The Kindle with Special Offers…not your typical low-end product

Amazon has introduced a low-end Kindle product, the Kindle with special offers. This Kindle sells for $114 compared to the standard $139 Kindle with Wi-Fi. This is not a typical low-end product. Low-end products offer fewer benefits than industry-leading products (we call these Standard Leader products) for either the buyer or the user of the product in return for a lower price. We call these low-end products Price Leaders. There are two kinds of Price Leaders. The first, called Strippers, strip out benefits for both the user and the buyer of the product in order to achieve a very low price. The second, Predators, offers the user equivalent benefits to the industry’s main product but fewer benefits for the buyer. On average, Price Leaders cost about 33% less than Standard Leader products.




You will note that the Kindle with special offers does not fit easily into either of these two Price Leader categories. It reduces the user benefits by delaying the use of the product until the customer has viewed advertisements. There is no change to the benefits offered the buyer of the product. The Kindle with special offers deviates from the norms of Price Leader products with its level of discount. The Kindle with special offers sells for about 18% less than the standard Kindle product.



The Kindle with special offers varies from the Price Leader pricing norm in another interesting and important dimension. Some of these “special offers” are really good deals for the average Amazon customer. In one particularly interesting offer, Amazon will sell an Amazon Gift Card worth $20 for just $10. So, an avid fan of the Amazon web site receives additional user benefits with this new low-end product. In many cases, these special offers may more than offset the disadvantage to the user of a delay in using the product while the user views an ad.



This new Kindle with special offers is a very creative product innovation. Congratulations to Amazon.

Amazon's Blockbuster Innovation

In 2005, Amazon introduced its Prime Free Shipping program. This yearly subscription program promised free two-day shipping on any purchase the subscriber made from Amazon. Five years later, 13% of Amazon’s 130 million active users are Prime members. More significantly, 20% of the subscribers who purchased products from Amazon in the last twelve months are Prime subscribers. These Prime subscribers purchase two to three times as much as non-Prime subscribers over the course of a year. This Performance innovation removes an impediment to purchasing on Amazon. In fact, it increases the odds greatly that online purchases will be made on Amazon rather than on a competitive site. This has been a blockbuster innovation for Amazon. The innovation holds a special appeal to the larger customers in the market. The Prime subscribers may also offer Amazon an entry into a business that it has longed to gain, for several years, subscription video rentals. It appears that Amazon will introduce a streaming video product for its Prime subscribers. This new product will not cost the Prime subscribers any more than their normal subscription. Netflix’s Watch Instantly service cost about $96 a year so Amazon may have a price advantage on Netflix. Of course, Convenience and Price are only important provided Amazon offers equivalent Function, that is, streaming video content. We don’t know about that yet. Still, Amazon has proven to be an innovative company who can find ways to build a business in non-traditional ways. It continues to grab market share in the retail business.

Apple Gets Crossways with App Developers

Recently, Apple rejected a digital book application from Sony. The disagreement here is over how and when Apple collects for its services. Apple is playing a dangerous game.

In theory, Apple has the right to insist, under its terms for developers, that any app, which offers customers the ability to purchase books outside of the app, offer the ability for customers to purchase within the app at the same time.

Here is the rub. In its application, Sony sends customers to its own web site where they complete the purchase of a book. By routing the customers to its own web site, Sony is able to avoid a payment of 30% of revenues to Apple.

Others, including Amazon, with its Kindle, and Barnes & Noble, with its Nook, have been able to sell e-books by sending users to the companys’ own web sites. Apple simply was not enforcing its policy requiring developers to use its in-app purchasing feature to buy new content.

A 30% charge on revenues is a high price to pay Apple. Apple may be setting itself up for future loss of market share by enforcing this policy. If the Android platform does not put the same requirement on its app developers, the developers will have a strong incentive to avoid the 30% charge by encouraging customers to purchase using an Android device rather than an Apple device. Alternatively, the application developers may charge a higher price for purchases through Apple.

