hesitancies by giving away a portion of the content so that consumers can better estimate its value. Amazon, for example, lets ebook readers have the first chapter of any title for free.

The second way in which free can be successful is if it increases consumption of complementary, paid goods. The newspaper industry provides an excellent example of this strategy. For all of the problems the industry is currently experiencing, many companies are able to generate positive contributions from their online divisions by giving away content. This model works because free content attracts readers. And, the more readers a company has, the more click throughs the company will receive on its advertisements. On newspaper websites, content and advertisements (if designed well) work as complements. Users consume both together.

Let’s look at each of these possibilities in turn:

Consumption hesitancies.

Allowing for partial samples of a book helps to reduce the fears and uncertainties associated with purchasing information. However, more recent arguments surrounding free focus less on partial product distribution and increasingly on total product give away.

The strategy of free digital distribution worked fairly well in the early days of the Internet. Authors could post content on the web and see an associated increase in print sales. Such an increase was possible because consumers (after evaluating the content online) still wanted to purchase the more convenient, print version. The value of such a strategy today, however, is uncertain. Many users seem comfortable reading on an LCD screen and those with e-ink devices can easily transfer content to eliminate any inconvenience. These changing consumption preferences impact the viability of this strategy because books are a unique type of information good (distinct from music or movies, for example). With books, there is little demand for repeat consumption. Once a user has read the book, his/her demand drops dramatically. The connection between free and paid, once driven by format convenience, is now lost.

Because of this, free’s ability to increase profit by reducing consumption hesitancy depends on its ability to generate positive feedback in overall consumer purchases. There is little doubt that a book’s strong sales today impact its sales tomorrow. A successful book gets more visibility, and visibility translates into additional purchases. Free could theoretically help to accomplish this: publishers could release a book for free and begin charging for it once it became sufficiently popular. This seems to be the strategy that Chris Anderson employed with his recent book. The title was available free of charge for a short period of time through the Kindle store. In that time, the book earned a place on the Kindle’s Top Seller list. Soon thereafter, Anderson’s price jumped to $9.99.

While this strategy makes some sense, it suffers from the fallacy of composition -- the idea that what is true for the part must also be true for the whole. In this instance, a strategy of temporarily free titles to create positive feedback is effective only if others do not also employ it. Each additional free ebook on the market would diminish the visibility of other free titles, reducing any individual book’s benefit.

Complementary Paid Goods.

Publishing companies and authors are now beginning to offer the first book in multi-book series for free in order to maximize overall sales. The free first book reduces consumption hesitancy and increases demand for the complementary, related titles. Based on statements made by publishing companies, this strategy of free can be very successful.

The problem with this model, however, is that it works only in very limited circumstances. Its success requires multiple, related books (ideally in a series). However, to get multiple books published (at least by an established publishing company), an author has to have already experienced considerable success. In fact, of those top 10 books that were free on the Kindle store, all came from proven, well established authors of fiction.

Free can work for ebooks -- but only in very limited scenarios and for a small subset of authors.