The evolution of an ecosystem that ties publishers to consumers is evidence that the second take on e-books will actually stick. The emerging e-book reader market is segmenting cleanly into three categories: high-end dedicated e-book devices aimed as business users; consumer e-readers; and reader software running on mobile phones and mobile devices, such as netbooks.

• Wholesale revenue from e-book sales in the U.S. hit $36 million for the second quarter of 2009, a jump of more than 200%, compared to the second quarter of 2008. Worldwide consumer spending on e-books (for consumer titles) is forecast to be as much as $2.3 billion in 2013.
• Amazon's Kindle e-reader devices reportedly hit the 300,000 mark in the summer of 2009 (mostly of the Kindle and Kindle 2 products, according to Citi financial analysts' estimates); as of July 2009, more than 300,000 Sony e-readers (the 700 and 500 product lines) were sold.
• Book publishers have made investments in digital warehouses, either through building one of their own or through partnering with providers, such as Ingram or LibreDigital, and are better positioned to successfully embrace multiple revenue streams in the e-book market (dedicated e-reader devices, mobile phones and other connected devices).

• Publishers and device manufacturers must experiment with pricing-service models that will pull in paper book readers yet deliver reasonable profit margins to device manufacturers — and publishers must be the ones to force the experimentation.
• Industry participants need to coalesce around standards for multidevice delivery, content-protection/digital rights management (DRM) and real-time transactions, while ensuring that ecosystems are not walled off to new entrants by use of noninteroperable technologies.
• Publishers must closely monitor Adobe's management of what is starting to look like a market-dominant Adobe Content Server 4 (ACS4) content-protection architecture. Publishers should collaborate to ensure that ACS4 is interoperable with other DRM solutions — including open-source solutions — as they emerge.
• Application developers need to begin designing "content as application" services that create compelling new reading experiences, such as including links to video clips or other information that can highlight or complement the title's content.

What's different between the 21st century e-book market and the late 20th century e-book market? It comes down to three things:

• Consumer behavior: We have seen a massive consumer behavior shift toward online acquisition and consumption of all forms of content.
• B2B ecosystems: A set of providers of enabling services, such as the digitization of book titles, has emerged.
• Wireless infrastructure: In developing economies, there has been a significant increase in both capacity and speed of wireless networks in developed economies between the first wave of e-book devices and this year's.

For today's book publishers, future success largely depends on individual responses to emerging consumer demand for books and other printed media on e-book readers and mobile devices. Successfully managing that market depends on publishers' ability to understand consumer interest in and usage of a host of new technologies for consuming printed material, as well as understanding the potential impact of social media and social networking technologies. What's more, these challenges have to be addressed while the industry continues to service the demand for physical books, which are expected to see relatively flat growth during the next three to four years.

While the book industry has not faced the same short-term threats from file-trading that the music industry has, managing the transition from physical products to online distribution, as well as finding profitable and consistent business models, is every bit as tough for book publishers as it has been for music labels and movie and TV creators.

In this research, we will describe the evolution of a linear distribution value chain to the nonlinear distribution ecosystems approach required for sustaining future growth, as well as exploring some of the applicable lessons and opportunities the digital transition in other media sectors can provide publishers.

What's changed since that first wave of e-book devices in the late 1990s? First, there appears to be reasonable demand for the e-book hardware, given the performance of products, such as Amazon's Kindle. The previous versions just didn't generate that many sales, initially. At the time, display technologies did not provide a usable reading experience. While some content was digitized for the first wave of devices, and e-reader software was created for once-popular PDAs, such as the PalmPilot and similar devices, this class never seemed to get big audiences. In other words, no momentum was built.

So, solid, attractive hardware devices are now on the market. Amazon's ability to leverage its relationship with publishers, its massive cloud infrastructure and e-commerce platform enabled it to offer a device fueled by e-books. Amazon was prepared to sell at a loss to build up demand for its e-reader.