Apple’s unique strength has been its superior list of available applications. Apple’s enforcement of this requirement to purchase inside the app so that Apple can collect 30% of the revenues puts at risk its major advantage. Apple needs to compromise here by charging a lower price or no price at all. After all, it already makes high profits on its hardware and software product combination. It also makes profits on many of the downloaded apps. The application developers are customers too. Why make their life difficult? Does the benefit Apple provides a seller justify 30% of revenues? Sounds pretty rich.

Best Buy in a Leader's Trap

Few industry leaders believe their prices are too high. Often, they are right. They are usually less right in a market where prices fall. Consider GM in automobiles and IBM in personal computers in the past. At one time or another, most industry leaders will get caught in a Leader’s Trap, where they assume that customers will stay loyal to their products because the low-end products do not enjoy their quality and reputation. This assumption rarely, if ever, holds. Best Buy has been in a Leader’s Trap and its assumptions won’t hold this time either.

Through the third quarter of 2009, Best Buy was gaining market share in flat panel TVs and personal computers. However, in the most recent quarter of 2010, the company lost over 1% of its market share in televisions and computers to competitors who were discounting. (See the Perspective, “The Two Best Consultants in the World” on StrategyStreet.com.) Now, if it were just a simple low-end, low value competitor, Best Buy might not worry. But their discounting competition was Wal-Mart and Amazon. By any definition, these companies would count as peers of Best Buy in the television and personal computer retail market.

In the recent quarter, Best Buy emphasized high technology, and high margined, TV and personal computer products. Customers did not follow along. Best Buy noted that it had faced tough competition from off brand televisions at lower price points.

Best Buy could have offered private label products to compete with low-end, off brand, competitors. Its store brands include Dynex and Insignia. The company decided not to emphasize these lower-priced products in their promotions because they have low profit margins. Best Buy “failed” its customer by refusing to offer something that at least half the other competitors could and would offer. (See “Audio Tip #35: How Does a Company “Fail” in a Market?” on StrategyStreet.com.) Nor did competition “win” the customers who switched. Amazon and Wal-Mart simply took what Best Buy allowed them to take. (See “Audio Tip #34: How Does a Company “Win” in a Market?” on StrategyStreet.com.)

The result: Best Buy missed its targets and saw its stock price fall by 15%. The company lost market share to peer competitors. And its sales and profits fell in televisions and personal computers. Competitors gained strength.

Best Buy is a fine company with capable management. It won’t stay down for long. You may expect to see them leave the Leader’s Trap very soon.

A Fast Growing Market Begins Developing Reliability and Convenience Innovations

In a fast growing market, new Functions and lower Price drive more share gains than do Reliability and Convenience (see Customer Buying Hierarchy descriptions on StrategyStreet.com in the Perspective, “How Customers Buy” and in “Video 25: Short Explanation of Customer Buying Hierarchy”). After awhile, though, market growth begins to slow and Function innovations become less important than innovations in Reliability and Convenience. We can see this developing in the wireless applications market.

This market has been on a tear for the last few years. Recently, Amazon announced that it was planning to enter the market for phone applications by creating an online store selling apps for smart phones running Google’s Android software. Amazon will then compete with Google’s web site offering apps that work on the Android system.

Amazon’s entrance shows developments in both Reliability and Convenience. Amazon offers Reliability innovations in at least two ways. First, Amazon encourages the reviews from its customers of the products it sells. These customer reviews are important sources of Reliability information about a product. Second, Amazon insists that any app it sells will not sell for a lower price anywhere else. This Reliability innovation assures a customer that Amazon will have prices that are competitive with anyone.

Amazon also brings great Convenience to this market. There are so many apps today that the market is becoming chaotic. Amazon will organize these applications in ways that fit with its customer base. Amazon has a long history of doing this very thing with other products. Just as importantly, Amazon already has a working payment arrangement with millions of customers. It is particularly adept at the “one click” payment system, which enables a customer to pay for purchases very quickly.

