Small Blue and the Bonsai Datacenter

Bonsai by Andreas D., on Flickr
Creative Commons Attribution 2.0 Generic License  Via Flickr

IBM today announced new datacenter investment plans to bolster its cloud computing presence. They’re going to spend $1.2 billion to build 15 new datacenters (seen above, lower shelf). After some consultation with the Twitterati on matters of long division, it appears IBM is going to spend a whopping $80 million per datacenter. That may sound impressive until you consider that the big boys in cloud can spend half a billion or more per datacenter. Google’s most recently reported quarterly capex was $2.29 billion.

Perhaps IBM is has some special sauce that lets them go toe-to-toe with the big boys on the cheap? If so, they haven’t bothered to mention it and they’re not known for their low costs or frugality. I for one am disappointed IBM has stifled its usual impulse to pitch the mainframe as the obvious choice for the workload de jour. Surely there is a story to weave about cloud computing bringing the industry back to its timesharing roots, blah, blah, blah, mainframe uber alles? Or maybe they’ve beaten their heads against that wall enough to knock some sense into them.

In the absence of special sauce, it seems more likely that IBM is either confused about what it takes to play in the big leagues and/or lacks the financial resources. They continue to confuse cloud computing with web hosting. Do they really believe their Amazon depositioning is relevant or is it just an attempt to muddy the water? What does IBM say when Amazon utters the letters C, I and A? IBM also has real constraints on their ability to invest due to their prioritization of financial engineering over engineering engineering.

I will offer IBM some free consulting for their next big initiative to help them come up with some differentiation and a storyline beyond how much money they are going to spend. What are the odds that they find themselves budgeting a billion dollars for almost every initiative? (The way we knew they had given up on AS/400 was when their grand revitalization initiative was only backed by $125 million). “One billion dollars” has been the only page in their marketing playbook for a long time. Had I more time and dedication to the cause, I would collect all the “one billion dollar” announcements and assess their subsequent market impact. Because this is capex (and because it isn’t a round billion dollars), the $1.2 billion number is probably a real number unlike most IBM investment numbers. But there is at least one real billion dollar number for IBM and that is their Q3 revenue miss.

Various evergreen belittlements aside, IBM seems to have woken up to the reality of cloud computing and the existential threat it poses. The “it is early days for cloud” speaking point seems to have been retired. They’re overreaching and flailing around with announcements and advertising. but are at least trying to get into the discussion. But they still face an extremely difficult road. IBM’s ability to develop technology (the engineering engineering thing) has atrophied (“SmartCloud? Just kidding…”) and letting others do the technology development is risky (e.g. taking an OpenStack dependency in the absence of controlling your own destiny is looking a lot riskier). And IBM is operationally unproven across multiple datacenters. It is easy to needle AWS for outages, but another to avoid outages yourself. The real question is would anyone notice an IBM outage. Finally, IBM is constrained financially relative to the competition.

Many financial observers assume that because IBM is one of the few technology companies to have survived multiple generational technology transitions, they will successfully traverse this one as well. Past performance is definitely no guarantee of future survival in technology and IBM’s past transitions are notable exceptions to the broader industry history. And this transition is different in that the workloads in play are core workloads for IBM. With the minicomputer and PC transitions (the later of which was near fatal to IBM), the workloads in question were mostly net new and didn’t directly replace mainframe workloads. The cloud is taking core workloads, so even if IBM executes well and moves existing customers to its cloud, they will take a revenue and margin hit.

IBM is damned if they do, damned if they don’t. If they accelerate the move to cloud, they will undercut their existing business and miss their sacred financial roadmap. If they don’t, everyone else will partition up their existing business. Maybe they can thread that needle, but IBM has not shown any reason to believe they can successfully catch up to and compete with the leaders in cloud computing. Bonsai datacenters show IBM wants (or needs) to compete on the cheap.

Amazon: Retailer or Platform Company?

Amazon’s App Store for Android has been denounced as “Rotten To The Core” by Shifty Jelly, a small Australian developer.  It would be safe to say Shifty Jelly’s experience as the “Free App of the Day” didn’t meet their expectations.  The headline complaint was that developers don’t actually get paid by Amazon when they’re the “Free App of the Day”, contrary to industry belief.  This resulted in at least one lede of “Apparently Apple isn’t the only company running an App Store with a penchant for secrecy” and generally conflating Apple and Amazon’s App Stores.

