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.

A few weeks ago, I wrote a post analyzing whether ebooks cause print cannibalization. The motivation for the post was Sourcebooks’ decision to delay the ebook release for “Bran Hambric: The Farfield Curse” in an effort to prevent hardcover cannibalization. A similar issue has come up again (albeit with a different result) with Dan Brown’s new book, “Lost Symbol.”

The issue of cannibalization is important for publishers and centers around the practice of versioning. For-profit companies design and implement strategies in order to maximize profits. In theory, profit would be maximized when a company is able to charge consumers their individual willingness to pay for an item. However, such personal knowledge is not easily shared by consumers, making this theoretical pricing practice impossible. Versioning is an attempt to understand consumer’s approximate willingness to pay and charge accordingly. Companies will release one version of a product designed to appeal to high paying consumers and more basic versions targeted at others.

Companies can implement versioning strategies in several different ways. Publishers, however, have long used time versioning. Publishing companies attempt to identify those consumers with a high willingness to pay by initially releasing only the more expensive (and more profitable) hardcover version of a book. Those who place the highest value on the content will want the book immediately and will not wait for the lower priced paperback. The result is higher total profit.

The fear among some publishers is that the simultaneous release of hardcover and ebook versions will limit the effectiveness of this strategy and thereby reduce profit. However, the underlying assumption of this strategy -- and the reason why this type of versioning works -- is that consumers choose content first and format second. Ebook consumers seem to be challenging this (at least those who have purchased a dedicated device).

Choice of format before content clouds a publishing company’s ability to use time as a metric of willingness to pay. Therefore,while ebooks will likely have a limited impact on a company’s print versioning strategy, publishers will need to find new methods of segmenting ebook consumers. Such segmentation can still occur through versioning strategies, though companies must be willing to experiment with different applications.

Random House, for example, has launched Book and Beyond in the UK. Consumers most interested in an author’s content can pay extra for enhanced versions containing audio and video components, interviews, and images. Those with a lower willingness to pay will likely forgo these extra features and purchase the basic version.

Other types of versioning strategies exist and could help publishers segment the ebook market. However, the success of these strategies may be determined by the extent to which the ebook market becomes modularized. Complete, vertical control over a market has its advantages, but it often acts as a disincentive for experimentation.

Publishing companies should recognize that current versioning strategies are effective (and therefore profitable) because they allow consumers to reveal their willingness to pay. While ebooks challenge current versioning practices, the same result can be obtained if companies are able to experiment with new methods.

Ebooks have been around, in some form or another, since 1971. However, it has not been until recently, with the help of Sony and Amazon, that the market has taken off. Sony and Amazon’s success is due, in part, to its control over the entire consumer experience. When these companies (re-)entered the market in 2006 and 2007, both decided to control all points of contact with the consumer. This approach overcomes the difficulties caused by a more modular, specialized market structure. In his book “Seeing What’s Next” Clayton Christensen explains:

Companies ought to control any activity or combination of activities within the value chain that drive performance along dimensions that matter most to customers. Directly controlling, or integrating, an activity gives companies the ability to run experiments and push the frontier of what is possible. Integration gives firms a full platform to run experiments to solve problems caused by unpredictable "interdependencies" between activities.

Sony and Amazon each created the device, sold the content, and managed the DRM on its own. The consumer, therefore, only needed to interact with a single company. By limiting this interaction, Sony and Amazon could better respond to the needs of their consumers and provide a better user experience.

While this vertical control may simplify the market for consumers and thereby increase adoption, it can lead to winner-take-all competition. In markets controlled by network economics, significant early consumer adoption can lead to sustained market dominance. Based on the information available, these network effects seem to be driving consumers to Amazon instead of Sony.

Recognizing this, Sony had little choice but to modify its strategy. Its proprietary platform could not compete with Amazon’s. However, Sony understands that it can still be successful if it can modularize the market and eliminate winner-take-all competition. To do so, Sony chose to reduce its vertical control and adopt the ePub standard.

As Carl Shapiro and Hal Varian explain when discussing proprietary versus open standards, a company’s total reward is a product of the size of the platform and its share of that platform. By abandoning its proprietary file format and instead selling only ePub content, the company hopes to increase the size of its new platform by an amount that more than offsets its decrease in share. To do so, Sony must do two things.

First, the company must limit the extent to which the new modular platform disrupts the user’s experience. Because users tend to care more about the quality of their experience than the format of their content, Sony must provide an experience that approximates that offered by Amazon and do so with far less control. This, as early ebook companies discovered, can be difficult. When a consumer with a Cool-er e-reader buys content from Sony’s store and has a problem, who should be contacted? The device manufacturer? The content aggregator? Or the DRM provider? In a modular architecture, problems can quickly become frustrating. And, anytime consumers adopt a new technology, problems will arise.

Second, Sony must make the argument that the increased complication necessitated by the modular architecture is preferable to proprietary platform lock-in. Amazon’s George Orwell drama continues to receive considerable coverage and serves to demonstrate that while consumers generally do not care about file formats, they will take notice when the format or the DRM protection impacts their experience. While Sony’s ePub adoption allows the company to capitalize on Amazon’s missteps, its marketing message is complicated by its own DRM policies. Fear of lock-in may cause many consumers to move to a more open system, but Sony’s new platform is susceptible to many of the same negative consequences as Amazon’s. Sony’s power over content has not disappeared -- it has simply been transferred to Adobe.