Amazon’s entry is a good example of a natural evolution in a fast growing market.

The Kindle as a Razor

Amazon is proving to be a stubborn competitor. Many people thought Amazon would be severely damaged by the market entrance of the Apple iPad. After all, the iPad does many more things than simply provide an eBook reading experience. But, the Kindle is not going away easily. The company claims that it appeals to “serious readers,” which it estimates at about 10% of the population, and Amazon is chasing that 10% avidly.

Amazon is using the Kindle as a Loss Leader. Recently, a company estimated that the cost of the Kindle, that is all its parts and labor, was about $185. Amazon claims that the cost is much higher. This cost was not a great deal of the problem when the Kindle2 sold for $400, about its introductory price. Nor was it a problem when the Kindle sold for $289, the cost of the second version. Now, the new and improved Kindle3 has a price as low as $139, well below the estimated $185 cost. Amazon is taking a significant haircut on the cost of the Kindle in order to populate future customers for its eBooks. The company makes an attractive profit on its eBook sales and uses the Kindle as the razor to its eBook razorblades.

Amazon has also hedged its bet. Kindle eBooks also are readable on the iPad, so we are about to see an interesting contest between a very inexpensive Kindle and the iPad for the eyes of future eBook readers.

This razor and razorblade strategy is common (see StrategyStreet.com/Improve/Pricing/Reduce Prices). Here are some of the other places it has taken place:

* Caterpillar often reduced prices on new equipment in order to assure itself of the replacement parts business.

* The Palm Trio 600 had a list price of $600, but a consumer could buy it for as little as $330 with a phone service contract.

* Nintendo subsidized the sale of its game consoles in order to boost the sales of its game software.

* Restaurants offer free, or inexpensive, appetizers at the bar in order to increase alcohol sales.

* Charles Schwab offered a $400 analysis of a client’s holdings, including two hours worth of in-person advice, in order to increase the odds that it would be able to manage the client’s money for a yearly fee.

These Loss Leader pricing innovations are worthwhile whenever the revenues from the attendant products, which follow the Loss Leader product, are worth considerably more than is the Loss Leader.

What's Missing in Internet Retailing

Every year I buy several things online. I don’t like to shop in stores because I usually need to buy only one thing. I hate to take the time to go to a store to buy just one item.

Online shopping, for me, beats bricks and mortar shopping on almost every dimension of the Customer Buying Hierarchy. (See “Video #17: Value and the Customer Buying Hierarchy” on StrategyStreet.com.) It has the advantage of Function. I can buy almost anything I want online. It has some advantages, though not all, over bricks and mortar in Reliability. When I shop online, I usually can find several web sites that will give me product reviews on exactly what I am trying to buy. Online shopping is more Convenient. I can sit at my desk to purchase, rather than going to a store and jostling with other equally impatient consumers. Online shopping is also more Convenient for me because I can easily check prices at a number of online outlets without having to visit them physically. So, online shopping also offers a Price advantage. I can usually get a lowest price guarantee when I shop online. That doesn’t necessarily mean that I will buy from the online site offering the lowest price, but I could if I wanted to do so.

I am sure I am not the only consumer who finds online shopping so advantageous. Web sales account for about 6.5% of total retail sales. That is a relatively small share, though it is growing. In 2009, total online sales increased by about 2%, while retail sales in bricks and mortar stores declined. So, online sales are growing market share in the retail sales industry. Why, though, doesn’t it have a higher share of total retail sales? Industry statistics lead me to think that the problem lies in a form of Reliability. (See the Perspective, “Customer Segmentation: Finding the Human Dimension” on StrategyStreet.com.)