Another key factor for book publishers building online businesses is that, unlike the music labels facing the consumer adoption of file-trading in 2000, book publishers have an opportunity to develop the internal skills or the third-party partnerships to build online-distribution infrastructures, while consumer demand for e-book readers and e-reader software for PCs and mobile devices is developing. So, book publishers aren't facing years of unfettered consumer redistribution of content. (Because we are focusing on the e-book and e-reader markets, we acknowledge but aren't addressing the centuries of consumer redistribution of physical books.)

It is also worth noting that, compared to the first e-book epoch, improvements in component technology, such as the emergence of E-Ink technology, have enabled vendors to develop products with much better performance than the first-generation e-reader devices. Additionally, it appears that publishers are coalescing around a set of file-format and content-protection standards much faster than with the previous generation of offering, with the electronic publication (EPUB) format and ACS4 DRM system gathering major and independent publisher support. In particular, it should be noted that Sony has announced that its next generation of e-reader devices will support EPUB and ACS4, a major departure from Sony's past proprietary strategies. (The new devices will also support the existing proprietary format Sony currently uses, ensuring backward compatibility for current Sony e-book customers.)

Because nascent markets need to encourage consistency by deploying industry standards wherever possible, the market momentum behind EPUB and ACS4 should be viewed as a net positive. However, if the market continues to grow as rapidly as it has in the past five or six months, publishers must remain vigilant that ACS4 does not hand Adobe a very large lever to exert on the rest of the market.

Rather, Gartner believes publishers and Adobe need to ensure that alternative DRM solutions can interoperate with ACS4-based solutions. Ignoring this concern could lead to an unhealthy situation in which a single vendor controls a very important link in the e-book value chain. Perhaps more important to the long-term health of the e-book marketplace will be ensuring that there is an open and competitive market for license distribution and maintenance of the associated content licenses.

Finally, between the first wave in the late 1990s and now, we have seen consumers become increasingly comfortable with all manner of online retail transactions — from buying songs and albums from music services and online stores to renting movies. It goes without saying that consumer usage of file-trading software helped train a generation of consumers in how to find and acquire content.

The maturation of e-commerce sites and online retailers is as important as file evolution of formats and content protection standards. Online sales of media through stores, such as iTunes, Amazon's MP3 and Unbox offerings, are the chief new growth opportunities for music labels, TV networks, movie studios and book publishers. While digital/online sales and licensing revenue are still dwarfed by the revenue generated by physical-media versions (for example, CDs, DVDs and physical books), strategists for major media companies know that their future rests on their ability to build and grow their online distribution capabilities.

This generation of e-book devices and services comes to market with a dramatically enhanced online delivery capability, shaped mostly by the evolution of wireless devices and networks in North America and the rest of the world. Gartner's Media Industry Advisory Service believes that, in addition to dedicated devices such as the Amazon Kindle, consumers will be looking to leverage e-reader software on the rapidly growing class of consumer smartphones, exemplified by Apple's iPhone, and the BlackBerry Curve and Storm, among others. According to Gartner's Dataquest mobile service forecasts, consumer smartphone sales in North America are expected to grow from 35 million in 2008 to 125 million in 2013; wireless data plan revenue (revenue spent by consumers on wireless data plans) is expected to go from $37 billion in 2008 to $100 billion by 2013.

All in all, publishers are looking at a much more friendly market opportunity than in the previous wave of e-book devices, resulting in a substantially more-optimistic set of market forecasts than seen previously. Physical book sales, especially in the consumer book segment, are expected to post flat to negative growth during the next several years, while e-book titles for consumer books are expected to post a 26% compound annual growth rate (CAGR) between 2009 and 2013, according to PricewaterhouseCoopers' (PwC's) "Global Media and Entertainment Outlook" report. Some other highlights of the market outlook include:

• Sales of consumer books (physical books) generated $72 billion worldwide in 2008, down from $73.7 billion in 2007, according to the PwC report.
• Wholesale revenue for e-book titles in the U.S. climbed from $11 million in the second quarter of 2008 to $37.6 million in the second quarter of 2009, according to the International Digital Publishing Forum.

