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.

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.