The way people purchase today suggests that Reliability still remains a problem for online retailers. The top 500 web sites offering retail products grew 9% last year, considerably faster than total online sales at a 2% growth rate. However, the top 100 retail online sites grew 12%. Consumers clearly preferred the bigger online retail companies last year. Even more impressive, those companies that offer only online sales in the top 500 internet sales sites grew at 20% last year. Consumers are showing a strong preference for those online retailers who live and die with their online performance.

The online-only retailers tell the story of Amazon and the several thousand dwarves. Amazon has a 52% market share of the web-only online sales. The sales statistics and Amazon’s market power suggest that a form of Reliability is holding back the growth of internet retail sales. Consumers would like to know that they will receive the product that they ordered, that the product will work, that, if the product does not work, the retailer will stand behind it and that the retailer will guard the consumer’s credit card information carefully. Amazon has hurdled these barriers well and has reaped the rewards in growth and market share. All the other retailers selling online, especially those outside of the top 100, need to concentrate on creating assurances for their consumers that they can do as well as Amazon in these forms of Reliability.

Make Them Wait

Three of the largest book publishers have decided to delay the release of their most popular new books to the e-Book market. This is unlikely to be a successful experiment. But another experiment from a fourth publisher offers promise.

E-Book readers, from Amazon, Barnes & Noble and Sony, among others, are some of this years hottest Christmas gifts. These e-Book readers are more than doubling last year’s unit sales. They are pulling the e-Book book sales with them.

The problem, of course, is money. An e-Book sells for about $10. The most popular hard cover books sell for $25 to $27. There’s the rub. The book publishers get about half of that $27 hard cover price. So you can imagine these publishers are less than excited about the opportunity in the retail price of an e-Book at $10, even if they would get all of that $10, which they won’t. (See “Audio Tip #88: Questions to Determine Your Response to a Low-end Competitor” on StrategyStreet.com.)

So, to try to hold the $27 hard cover market, three major publishing houses have announced delays in allowing their most popular titles to go to the electronic book publication market. HarperCollins Publishers, Hachette Book Group and Simon and Schuster plan to delay a few of the books that carry their highest expectations for profit. The delays will last from four to six months. These delays roughly match the time that the paperback version of a title follows the hard cover version.

On the one hand, these titles are unique Function innovations. Some readers will pay the higher price in order to be first in line to read the new publications. But there are many other unique books. The delays announced so far will cover less than 150 of the total 2000 new book titles issued each year.

The e-Book format is less costly and much more user-friendly. The e-Book is a much less expensive product to produce and deliver. Its digital format allows companies to distribute their product over the internet and to the e-Book readers by wireless connections. The e-Book reader can carry more than 1500 books. The user, then, can carry many books in the space of one paperback. This technology is not going to shrink nor pass away, no matter what publishers decide to do with their most popular new book titles. The cost of book publishing is simply going to plummet. But the revenues available to the industry over time should increase dramatically as new customers enter the market.

This e-Book market is an entirely new market. The e-Book offers opportunities to do things never before possible with hard cover books. The digital format allows companies to provide “special features” that enhance the attractiveness of the e-Book. These special features could include such benefits as interviews with the author, in-person video reviews by some of the country’s best book reviewers and videos of the geographic settings in the book, among others. There will be a lot of these new features (See “Audio Tip #29: Positive vs. Negative Volatility” on StrategyStreet.com). These new features, along with the much lower prices charged, will bring a whole new set of e-Book customers into the marketplace. Many of these new customers are not candidates for the $27 hard cover product. They will be happy buyers of the e-Book at $10 with its enhanced features.

A fourth member of the major book publishers, Macmillan, has developed a more creative and more promising approach. This approach envisions the release of an e-Book version of its best sellers on the same day as the hard cover book hits the shelves. The company envisions a “special edition” of the e-Book. This special edition will cost the same as the hard cover book and will be on the market for only 90 days. The special edition will include author interviews and reading guides, along with other material. At the end of 90 days, the special edition will discontinue and the company will issue the standard e-Book format at the lower standard e-Book price.