A better set of delivery options exists, along with a marketplace of consumers who are much more attuned to and comfortable with online transactions, as well as a growing number of devices. The number of major and independent book publishers supporting the e-book market is definitely large, and their support for the segment is very strong, though that support might be at different stages of maturity and reflects different go-to-market strategies. Table 1 provides a snapshot of the major independent publishers and their e-book status.

Figure 1 depicts the typical workflow for books from author to consumer. The workflow generally assumes the inclusion of a book publisher that, like a music label, takes on the task of managing and distributing the finished asset. While working with established or even emerging book publishers is still the predominant way books are published. The entrance of Web 2.0 intermediaries such as Scribd and Docstoc, not to mention vanity e-presses such as Amazon's CreateSpace and BookSurge, provides content management and distribution services. Authors are looking at self-publishing to exercise greater control of the works as well as keep larger percentages of sales revenue.

One of the more disruptive characteristics of the e-book value chain is the development of hybrid providers hoping to capture more than one area of value. Much as Apple has for the music business and Amazon has for the physical book space, the ability to control distribution (and, in the case of Apple, consumption) of content provides greater leverage at the center of the supply and demand universe.

"Hybrids," in some cases, are attempting to appeal to publishers, because of their ability to integrate more than one technology function (to ingest, encode, distribute and sell devices) offering a one-stop solution. Hybrids also are attempting to provide publishers a viable option to Amazon (and perhaps, over time, Google) by offering more-favorable revenue splits and value-added services, such as hypersyndication tools. Following is an overview of each part of the digital distribution value chain for e-books and the impact hybrid offerings are having, adding a mix of market disruption, choice and confusion to publishers.

The publishing part of the value chain remains much the same as it has since the advent of the printing press, aside from the use of word processing as the canvas on which books are created. Generally, books are authored using common productivity applications, such as Microsoft Word or, in the case of plays, a specialized template such as Final Draft that easily populates scene characteristics.

If there is one change in authoring, it is the creation and inclusion of metatags as part of the authoring process. Following the lead of newspapers, which encourage writers to apply tags as they create online content, e-book publishers are encouraging authors to add metatags during the authoring process that are descriptive of characters, scenes and locations, and other related descriptors. These metatags, which can be edited and even amplified during the editing process, are valuable for such functions as searching or even creating mashup opportunities.

In "Publishers Turn to Digital Warehouse Vendors to Meet Dynamic Market Opportunities," Gartner outlined the role of digital warehouses as disruptors of the conventional, more-manual process of taking the "handoff" from a publisher (in forms that ranged from physical paper to Word files) to produce output in the form of bound books ready for distribution. Figure 2 provides a description of how a digital warehouse works as a provider of multiple services in the e-book value chain.

One difference in the value chain is in the area of "experience management." In the past year, the function of how content is presented to the consumer has become a function that, to some degree, has moved out of the sweet spot of digital warehouses. Using such platforms as Flash, Adobe Air and Silverlight, developers are building "content applications" that marry assets exported by digital warehouses along with payment gateways or ads along with experiences that "play" across multiple platforms.

In the book world, Scribd has ventured into this space for book publishers, using its iPaper technology, but using content applications being built for newspapers (The New York Times player in Adobe Air) and magazines (using Bite Sized Candy), it's logical to believe book content applications are close behind. The impact on digital warehouses will be in their ability to create relationships with developers that can turn content asset output into cross-platform content experiences.

In the year since our report, the market for digital warehouses has expanded in the number of providers as well as the opportunities for multichannel distribution. From the provider standpoint, Ingram and LibreDigital remain the largest players, with both companies adding investment dollars and inking partnership deals with book publishers as well as device manufacturers. LibreDigital, based in Austin, Texas, secured $15 million in Series B funding while Ingram, in May 2009, consolidated its print and digital publishing services into one company called Ingram Content Group, a move the company said would make it easier for customers in the publishing industry to find what they need. The restructuring includes Ingram Book Group, Lightning Source and Ingram Digital. While not a pure digital warehouse, Amazon, which offers ingestion and transcoding to its proprietary AZW format, must be included in any discussion in the digital warehouse space.

