How Amazon squeezes writers to make you richer

When writer Andrew Hyde published a new e-book through Amazon.com (Nasdaq: AMZN), the online megaretailer promised him 70% of sales. But a hidden fee slashed his initial take to slightly more than 50%. As a leading seller in the fast-growing digital book market, can Amazon afford to anger authors? As the company expands from retail into cloud computing, two reasons suggest that it can — and will.

The strange case of Mr. Hyde
For his US$9.99 book, Hyde expected US$7 from every Kindle copy. Citing digital delivery costs, Amazon paid him just US$5.10.

Kindle owners download new books wirelessly, over Wi-Fi or cellular networks. Amazon charges authors for this, not readers — and the e-tailer apparently doesn't mention up front how big those fees can get. In contrast, Apple (Nasdaq: AAPL) charged Hyde nothing to deliver books through its iBooks store and paid him its promised 70%.

Compressing his book's Kindle file cut Hyde's delivery costs from US$2.58 to around US$0.60 per copy. However, Hyde learned that if he'd set up his own site to distribute the book on Amazon's cloud servers, each download of the original, larger file would only have cost him one-fifth of one penny.

Hyde suspects that Amazon is marking up delivery costs just because it can. After spending roughly US$0.05 of every 2011 sales dollar to ship physical goods to eager customers, the company may aim to blunt those costs with fatter digital margins.

Furthermore, Amazon's sales trends suggest little financial incentive to appease angry authors like Hyde.

Books are the past …
Notoriously secretive, Amazon doesn't disclose Kindle hardware or e-book sales. Instead, it lists revenue in three categories: media (including books), electronics and general merchandise, and other, which mostly involves Web services.

In 2011, Amazon booked more than US$17.7 billion in media sales worldwide — just 37% of its more than US$48 billion in total sales. That slice shrank from 43% in 2010, and 52% in 2009.

Furthermore, media's grown more slowly than Amazon's other categories, rising at 16% each year from 2009 through 2011. Electronics and general merchandise sales grew 53% year over year in 2011, while other sales grew 66%.

In response, Amazon's investing where it can reap the greatest gains.

… Bits are the future
Amazon may lavish publicity on Kindles and e-books, but cloud computing — renting cheap, convenient computing power to help customers crunch numbers and do business by way of the Web — looks like its true future.

Amazon's "other revenue" category rang up US$1.58 billion worldwide in 2011, including US$1.43 billion from the U.S. While that represented just 3% of Amazon's total net sales, that proportion could soon grow much bigger.

Amazon nearly doubled capital expenditures from US$979 million 2010 to US$1.8 billion in 2011. The company says it's building new shipping warehouses and bulking up tech infrastructure, including its burgeoning Amazon Web Services, or AWS. Its spending on site and software development alone surged from US$176 million in 2010 to US$256 million in 2011.

For its investment, Amazon's getting one of the biggest, baddest names in cloud computing. Numerous sites dub Amazon the top cloud services provider, beating rivals such as Rackspace (Nasdaq: RAX), salesforce.com (Nasdaq: CRM), and Google (Nasdaq: GOOG).

With roughly 66% growth last year, Amazon seems to be expanding its cloud revenue faster than its competitors. In 2011, Rackspace posted net cloud revenue of $1.02 billion, up 31.3% year over year. Salesforce booked $2.12 billion in service and support revenue for its latest fiscal year, rising 37% year over year.

Google doesn't reveal revenue for its own cloud offerings, but it's clearly gunning for Amazon. On June 28, the search giant confirmed plans to debut a competitively priced AWS rival later this year. No wonder Amazon's pumping capital into its own cloud operations.

Recent forecasts suggest that cloud services could reach US$16.7 billion in revenue by 2013 and become a US$241 billion global market by the end of the decade. As fellow Fool Travis Hoium noted, Amazon would need to grow sales 38% over the next five years to justify its sky-high 88.58 forward P/E. That gives the company every incentive to conquer the cloud — and far fewer reasons to care about Kindles.

What does a 400-pound gorilla charge e-book authors?
E-books are just a drop in Amazon's very big bucket. If writers revolt en masse, the e-tailer could arguably abandon them and still thrive. Ditching e-books might even improve its margins. To capture market share and consolidate its power, Amazon often sells major publishers' Kindle titles at a loss.

For now, irate authors have few Amazon alternatives. With Apple's iBooks still ramping up, Barnes & Noble struggling, and major discounters like Wal-Mart and Costco selling only a relatively small sampling of best-sellers, Amazon enjoys unmatched size and selection.

Andrew Hyde, at least, got his revenge. After he told readers about Amazon's hefty fees, his book's proportion of Kindle sales shrank to just 18%; 65% of new customers bought the book directly from Hyde.

Still, if authors like him want their work to reach the broadest possible audience, they'll have to get used to having Amazon take a bigger-than-expected bite of their earnings. Server farms don't come cheap.

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