The publishing industry will fail at its delay experiment. They would be better off embracing the new technology, with its potential for extra Functions and ease-of-use, and then spending the next few years reducing the scale of the paper-based cost structure they carry today. My guess is that a hybrid version of the Macmillan experiment will eventually emerge. Under this hybrid version, all of the most popular books will be available in e-Book format, along with many function enhancements, like those in the Macmillan special edition, for a price a few dollars above the standard e-Book price, but at least 25% below the hard cover price. This approach ensures a much better value proposition for the e-Book customer, builds the e-Book market, and should allow the industry to make an attractive profit at the lower price, due to the much lower cost of production and distribution. Over time, the higher price of the most popular e-Books would gradually fall to the price of the standard e-Book in the market place so that the publisher may reap the rewards from customers willing to wait for a lower price on a good product.

The eBook Competition

Amazon and its Kindle products have had the eBook market to themselves since the market began taking off a couple of years ago. The eBook market is now starting to grow fairly fast. Sony has decided to grab some of that growth.

Sony is entering the market with three price points: a $199 entry product called the Reader Pocket Edition, the $299 Reader Touch Edition with a touch screen and the high-end Reader Daily Edition at $399 with both touch screen and wireless capability.

Very fast-growing markets see market share changes due to Function and Price innovations. Let’s use the Customer Buying Hierarchy (see Audio Tip #95: Customer Buying Hierarchy on StrategyStreet.com) to evaluate Sony’s prospects against Amazon.

The Customer Buying Hierarchy holds that customers buy using four major criteria: Function, Reliability, Convenience and Price. Customers go through the hierarchy in that specific order and purchase when there is one, and only one, competitor who can offer them a unique benefit.

Function refers to the way the customer uses the product. Function innovations in this eBook market are two types: hardware innovations and content. In hardware, Sony has two Price Points with a touch screen capability that Kindle does not offer. On the other hand, the regular Kindle 2 offers wireless downloads. The only Sony product that offers wireless is the high-end Reader Daily Edition at $399, compared to Kindles’ $299 Price Point. Without considering price, it is hard to call a winner when the Kindle 2 offers wireless connectivity while the Sony offers a touch screen.

Content is likely to be a different story. Sony has adopted the ePub format, which is an international format for digital books and publications. Amazon, on the other hand, offers eBooks which can be read only on Kindle 2 devices, a proprietary approach. Sony argues that its readers can download books from the local library using its format, saving costs. But libraries have only a limited number of digital copies of books available. And, if the market takes off, the authors and publishers are likely to severely limit the number of free library copies available to ereaders. Kindle, for its part, is the progeny of a book retailer. There are many books available through Amazon for the Kindle 2, far more than will be available for the Sony products. In addition, the Apple iPhone and the iPod Touch also allow their owners to read books in the Kindle 2 format. With its extensive experience and product platform already in the market, content providers are highly likely to choose the Kindle 2 format before choosing the Sony format, if they must make a choice. Certainly in the early going, the content, and thus the Function advantage, goes to Amazon and it’s Kindle 2.

Reliability refers to how a company keeps the promises it makes to its customers. For an end user customer, Reliability means that the product works and will be fixed promptly if it does not work. Amazon has a superb reputation for Reliability among consumers. Sony’s reputation is also good. However, since Sony produces mostly electronic gear, its reputation is unlikely to be as good as that of Amazon, who sells mostly digital products. I would guess Amazon gets a slight nod in Reliability.

Convenience refers to the ease with which a customer can buy and begin using the product. Sony’s products will be in 9,000 retail outlets, including all the leaders in the industry, this holiday season. Amazon sells its Kindle online. The customer can see and touch the Sony products in the many retail outlets. Seeing and touching a Kindle is much more difficult for the perspective Amazon customer. The nod in Convenience clearly goes to Sony.

