Amazon's Dispute With Hachette Group Will Have Negligible Impact On Its Business

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Amazon ( AMZN ) recently made a clever move to garner authors' sympathy in order to protect its control over the e-books business. It proposed to Hachette Book Group that the book authors can keep 100% of the revenues generated from e-book sales while the two companies reach a common ground as they re-negotiate their expired e-book contract. Hachette Book Group has rejected the proposal. While the proposal was a tactical PR (public relations) move by Amazon, the retailer's priority remains to retain control over pricing and discounts of e-books in order to manage profits. In case of any fall out, Amazon will come out with an upper hand as Hachette's e-books constitute a very small portion of its overall business.  Moreover, Amazon's strong stand will deter other e-book publishers from going down the same path. On the other hand, if Hachette manages to swing things in its favor, it could set a precedent for the industry, thus affecting Amazon's overall e-book revenues.  However, e-book sales form a very small portion of the retailer's revenues. Hence, the risk associated with the outcome of this negotiation is minimal.

Our price estimate for Amazon stands for $341 , implying a premium of 5% to the market price.


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Estimating Amazon's E-Book Sales

While the chart above shows total Kindle device sales which include e-readers and Kindle Fire tablets, we have separate estimates for Kindle e-reader alone. The annual sales for Kindle e-reader peaked in 2011 to roughly 13.44 million, followed by a decline in 2012 when the figure totaled an estimated 9.68 million. The sales in 2013 were more or less flat, which suggests that roughly 43.7 million Kindle devices had been cumulatively sold up to the end of 2013.

Amazon launched its Kindle e-reader in late 2007. Assuming a three-year replacement cycle, we conclude that there may be approximately 30 million Kindle e-readers currently in use. Looking at the Kindle library, it is easy to notice that most e-books are priced between $4 and $10, with a slight skew towards lower-priced books. Therefore, we assume average price per e-book at $6 for the purpose of estimation. Additionally, we also know that Amazon gets a 30% cut on sales of most e-books, with remaining 70% going to the publisher. Keeping these figures in mind and the assumption of five e-books sold annually per Kindle e-reader owner, we arrive at annual revenues of close to $265 million. If we assume a figure of 10 e-books sold annually per Kindle e-reader owner, the annual sales will amount to $530 million. There is room for error here, but the assumptions are reasonable enough to give us an idea of a probable range of revenues.

Impact Of Reduced Cut Will Be Negligible

If Amazon's revenue cut is effectively reduced to half, i.e. 15%, its annual revenues from e-book sales could dip to much less than $500 million. However, that's less than 1% of its total revenues as more than 99% of its sales can be attributed to electronics and general merchandise, digital music, DVDs and books. The reduction in Amazon's revenue share could happen in a couple of ways. First, the new terms of the re-negotiated contract could specify lower percentage share. Second, the pricing power could be taken away from the retailer, thus reducing its ability to manage sales by using discounts which could result in lower revenues. These lower revenues would be a manifestation of reduced unit sales.

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This article appears in: Investing , Investing Ideas , Stocks , US Markets

Referenced Stocks: AMZN , EBAY , GRPN

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