Why Apple's iPad E-Book Model Is Giving Amazon a Headache

With the iPad release just ahead, the device will soon be in hundreds of thousands of customers' hands, and the reviews coming in are largely good. Even Apple's (AAPL) newest category addition, the iBookstore, is getting strong marks, with readers of e-books holding it up as a much better experience than using the Amazon (AMZN) Kindle.

The one criticism of the iBookstore, as expressed by The New York Times' David Pogue, has been that its offerings are "puny" -- a mere 60,000 e-books so far -- compared to what's available on the Kindle or other e-readers offered by competing retailers like Barnes & Noble (BKS) and Sony (SNE).

But the reason for the iBookstore's currently limited offerings isn't that Apple was thinking small. It's that Apple chose to change the e-book game.

No Laughing Matter

The iPad required publishers to alter entirely the way they do digital business, moving from the old "wholesale" model to Apple's preferred "agency" model, in which the retailer gets an immediate 30% share of prices that publishers set. And even though publishers had more than two months to make this transition happen, April 1 is turning out to be no laughing matter for publishers, retailers and especially readers who want to buy new e-books, even those who have no desire to buy an iPad.

Back on Jan. 27, when Apple CEO Steve Jobs unveiled the iPad, five of the "Big Six" publishers had agreed to make their e-book catalogs available for the iPad, effectively agreeing to switch to the agency model. The lone holdout remains Random House, which hasn't ruled out an iPad deal, but isn't rushing into it because, as per The Big Money's Marion Maneker, it stands to lose almost 7% of its earnings by making the switch.

Macmillan, of course, ended up in a well-publicized tiff with Amazon, during which the "buy buttons" on Macmillan's digital and print offerings were removed from the retailer's pages. The situation was resolved, but the possibility loomed that other major houses might see Amazon halt their sales as well if they couldn't come to an agreement by the time they moved to an agency model.

Both Simon & Schuster (CBS) and HarperCollins (NWS) sidestepped such complications, as The Wall Street Journal reported Wednesday. Moving to the agency model, Amazon will now price these publishers' e-books primarily between $12.99 and $14.99, though some new bestsellers will be available at the $9.99 price deemed so incendiary that publishers insisted on leaving behind the wholesale model, even though doing so means they make less money and Amazon will make more. (Sony is also officially raising its e-book prices, as documented in a letter sent to customers Wednesday.)

"A Few Hiccups Along the Way"

But the news isn't so good for readers looking on Amazon for new e-books published by imprints of Penguin (PSO) and Hachette (LGDDY): Buy buttons have disappeared for those publishers' e-books, albeit temporarily. (Print editions remain available.) In a letter sent to agents announcing the agency model switch, Hachette CEO David Young said "there will be a few hiccups along the way, and you may even see some short-term interruption in the availability of our eBooks, especially in the first few days, as systems are being adapted to accommodate changes."

On its website, Amazon offered its side of the tale: "We recently signed an 'agency' agreement with Hachette and we are working with them to offer their books under these terms in the coming days. This means we will not be selling Hachette ebooks in the interim." In a clarification later in the morning, Amazon put the blame squarely on Hachette, saying that the publisher "has disallowed the sale of ebooks except on agency terms effective as of 12:01 am this morning. We came to terms late last night but we cannot be operationally ready to sell their ebooks on agency terms until two days from now -- April 3 -- when we will also cut over for the other publishers that are switching to agency. If we can get a two day extension from Hachette to continue selling their ebooks under the prior terms, we can have the Hachette ebooks promptly back for sale today. If not, then they will be back on April 3."

Penguin USA CEO David Shanks sent out a similar letter to agents this morning explaining both the agency model rationale and why e-book editions of books published on or after April1 aren't available on Amazon. "In recent weeks we have been in discussion with our retail partners who sell eBooks, including Amazon, to discuss our new terms of sale for eBooks in the U.S. At the moment, we have reached an agreement with many of them, but unfortunately not Amazon -- of course, we hope to in the future." Shanks assured agents that "our conversations with Amazon are ongoing and we do hope to continue our long-time relationship with them."

As Amazon, Penguin and Hachette sort out their digital dealings, bigger questions about switching to an agency model loom large for companies occupying a variety of points along the publishing supply chain, firms that have complicated back-end processes and can't just make this switch with the proverbial snap of the fingers. As we're now seeing, there will be lots of "hiccups" the transition, affecting which books are available digitally and which aren't. There are tax compliance issues to sort through. And many other publishers are following Random House's lead in eschewing the agency model altogether.

An Open Door for New Competition?

Michael Tamblyn, vice president of content, sales and merchandising at e-book retailer Kobo explained one of the complications earlier this week. A number of things e-book customers have come to expect -- such as low prices, loyalty programs, promotions and discounts, will go away with advent of the agency model. "We could still do [discounting] for non-agency titles, but then we end up in a weird situation of 'Get $1 off, but only on these books, and definitely not on these other ones.' That's not fun. And worse, it's confusing to consumers." The discounting issue has already caused one e-book retailer, the Barnes & Noble-owned Fictionwise, to discontinue its loyalty program.

The switch has caused wholesalers such as Ingram and Overdrive to bend over backward to meet the early April 1 deadline, with mixed results. Last week, Ingram Digital General Manager Andrew Weinstein told more than 60 of its retail customers to be prepared for "the very real possibility that Ingram will have to discontinue the availability of ebook titles from all publishers wishing to do business under an agency model ... on or before April 1."

In a conversation with industry newsletter Publishers Lunch, Weinstein and Chief Content Officer Phil Ollila said that Ingram's standpoint is that they are serving both publishers and retailers under any model they work with, but because the switch was happening so fast, they weren't certain they would be ready in time, even as they are "treating this current e-book environment with a great sense of urgency."

Overdrive CEO Steve Potash wonders how the picture is going to look in six or nine months. Even if the strategy turns out not to be correct, "by leveling some of the pricing we'll see some new e-tailers come into the market offering e-books." And in an alert sent out Thursday afternoon, independent e-book retailer BooksonBoard warned that availability for digital offerings from the "Agency Five" publishers -- Macmillan, S&S, Hachette, HarperCollins and Penguin -- could be delayed for "several days to a week or more" as a result of the agency model switch.

With the major houses in serious flux for the next 48 hours, other outfits stand to benefit in the short term. Both Smashwords and Lulu, which distribute and print digital and print books by thousands of authors, have deals to make their catalogs available on the iPad, with Lulu titles readily available on Amazon (Smashwords, as it turns out, isn't quite there yet.) If it turns out that readers abandon the agency modeled-majors in that very short time window between now and iPad release day, it may turn out that the best mantra for e-books from a publishing standpoint is "I Can Get It For You Wholesale."

Correction: An earlier version of this piece stated that Smashwords e-books, under the agency model, would be "readily available on Amazon." According to the company website, that is not thecase so far.