Searching for the equilibrium: Apple and eBooks

Posted on: March 26, 2009

My Wednesday night DVD routine (I love Netflix) gave an interesting twist to my thinking about the ebook market and how it might unfold.

So far, I’ve been pointing out in previous posts that we are currently observing a race between amazon, google and Apple to gain critical mass in the ebook market. Maybe I have been wrong about their intentions. With the release of the 3.0. iPhone software update, Apple decided to pursue a new strategy by opening up the way for third parties to develop iPhone applications that allow users to download ebooks from multiple sources. Since the announcement  of the release, I  was wondering why they did it? And why do I think today that this has been a brilliant strategic move?

The answer lies in the movie “A Beautiful Mind”. The movie tells the story of Professor John Forbes Nash and his work in the field of Game Theory. The Nash Equilibrium explains Apple’s move. The basic idea of Professor Nash’s is:

a solution concept of a game involving two or more players, in which each player is assumed to know the equilibrium strategies of the other players, and no player has anything to gain by changing only his or her own strategy unilaterally.

Contrary to a strategy that aims to do what is best for one player, an equilibrium strategy takes into account the outcome for the other players. The equilibrium outcome is what is best for me and the group. If that does not make sense to you, the following dialoge will make it clear.

Nash (in the movie talking to his peers in a bar): If we all go for the blonde and block each other, not a single one of us is going to get her. So then we go for her friends, but they will all give us the cold shoulder because no on likes to be second choice. But what if none of us goes for the blonde? We won’t get in each other’s way and we won’t insult the other girls. It’s the only way to win. It’s the only way we all get laid.

Until yesterday, I thought that google, amazon and Apple were all going for the blond, competing against each other for the individual best outcome. Today, I believe that Apple thinks that the equilibrium outcome is better for them. This outcome allows everybody (publishers and retailers) to win (or to “get laid”).

Here are some reasons why I think this might be the case:

  • The iPhone is a huge success and already used widely as a mobile reading device. (check out the stanza application) It is not clear if “ever” a stand alone device will dominate the ebook market. Why wait if you can earn revenue from multiple content providers through the application store. Even if the iPhone is inferior to whatever Apple is going to launch in the future, a healthy ecosystem around downloadable content through the app. store creates demand and gets people used to the idea. This will fuel demand for future Apple devices. This has great option value to Apple.
  • Apple requires a 30% margin for digital goods sold through the iTunes store. If the retail price for ebooks evolves to be around $9.99 (which I argued it will), the 6.99 that Apple would be prepared to pay to publishers won’t satisfy publishers and would gradually drive them out of business. Giving publishers and retailers the possibility to directly approach customers through applications, preserves the status quo in the value chain. Apple needs quality content to fill their products.
  • Consequently, other than amazon or google, Apple has no interest in disintermediating the editorial process, in order to make the $9.99 work.
  • Apple realized that achieving critical mass on the device site and at the same time on the content site is a high risk strategy, especially as multiple formats and devices are already established.The efforts of three players actively pursuing their best case scenario might cancel out the benefit to the consumer and might slow down the development of the market. This is not in Apple’s interest as digital entertainment content and their hardware and software solutions depend on each other.

From the perspective of the Nash Equilibrium, the individual best outcome would be to totally lock-in the ebook market with control over content and device. Apple decided to move away from this strategy by acknowledging that doing what is best for the group is ultimately best for themselves.



1 Response to "Searching for the equilibrium: Apple and eBooks"

Per definition, that would require cooperation (or a regulating institution) between the players to achieve the group optimum, which is more or less unlikely. Thus, it’s hard for me to believe that Apple’s decision is based on a vague estimation of what Google and Amazon are considering – unless we are still mistaking what their business model is and the group itself has a pretty clear picture.

By the way: My university Prof was always bragging about how the Nash Equilibrium portrayed in the movie is wrong: The cooperative solution of which girl(s) to go for is pretty much the exact opposite of the Nash Equilibrium, which would lead to the failure of cooperation. Anyway, I think the movie is really awesome in conveying the general idea – and I also think it is pretty cool that you consider this perspective for your analysis.

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