Sony’s new structure, despite being more modular, is still a platform. As such, network economics will continue to play a role in determining the winners and losers in the ebook market. What’s new, however, is that Sony’s success is now to some degree in the hands of multiple companies.

In a Harvard Business Review article, Rita McGrath explains why she believes Barnes & Noble may topple Amazon in the ebook market. David Rothman over at TeleRead posted an excellent response to McGrath. Without repeating what Rothman has already said, McGrath’s piece deserves a closer examination.

In her article, McGrath correctly characterizes Amazon’s business model as vertical and states that this decision is grounded in early market leaders’ need to delivery a quality user experience. However, as standards come about, other companies can challenge this vertical business model. She then goes on to state:

But here's the more interesting move to me: while B&N has announced that they too will be offering a touch-screen book reader, using B&N's electronic bookshop does not confine a user to their device alone. While they won't be compatible with Kindles or Sony readers, they will work with the iPhone and iPod touch, Blackberry, and most MAC and Microsoft Corp Windows laptop and desktop computers.

The number of screens on which a user can access content, however, is not the issue. After all, Kindle books can be read on multiple devices (Kindle, iPhone, iPod Touch). The issue that McGrath raises is whether the ebook market is ready for a more modular structure.

In their book “Information Rules” Carl Shapiro and Hal Varian discuss the advantages of proprietary control when it ensures a better experience (and especially when that control is exercised by the market leader). They go on to qualify this:

However, failure to open up a technology can spell [a company’s] demise, if consumers fear lock-in or if it face[s] a strong rival whose system offers comparable performance but is nonproprietary.

The market may be maturing to the point where consumers do, in fact, fear this lock-in. Having Amazon’s tight control over the user experience in the news certainly does not help lessen these fears. However, if Barnes & Noble (or any other company) wants to capitalize on this, it needs to alter its strategy.

First, Barnes & Noble must recognize that accessing content on multiple screens is, in and of itself, insufficient in alleviating consumers’ fear of lock-in. Barnes & Noble content, just like that of Amazon, will work on multiple devices -- but only in the software the company allows you to use. If you don’t want to use the company’s software, you are out of luck. More importantly, Barnes & Noble is wrapping content -- even its public domain books -- in proprietary DRM. In other words, Barnes & Noble’s response has not been to open its technology and embrace standards. Its platform creates the same kind of lock-in created by Amazon.

Second, Barnes & Noble must recognize that reading content on multiple screens forfeits any remaining value if the devices are unable to communicate with one another. As I said in a previous post, after reading a couple of chapters on a phone, users will not want to laboriously try to find their place again once they reach their PC. Without this device-to-device communication, Barnes & Noble’s platform is not a comparable competitor to the Amazon ecosystem.

While this will turn off some customers, McGrath correctly recognizes that Barnes & Noble’s approach does have a separate advantage: working with multiple devices allows Barnes & Noble to tap into the market segment that wants to read ebooks on PCs rather than spend the money to purchase a dedicated e-reader. However, the size of this segment is unknown and may be small (in terms of users and the amount of content purchased).

To succeed, Barnes & Noble should instead be moving to establish additional partnerships with companies manufacturing dedicated e-readers in order to ensure its compatibility with those devices. Doing so will help to truly reduce fear of device lock-in and can therefore help modularize the market.

With the rise in popularity of ebooks, many publishing companies have begun to focus closely on the cannibalizing impact that ebook sales have on print sales. Sourcebooks, Inc. has even announced that it will delay the release of “Bran Hambric: The Farfield Curse” as an ebook in order to prevent any loss of hardcover sales. However, the discussion of cannibalization may be less relevant than once thought. While the introduction of the ebook format necessarily brought about some cannibalization, the market may have reached the point that the issue is no longer cannibalization, but missed sales.

The argument that ebook distribution will result in print cannibalization rests on a number of consumer behavior assumptions. In order for print cannibalization to occur, consumers would need to seek out book titles first and select the desired format second. This consumer behavior is consistent with many current and past retailing practices (both in physical stores and e-stores) where consumers browse in sections and select the format (hardcover versus paperback) only after the desired content is found. This consumer behavior is a primary reason why paperback editions are released at a later date.

However, ebook distribution challenges this behavior. Consumers who want ebooks now go to dedicated ebook sites to browse and buy. This type of purchasing behavior is possible because ebook distributors have amassed enough content to satisfy the majority of ebook consumers. Amazon, the most popular ebook distributor, has over 300,000 titles and nearly all of the titles on the New York Times Best Seller list. Individuals buying from these distributors (and especially those who have purchased a dedicated e-reading device) have chosen their desired format before choosing the content.

Given this change in consumer purchasing behavior, the argument of print cannibalization rests on an even more difficult assumption -- that any given book title has limited substitutes. Those who subscribe to this idea believe that as long as their content is not available in an ebook format, consumers will continue to purchase the print book instead of purchasing a similar title in their preferred format. However, a publishing company cannot dictate the format when consumers cannot find an author’s content. While a limited number of authors will be able to overcome this (at least to some extent) through reputation-based marketing, dictating the format may alienate an author’s readers. This alienation poses a significant risk to the long-term success of a publishing company.

There is no doubt that the introduction of a new format brings about some level of cannibalization. However, publishing companies and authors must realize that there is a difference between avoidable and unavoidable cannibalization.