With less market experience and infrastructures geared only for digital distribution, a number of new entrants to the space include Scribd, Shortcovers, Myebook and Google.

Some of the events in the past year that have brought both challenges and opportunities to the digital warehouse space include:

• The emergence and expansion of e-book distributors such as Barnes & Noble, Borders and OverDrive, not to mention e-storefronts on publishers' sites that rely on digital warehouses not only to prepare content for e-distribution but also to build social media applications to enable consumer interaction.
• New book-reading devices, such as the Cooler, Kindle DX, Sony's Pocket and Touch products, as well as book-reading applications for smartphones (ScrollMotion and Stanza) creating additional consumer demand for e-book titles, which puts pressure on digital warehouses to ramp up their efforts.
• Battles both in the book DRM space pitting Adobe's ACS4 against Amazon's proprietary DRM and in the e-book format space, with primarily the universal EPUB standard going against Amazon's AZW. Multiple formats require digital warehouses to spend more time and money encoding content.
• Google's settlement of a lawsuit brought by the Authors Guild, now under Justice Department view, for copyright infringement based on Google's book-scanning project. The final ruling in this case will impact the market overall, with:
  • The desire for new content experiences, including value-added e-books that contain video and audio.
  • The looming threat of Apple as an e-book distributor (via iTunes), if it launches a tablet computer. Apple's entrance adds yet another powerful force that could benefit a handful or digital warehouse providers — if Apple were to work with one or two to manage e-book ingestion and distribution via iTunes or apps in the App Store.
  • The globalization of e-books. As new devices roll out overseas, digital warehouses may strain current resources to keep up with demand, which includes e-book localization (i.e., translations).

In "Amazon's Kindle DX Targets Newspaper and Magazine Markets," Gartner raised the question regarding the future of Amazon's Kindle as a dominant device for the publishing world. We hold firm to the position that myriad devices and reading experience will create a fragmented opportunity that will evolve into three basic opportunities for the book industry:

• High-end devices, such as the Amazon Kindle family, geared for business travelers. Storage, battery life and the ability to store personal documents such as presentations and reports will be key features.
• Consumer-oriented devices, such as those coming to market from Sony and Astak, which will initially be priced in the sub-$300 range. These will have less storage, and perhaps less battery life, but will deliver a solid reading experience. The success of this space will largely depend on the increasing availability of titles early in the distribution window.
• Smartphone applications, in which book content and applications are sold via e-storefronts such as iTunes. The key here is to create experiences suited for the smartphone screen. Gartner believes the book-reader opportunity is likely to be relegated to the relatively high-end of the consumer smartphone market, mostly because of screen requirements. The small sizes of most consumer "feature phones" are too small to support a serious reading experience.

No mention of the consumption market can be complete without mention of Apple's future role as a device manufacturer for e-reading as well as utilizing iTunes as an e-book storefront. In our blog post "Amazon Braces for Market Collision" (http://blogs.gartner.com/allen_weiner/2009/07/28/amazon-braces-for-market-collision ), not only will Apple's entry provide market turbulence, but also it will focuses on Adobe's role in a future scenario that may yield "co-opetition" between Apple and Adobe against Amazon and Google. While we do not want to add to the hype that is almost always swirling around Apple and the company's decisions to enter, or not enter, new market segments, iTunes, as an online content transaction store is a natural fit for the evolving e-reader/e-title market for book publishers. Among its chief assets are 70 million active credit cards (and gift cards) on account. If Apple is developing a tabletlike product capable of displaying e-book titles, a significant percentage of those accounts become potential book (title) buyers.

