You may have heard recently about a disagreement between Amazon and Macmillan over the retail price of ebooks for the Kindle. The disagreement led Amazon to pull all Macmillan books from its website. Not just the ebooks, but all of them. A few days later, after customer complaints, Amazon relented and put Macmillan’s physical books back on sale. However, as of today, Macmillan’s digital books are still not available. Even if they come back soon, I don’t expect the disagreement to be resolved in Macmillan’s favor.

Amazon wants to make the Kindle an indispensable device for people who read lots of books. But I don’t think it’s because Amazon wants to be a hardware developer. (Designing hardware is tough and I think Amazon has done an excellent job with the Kindle.) No, it’s because Amazon wants to be the undisputed leader in the sales of ebooks. By being the largest seller of ebooks, it is in a stronger bargaining position when dealing with publishers over a wide variety of issues, such as licensing fees, availability dates, derivative works, and copy protection (DRM).

The best explanation of the possible thinking process among Macmillan’s executives is provided in an excellent Charlie’s Diary Jan 2010 blog post and today’s TechCrunch column. As Charlie Stross points out, publishers are really in the talent discovery business. They lose money on about 80% of their authors. They make a small profit on most of the remaining authors, and make their real money on a few blockbuster hardcover books. After the hardcover sales taper off, they sublicense the publishing rights to other companies that produce paperback editions of the work. This is a good way to make extra money with little effort. And apparently, this is the same type of contract the publishers have signed with Amazon for the Kindle.

Paul Carr points out that many publishers, including Macmillan, gave authors higher royalty rates for electronic versions of their work, thinking that they would never have to actually pay them. But now that ebook sales threaten to overtake hardcover book sales, they are in a panic. In a desperate attempt to staunch the profit loss, they want to force Amazon to pay higher licensing fees (similar to higher wholesale prices in the world of physical books), restrict sales of ebooks while the hardcover edition is on sale, and set the minimum price of ebooks (by requiring the retail price to be a fixed percentage above the license fee) to reduce competition with the hardcover edition. Naturally, Amazon wants lower fees, immediate availability of ebooks, and the right to set any price it wants for ebooks. (It is believed that Amazon is pricing its ebooks below cost as a loss leader to encourage Kindle adoption.) As the largest ebook retailer, Amazon has the leverage to force Macmillan to accept its terms.

Now that Apple has entered the ebook market with the iPad, publishers are hoping to play the two companies against each other. I don’t see that as a viable strategy. Apple knows how profitable the iTunes store is and how important it is to the success of the iPod and iPhone. It won’t play this game and neither will Amazon.

[Update1: Today, Macmillan announced it had reached an agreement with Amazon (Wall St. J. Feb 2010, subscription required). Amazon has accepted Macmillan’s terms, which are similar to the terms that Macmillan set with Apple. This contract will probably set the pattern for future negotiations between Amazon and other publishers. So I was wrong about Amazon having the upper hand.]

[Update2: Hey booksellers, you know what I really want? I want someone to offer a Netflix-style pricing plan. I want all the ebooks I can read for $40 a month. The monthly fee should include complete search and display capability, a Search Inside the Book on steroids.]

[Update3: For more on the Amazon ebook pricing controversy, see this April 2010 blog post.]