This is a misleading comparison.  Amazon’s philosophy towards developers is fundamentally different from Apple’s.  The Apple App Store is far more developer-friendly today. Shifty (it may be presumptuous but I’m going to leap to a first name basis here) also mentions in passing that Amazon retains the right to set pricing and write the product description, amongst other terms, for any app in their store.  This is far more important than how they compensate for promotional sales.  And Shifty is not the first developer to question Amazon’s approach.

Amazon is fundamentally a retailer. Their lizard brain comes from the same evolutionary tree as Walmart (and there was a fair amount of genetic transfer from Arkansas to Amazon in their early days).  Great retailers squeeze every last drop of blood out of their suppliers (here is a briny illustration of Walmart in action on this front).  The problem is that without a very conscious and explicit effort, Amazon will default to treating app developers as suppliers, triggering all sorts of behavior that it going to make it very hard to cultivate developer loyalty.  They almost can’t help but behave this way; it is the expression of their corporate DNA (and that is something I appreciate when I am an Amazon customer).  Retailers see applications as just another product that sits on their shelf.  And they unilaterally print the price tags for anything on their shelves and completely control the contents of any marketing materials they create. It is inconceivable to a retailer that someone else would be setting prices or deciding what goes in their weekly advertising circular.

This isn’t just one-off behavior for Amazon; they run the Kindle app store the same way.  It isn’t well known, but there is an SDK for Kindle (the device) and you can build apps for it (you can see various Kindle apps here).  I’ve now heard from developers about submission experiences for multiple Kindle apps and the approval process makes Apple look open, transparent and speedy by comparison.  Developers get heavy-handed guidance on what their price should be and once in the store, have no ability to change price, even to run a temporary sale.  Product descriptions are rewritten by people guaranteed to know less about the application and its customers than the developer.  Some of this is a function of a team that is running flat out (Amazon runs lean and has not staffed up for reviewing lots of apps, much less learning enough about apps to write accurate and persuasive sales copy for each app), but it also is a reflection of the basic fact they are a retailer.

Contrast this to Apple who are fundamentally a platform company (despite all those stores…).  Yes, they have a bunch of rules for what gets into the App Store, occasionally make a bad judgment call, stumble on political landmines or put their thumb on the scale to advantage their own products, but by and large they do pretty well by developers.  Once you’re into the Apple App Store, you control and can change your pricing and you get to explain to potential customers what your app does.

This cultural dichotomy between seeing developers as just another set of suppliers to be plucked versus partners to be cultivated is the biggest challenge for Amazon as they roll out what otherwise looks like a promising tablet strategy this fall.  Hopefully they will suppress the WalMart gene, recognize developers have a choice of platforms and at least meet if not exceed the Apple bar in order to build a vibrant application ecosystem.  Amazon has hired a lot of Microsoft people with platform experience who understand the care and feeding of developers.  They need to step up if Amazon is going build winning platforms.

Priceless Indeed

Amidst news of Amazon’s apparent surrender today in the war with Macmillan over ebook pricing, the highlighted book on Macmillan’s home page is Priceless, subtitled “The Myth of Fair Value (and How to Take Advantage of It)”:


I haven’t read the book so can’t comment on whether this placement is intentional or ironic, but it does tee up a discussion about the “collective hallucination” of Macmillan’s pricing. 

The tiff between Macmillan and Amazon is over who sets end customer ebook prices.  Amazon wants most books to be priced at $9.99 and is today selling ebooks at a loss to realize that price.  Macmillan wants dictate ebook prices for end customers (in other words, no discounting by resellers) and will treat its resellers as “agents” who get a fixed 30% of the sale.  In Macmillan’s own words:

Under the agency model, we will sell the digital editions of our books to consumers through our retailers. Our retailers will act as our agents and will take a 30% commission (the standard split today for many digital media businesses). The price will be set the price for each book individually. Our plan is to price the digital edition of most adult trade books in a price range from $14.99 to $5.99. At first release, concurrent with a hardcover, most titles will be priced between $14.99 and $12.99. E books will almost always appear day on date with the physical edition. Pricing will be dynamic over time.