Transitioning from physical products to file- or stream-based delivery has affected media sectors in different ways. How each is coping with the transition — in terms of strategies and tactics —has as much to do with consumer expectations for ownership and portability of content as anything else. As premium content — be it movies, TV shows, music or book titles — consumers are beginning to shift their entertainment collections from shelfware to "access ware" — access to streams of music, movies as well as newspaper and magazine content.

Book publishers have the advantage of seeing how other media industry sectors adapted to online distribution and a wide variety of different consumption devices. Among these object lessons from other sectors:

• Finding and acquiring content online can be much more efficient than in a physical-world store. Searching for titles, finding recommendations and discovering new content is actually a more efficient and better use of online tools than most physical retail stores, save for those few music stores, book shops and movie-rental stores that really do have sales reps who know the content. We are not comparing the personal, subjective experience of wandering around a book store (one that is, in our opinion, defined by the physical space itself), but rather the ability to do online searches through titles and to find associated material that might be of interest.
• Don't try to stall the transition. Sophisticated consumers have plenty of alternatives. Tech-savvy consumers, young and old, are generally more sophisticated, in terms of knowing how to find and acquire online alternatives for content. They expect media companies and content producers to meet them on their terms. They will pay if it's convenient, reasonably priced and delivered via a compelling content experience. If content owners or service providers create restrictive, high-friction environments, these consumers will find alternatives.
• Today's online consumers have high expectations for low or "reasonable" prices. The digital consumer's expectation is that the digital version of its product should be considerably cheaper than the physical version. While they may not be familiar with the concept of marginal cost, consumers "know" that the digital version of a book or an album or even a movie does cost less for the producer to create and distribute.
• Don't try to extract money every time a consumer wants to touch your content. There is a desire to extend previous business models based on control of content in physical form. Book publishers might be tempted to use DRM to prevent uncontrolled or unmonetized distribution of content and overly restrictive licensing terms to exert a level of control that did not exist in the physical book marketplace. They shouldn't expect to be able to achieve that.
• Content ownership expectations will vary — build flexible business models. There are expectations of content ownership. Books and music are similar in that, in general, consumers have been willing or expected to build out libraries of content — permanently owned, consumed repeatedly. However, as online distribution options increase, publishers may find out that permanent ownership may not be as important to consumers, with reference books/material being the obvious exception.
• Clean up the metadata now. Future success in moving to online distribution models is greatly dependent on the ability of book publishers to create online, centralized rights-in/rights-out management systems to expedite the licensing process for distributing content via different distribution intermediaries. Movie studios, music labels and the online service providers working with them have been dealing with this for several years.
• The public library? Finally, one distribution channel available to consumers will play a very important role in the future of the e-book (as it has in the music space) and that's the public library system. Over the past several years, libraries have been adding audiobooks to their collections. As consumers consider multiple paths for acquiring book titles, how libraries evolve to meet the needs of their consumers will have an important effect on the overall book market.

During the next four or five months, Gartner expects the e-book market to heat up as multiple dedicated devices come to market. The most recent evidence of the amped-up market is the 6 August introduction of two new Sony e-book devices, the Pocket ($199) and the Touch ($299). Sony apparently felt the need to move the announcement date up as press leaks were starting to mount. In and of itself, a bumping up of an announcement date in the high-tech business is not that unusual. However, given that Amazon's Kindle II and Kindle DX introductions were within a couple of months of each other, and pending announcements from companies, such as Plastic Logic, it appears that vendors are jockeying for market position to meet demand — a very different situation from when the first wave of e-books hit the market. At that time, vendors had to justify the product's existence as much as anything else.

Among the key challenges facing the publishing industry that we will continue to monitor:

• Finding the appropriate and revenue-generating role of social media in the e-book space
• How the industry does or does not coalesce around a set of compatible DRM and file formats
• The market forces and enabling technologies needed to develop a winning device strategy

"Newspapers and Magazines Must Focus on Digital Channels That Offer Immediate Payoff"

"Amazon's Kindle DX Targets Newspaper and Magazine Markets"

"Publishers Explore Digital Editions, Devices as New Channel Opportunities"