TABLETS AND E-BOOKS

by Leap roggers

BCG Strategy Cup 2011

f

48%52%

69,4%10,6%

20%

AmazonAppleOthers

Amazon’s Kindle provides a channel to buy and read e-books. Apple’s iPad, on top of that, is a source of tremendous income in itself.

Tablet market share in numbers

E-book market share in 2010

0

175

350

525

700

Apple Amazon

RevenuesProfit

01 5003 0004 5006 000

Apple Amazon

In 2010, the US e-book market is valued at $966M.It is assumed that Amazon and Apple control 80% of this market. Barnes&Nobles, Sony as well as platforms non-associated with any proprietary readers control the remaining 20%.Previously minor, e-books became a true alternative with the introduction of e-readers and tablets.

*Given the scope of the analysis and poor market penetration by other players only Kindle and iPad were considered.

Key tablet revenues and profits in $M

Operating profits generated by Kindle are negligible at $3.51 per device.

54.83%1.86% O p e r a t i n g M a r g i n

Amazon and Apple play different games in an evenly split market

8.5M8M S a l e s i n 2 0 1 0

Apple launched the iPad in April 2010 and created a new category.Several other devices were launched before, however Kindle and iPad were a real boost to the market. ey offer different functions and operate in different price segments. Both will stage a war to define this nascent segment and to impose proprietary standards.

Key e-book revenues and profits in $M

Amazon Apple

What Apple wins on premium tablets..2010

a v e r a g e r e t a i l p r i c e

Agency Model by Apple where publishers get 70% of the retail price of e-books.

Wholesale Model where Amazon buys e-books at 50% discount on the retail price of paper version.

Based on NY Times Paperback Bestseller list ( July 2010), average publisher margins are:

$2.32 $2.45

Customers prefer Wholesale which offers them lower prices.

In the short run, publishers gain more with Wholesale, but in the long run, Agency Model prevents them from

becoming a mere content provider.

$9.45 $10.90

*is estimate abstracts from market dynamics. It is likely that the $9.99 policy will be discontinued as:a) TOP5 publishers control 84/73% of the hardcover/paperback market and therefore their supplier negotiation power is hugeb) Apple is explicitly against $9.99 and binds its contractors not to offer lower prices at any other platform

In this case, publishers would renegotiate upwards the 50% discount rate, thus making the two models converge.

p u b l i s h e r p r o f i t p e r b e s t s e l l e r s o l d

}Short-term perspective

Long-term perspective

Amazon offers lower prices at its own risk and thus extends publishers’ market.

If the $9.99 e-book price persists:– current paper book prices are not sustainable, therefore publishers’ revenues from the Wholesale model diminish– e-book retail platforms become the sole distribution channel thus putting publishers at retailers’ mercy. In the Agency Model:– publishers keep full control of retail prices– avoid the threat of customers getting used to low prices.

Aer factoring in margins on hardcovers at their current 23% market share, publishers’ profits per e-book rise to

$4.96 $3.763 2 % m o r e w i t h W h o l e s a l e

Wholesale

Amazon recoups on wholesaling e-books

Agency

Historical leader in online book retailExhaustive choice of competitively priced booksExemplary customer service and logisticsKindle, the first e-Ink reader to ship in volume

Apple can encroach on Amazon’s turf (Amazon cannot)

Established & dominated new markets (iPod, iPhone)Product design and soware-hardware integrationCross-media 1-click platform with a large client baseStores: client interaction and first-hand experience }{A m a z o n

s t a n d s f o rb o o k s

A p p l es t a n d s f o rintuitive

Kindle iPadReader-friendly

E-Ink technologyAllows for reading in sunlight

Limited eye strainLong battery life (up to one month)

Lower price tag ($139 w/o WiFi)

Status symbolVersatile

Excellent user interfaceGames

ApplicationsWeb browsingE-mail support

Surveys show substantial interest in new functions like color display

or video support.

Kindle is preferred by active readers, they buy 8 times more books than

iPad users.