Macmillan lets you buy Priceless in hardcover from their site for the full $26.99 list price and provides links to other resellers including Amazon.  They would no doubt say they sell at full list price because they don’t want to compete with their resellers.  When you click through to Amazon tonight, they still aren’t taking orders but third party sellers on Amazon offer it new for as low as $14.41.   Now Priceless (at least before this blog post…) is not exactly a blockbuster title, so lets look at The New York Times Bestseller list on Amazon:


List Price

Amazon Price

Game Change $27.99 $13.00
Committed $26.95 $12.00
Stones into Schools $26.95 $11.50
Have a Little Faith $23.99 $13.19
Going Rogue $28.99 $13.50
Outliers $27.99 $11.75
Just Kids $27.00 $12.49
The Checklist Manifesto N/A N/A
SuperFreakonomics $29.99 $13.96
What the Dog Saw $27.99 $14.47
Drive $26.95 $14.45
Open $28.95 $15.92
Intellectuals and Society $29.95 $16.47
Evidence of the Afterlife $25.99 $14.97
Too Big to Fail $32.95 $17.96
Freefall $27.95 $15.37
Comeback America $26.00 $14.97
Born to Run $24.95 $13.72
Anticancer $26.95 $14.82
Half the Sky $27.95 $14.97
Average $27.71 $14.18
Average Savings   49%

Amazon also isn’t selling The Checklist Manifesto tonight, which is the only Macmillan book to make the list (you’d think as one of the “big six” publishing houses Macmillan would have a better showing, but maybe they’ve been focused on things other than publishing popular books).  But for the rest of the list, list prices average $27.71 and range between $24.95 and $32.95, while Amazon’s average price is $14.18 and range between $11.50 and $17.96.  You average 49% savings off list from Amazon.

The net is, at a $14.99 list price for a new ebook, Macmillan wants to actually increase the effective price of new books to end customers even as the cost of cutting down trees, making them into paper, putting ink on that paper, putting those books in trucks and shipping them all over the place to stores disappears from the equation.  The savings, needless to say, are not being passed on to you and me.  Macmillan evidently sees themselves as a lone exception to the deflationary pressure of the Internet.  We’ll see how that goes.

If it is not obvious, the big loser here is not Amazon, but the we the consumer:

Price Margin Reseller Publisher
$9.99 50% $4.99 $4.99
$14.99 30% $4.50 $10.49

To the degree Amazon is paying over $9.99 for ebooks today and subsidizing them, then they’re actually much better off margin-wise under this model.  The question is what happens to volume and Amazon clearly believes there is price elasticity for new books (and so do I, speaking purely as a consumer).  Macmillan meanwhile believes they can roll out a new book at $14.99, sell to everyone who will pay at that price, and then slide down the demand curve and pick up all the purchasers who were holding out for $14.98 or $13.99 or whatever.  They will be profit maximizers like the world has never seen before.  We’ll see how that goes.

Amazon waited too long to drop to the 30% revenue share Apple pioneered with iTunes and let Steve “all music should be priced at $0.99 a song” Jobs suck at least some of the publishers into his reality distortion field.  Jobs even seems to have had advance knowledge of Macmillan’s ultimatum to Amazon.  It is hard to see how other publishers don’t follow and put a damper on the ebook market overall. 

I’m too lazy to pull links from Apple playing hardball previously with record companies and movie studios who wanted to set their own pricing in iTunes, but the degree of Apple involvement here appears significant.  Despite the soft sell on iBooks at the iPad announcement, they seem to take Kindle very seriously.  It will be interesting to see to what degree they impede the current Kindle app for iPhone/iPod Touch that should also work without modification on the iPad.

I have a few questions for Macmillan:

  • Do you really believe dynamic pricing/yield management is the best model for your business?  After all, it has worked so well for those paragons of profitability, the airlines, one of the few industries that makes publishing look good by comparison.
  • How does your marketing model change if you’re doing dynamic price reductions?  Do authors have to go out on additional book tours at what increment of price reduction?  Every penny?  Quarter?  Dollar?
  • When will you be instituting the agency model for your dead tree channel?
  • How much more money will authors make per book under this model?  After all, they have to like getting a royalty on a $14.99 book that sells in $9.99 volumes.
  • How do I short your stock?  Evidently Macmillan has already been captured by an organization that sounds like it was at the Battle of Stalingrad:

Macmillan in the US is a group of publishing companies in the United States held by Verlagsgruppe Georg von Holtzbrinck, which is based in Stuttgart, Germany.

Disclosure: I need to get around to commenting on/lampooning the FTC’s vague requirement that bloggers disclose commercial relationships, but in the meantime I hold no stocks of any of the companies mentioned in this post.  Amazon pays me pennies if you buy books that I link to, which I then spend on more books, though I anticipate buying fewer books from Macmillan in the future.  I might read Priceless (click here to tell them to make it available for the Kindle).