Price is the last consideration. The Kindle 2 product has a price of $299. The Sony Reader Daily Edition has a price of $399. As we noted above, the Sony product offers a touch screen at this price. Kindle does not, at least not yet. The Sony product is a third more expensive than is the Kindle. This additional price is likely to make the Sony product a Performance Leader product (see Audio Tip #82: Performance Leader Products and Companies on StrategyStreet.com), rather than a true competitor for the leading Standard Leader position.

It is going to be difficult for Sony to make the $399 product the most common product in the market. Amazon’s Kindle has already established the industry standard for benefits and price. Sony would have been more successful offering its touch screen benefits at no price increase over the Kindle 2 Standard Leader product. Sony looks to be in a Leader’s Trap here. It will eventually have to reduce that price or see the product garner relatively little market share, likely well below 15% of the market.

Both Sony and Amazon would probably be better off if they responded to the content challenge each offers the other. Sony might try to license the Kindle software and offer that format, as well as the format. Then Sony could have competed on its strengths in making small electronic equipment. Amazon could add the ePub format to its software and open up a new world of content for its customers. This will become imperative for Amazon if a great deal of content comes available in the ePub format that is not also available in the Amazon proprietary format.

New Product in a Fast Growing Industry: Verizon Cloud Computing

Verizon Communications recently announced that it was entering the market for cloud computing. Cloud computing is a service that allows a business to increase its computing power by using the internet, network bandwidth, on demand, from facilities operated by companies like Verizon. This market is fast-growing because it allows businesses to save the costs of building and managing their own computer facilities. Let’s use the Customer Buying Hierarchy to evaluate the prospect for Verizon’s success.

The Customer Buying Hierarchy (see “Video 27: Full Description of How the Customer Buying Hierarchy Works” on StrategyStreet.com) holds that customers buy a product using four categories of evaluation: Function, Reliability, Convenience and Price. Function (see “Video 13: Definition of Function” on StrategyStreet.com) refers to the features of the product that affect how it is used. Reliability (see “Video 14: Definition of Reliability” on StrategyStreet.com) refers to the benefits of the product that assure the customer that it works and will continue to work. Convenience (see “Video 15: Definition of Convenience” on StrategyStreet.com) refers to the ease with which the customer may find and purchase the product. Price is the cash cost the customer pays for the product.

Verizon offers a valuable Function advantage. Cloud computing is a service that today is targeted at large corporations. These corporations use several different types of computers and software applications. Verizon has made a Function innovation leap by offering customers options in setting up their cloud service that would include being able to use various types of computer servers, depending on the software applications the business needed to use. But this is early in the game, so many Function innovations have yet to be introduced.

Verizon, along with its telecom competitor AT&T, does have some real Reliability advantages. These companies have spent years managing network services, data infrastructure and transfer. (See the Perspective, “Reliability: The Hard Road to Sustainable Advantage” on StrategyStreet.com.) This gives them real credibility with corporate customers. Verizon and AT&T also have a significant Convenience advantage in their global reach. (See the Perspective, “Convenience: Much Tougher Than it Looks” on StrategyStreet.com.) These two phone companies are able to offer cloud services to overseas divisions of companies.

Pricing is the great unknown. Low prices can move a lot of share in a fast-growing market. Neither Verizon nor AT&T are what you would consider sharp pricing companies in their other businesses. It is unlikely, then, that they will be aggressive price competitors. On the other hand, Amazon also plans to enter this marketplace. Amazon has learned to compete aggressively on Price and may be the eventually price-setter in the market.

This is very early in the development of the cloud computing market. Unique Function advantages may emerge and remain unique due to legal barriers. The early Reliability and Convenience advantages strongly favor Verizon and AT&T with their technical competence, corporate reputations, and global reach. One, or both of them, should be very successful in cloud computing, assuming that they don’t get tripped up with high prices.