Apple reaps the fruits from the education market

0

750

1 500

2 250

3 000

2010 2011 2012 2013 2014 2015

K12 EducationHigher EducationAdult&JuvenileReligiousOthers

– Tablet sales are expected to grow at 11.8%.– E-book sales are driven by the number of tablets operating in the market, not by current sales.– Obsolescence period of two years = tablet sales of last two years constitute this client base that is directly correlated with e-book sales.– Initial boost in 2011 as the number of tablet roughly doubles and stable growth thereaer.– It is assumed that initial e-book market structure is identical as in the paper book market.– However, Higher Education sector will grow at 21.8%, thus outpacing all other segments and increasing total Education share from 42 in 2010 to 48% in 2015.

28%

14%34%

3%

21% 27%

21% 29%

2%

21%

2010 2015

Education demands color, video and interactive features.Amazon will lose market share in this critical segment. By 2015, Apple will multiply its market share by four.

It is assumed that churn from Kindle to iPad will be concentrated in both Education sectors as its demand for

features cannot be met by Kindle.

0%

20%

40%

60%

80%

100%

1320

3139

45 48

8780

6860

5551

2010 2011 2012 2013 2014 2015

0

300

600

900

1 200

1 500

2010 2011 2012 2013 2014 2015

Apple Amazon

Education sector evolution by providerin $M of sales

E-book market share between Amazon and Apple

E-book market evolution by sector in $M of sales

iPad will increase its initial share from 51% in 2010 to  72% in 2015, thus reaching the saturation point for devices in its price range.Apple’s business model enables it to generate tremendous profits both on device and e-book sales with $7200M profit only from iPad in 2015.

Amazon will see its market share be restricted to readers of traditional black&white books. Customers craving a versatile device are likely to switch to an iPad. Profits on Kindle will remain stable, but relatively low ($49M) as it is sold almost at construction cost. ey show however a slight upward tendency starting 2013.

06

12182430

2010 2011 2012 2013 2014 2015

Tablet sales by manufacturerin mln units

0

250

500

750

1 000

2010 2011 2012 2013 2014 2015

Apple Amazon

Publisher profits by e-book platformin $M

0

375

750

1 125

1 500

2010 2011 2012 2013 2014 2015

0

375

750

1 125

1 500

2010 2011 2012 2013 2014 2015

Revenues w/o profitProfits

E-book Revenue Evolution at Amazon in $ME-book Revenue Structure at Apple in $M

0

3 750

7 500

11 250

15 000

2010 2011 2012 2013 2014 2015

iPad sales Revenue Evolution in$M

0

500

1 000

1 500

2 000

2010 2011 2012 2013 2014 2015

Kindle sales Revenue Evolution in $M

Amazon doesn’t budgeApple’s numbers skyrocket

0

10

20

30

40

50

2010 2011 2012 2013 2014 2015

KindleKindle to iPad churniPad

Tablet client base evolution by manufacturer (in mln of units)

iPad will attract Kindle customers who need a color display in the Education market.

e challenge Amazon will face is to convince switching customers to continue to buy books at its platform. To succeed in leveraging its unique market positioning, Amazon should:

1) develop reading applications going beyond existing ones that would enable:- taking notes and sharing them- multi-device support, you open the book where you closed it the last time- updating textbooks as they published- enhance college features, e.g. teachers indicating chapters to read2) address campuses and teachers directly to sell textbooks in bulk

Since iBookstore is mainly restricted to Apple users, Amazon should recognize the opportunity of capturing all ebook sales that are not tablet-bound, including e.g. netbooks and Android devices.

Amazon should reinforce unique positioning without blurring its image

e temptation to launch an imperfect substitute of an iPad should be resisted.

Simple color reader iPad-like tablet– Lacks the e-Ink comfort– Reduced battery life– Losing brand identity– Poor versatility compared to an iPad– Little value for money (at least 35% price increase)

– Impossible to match iPad on usability and design– Lacks relevant skills and R&D capacity– Inadequate brand image to become a status symbol– Risk to lose advantageous books/device ratio as customers will be seduced by low price and other features

Analysis of two color device options lead Amazon to the same conclusion:

Binding books to proprietary platforms

Color was not an option before

– By 2015 Apple will control 87% of the Education e-book market.– Apple’s increased negotiation power with publishers will enable it to convince them to launch applications replacing both paper and e-books, thus locking out the competition.– anks to unmatched expertise in user interface, Apple will introduce new proprietary options.

– Apple will prompt authors and publishers to include color and animation that would bind them to Apple’s device – Many books bought on iPad today are children’s books. ose young readers are accustomed from their early days to iPad’s dynamic interface. As they grow up, they will crave it even more.– Apple should focus its marketing effort on these users by facilitating their access to iPads.

New publishers to appear

– anks to e-books, publishers’ margins increase significantly (from $1.04 to $2.32 for an average bestseller)– Retailers will recognize this opportunity to integrate vertically and to act as publishers.– Today integrated publishing is in test phase in offstream segments but can easily be extended to bestsellers.– Individual authors will gradually become independent of the current value chain in the publishing industry.

Tomorrow: Color by default and integrated publishing

38%

31%

31%

iOSAndroidOthers

Tablet market share by operating system in 2015

– By 2015, Apple’s share in the high-end tablet market is on a slippery slope down to 50 , the rest being evenly split between Android and others, just as in the low-end segment.

0

25

50

75

100

2010 2015

Cell & TabletComputer

Internet ad market share by access platform

– In 2015, ad market on mobile devices accounts for 10.6% of the overall Internet ad market, up from 2.6% in 2010.

– We assume that the share of display ad will remain stable at 30.2% with search accounting for the remaining 69.8%.

– Mobile devices will increase their ad share as they will capture parts of the display market. Most of search ad revenues will still be generated on computers.

– Since display ads within apps are OS-bound, the real challenge for Google is to impose Android in the tablet market.

– Put side by side with the Internet ad market, e-book market remains tiny at 4%.

– erefore, Google should focus its strategic efforts elsewhere.

– e value of the US Internet advertising market in 2010, display and search combined, was $22.4B.

Android: an ad-selling machine

Advertisement

Operating systems

– Application developers earn 60% of ad revenues generated in Apple apps.

– It is assumed that Google will converge towards this model for Android apps.

In display ads, the transfer from computer to mobile devices will clearly diminish Google’s revenues.

100%

40%

0%

Support pre-tablet markets

Impose web-based Chrome OS to maintain sales of app-free netbooks

Encourage app development on Android mainly as a selling argument

Improve web browsing experience on tablets so that applications lose their appeal

Re-emphasize Google’s founding values and promote open, unconstrained access to the Internet as opposed to restricted environment of applications

Browsing is the real cash cow

For AdSense ads in browsers, whether on a computer, a tablet or a smartphone

For iAds in apps on Apple operating system (iPad, iPhone, iPod touch)

For ads in Android apps

– Google’s revenues from display ads vary by access platform:

•

•

•

•

•

– To remedy this unfortunate evolution, Google should:

Executive summary

– e nascent tablet market is evenly split between Amazon(8M Kindles) and Apple (8.5M iPads), Apple has far better margins on devices.– anks to its historical position, Amazon dominates e-book sales at almost 70% market share.– ey offer competing pricing models in the e-book market. Amazon buys e-books at discount and sets up an aggressive pricing strategy. Apple leaves pricing decisions to publishers and imposes a 30% fee.– In the long-run publishers will either favor the Agency model or make the two converge.

– Education market will grow from $405M to $1543M.– It will trigger demand for color, interactive devices like the iPad.– Kindle sales remain stable as customers switch for an iPad (significant churn rate concentrated in Education market)– iPad sales reach 21M p.a. and 8M for Kindle.– ere are 55M tablets in operation. Market for high-end, expensive devices is saturated at 13% penetration rate.– Apple’s market share in e-books reaches that of Amazon’s.

{ 2015 { 2010

– Amazon has to retain Kindle-to-iPad switchers within its e-book shop.– Multiple device applications will be more important in retaining customers than the device itself.– Amazon should stick to its core competence rather than compete with device manufacturers.– Books will become platform-bound applications.– Publishing will become more profitable and retailers will try to integrate vertically. {Next steps

– E-books are tiny drops, Internet advertisement is an ocean.– Display ads will be partly transferred from computers to mobile devices.– Increasing OS market shares translate directly into increased display ad revenues.– Google should keep users on browsers and out of applications.{Google