Mallesh Pai offers the following explanation. My responses in quotes.

I think there’s an additional reason why ebooks are priced at a loss on kindle. It’s not the one you argue, but it’s worth mentioning- for additional entertainment, I’ll make the claim that it’s the primary reason the pricing is as your describe.

The razor-blade analogy is a bad one since even I really need only 1 blade at a time, my “lock in” (if we must be formal, lock in is how much my RP for a competing product decreases because of my owning/ using this one)  is only to the tune I don’t want to walk over to the store and buy a new blade. Since any inventory of blades deplete over time, even if I buy, say, an 8-pack of blades, I’ll be free to buy the latest in razor technology (Gillette ProFusion Glide) in under 3 months time. With Kindles (or iPods), this is not true. Every time I buy a ‘blade’ equivalent (e-book, MP3), I’m increasing my own lock in to the platform. A hypothetical colleague, let’s call him N, having bought 30-40 e-books on Kindle, is less willing to switch to an iPad, simply because switching would require him to recreate his book ecosystem on the ipad (not just buying the books which is an expense but also recreating things like his annotations on on those books, which is almost impossible). In effect therefore, subsidizing book sales is simply buying future profits once you have a large user base that you can extract from as a walled garden.

interesting point……however it would be in the interest of the book seller to have device independence for the e-book, and I think this would be technologically feasible. The annotations are different matter. I would guess that this lock in effect would apply to a >small fraction of book buyers……OK, perhaps they buy in largest volume………..

Book sellers object to this because they’re wary of Amazon becoming the next iTunes, i.e. the dominant conduit to access end-users, which gives (gave) Amazon (itunes) pricing power over them. As amazon grows more dominant in this space, it has been flexing its muscle in places: for example it dropped a (small) publisher from its physical store earlier this year for not joining it’s e-book store, or offering authors who own the copyrights to their books a higher fraction of revenues if they make the e-book `fully’ available to amazon. Most of the bone hasn’t been about the prices, it’s been about Amazon retaining the rights to price the books at the rates they like (something they already have for all paper books they sell).

but publishers could deal with this via device independence………..

The price fall post the entry of the Nook is predatory pricing. The reason they’re so focused on this is that I think they realize that in the end, profits will require having a locked-in user base like this. If I’m just buying a book, I can comparison shop over multiple websites. By offering things like Amazon Prime (unlimited free 2 day shipping for a low annual fee), I’m more likely to buy from Amazon than say B&N, but not necessarily by much. Once I have a Kindle and 30 books on it (a la the hypothetical N)  I don’t comparison shop any more, and Amazon is now a monopolist seller to me: prices can drift upward over time making Amazon more money, especially since they don’t have to maintain a physical infrastructure like their physical warehouse to sell e-books.

but why not do this at the beginning before the nook, iPad etc……..if getting the large installed base of users is the real goal, then shouldn’t they have been more aggressive when they faced no competition!

I think all the pricing strategies in the current tech industry should be understood as the majors attempting to funnel users into their walled garden:

1. Apple: most blatant example, and the one people are most familiar with. sell gadgets that perpetuate the monopoly of the iTunes conduit (now serving apps and books). They’re the furthest along on extracting profits frm their walled garden (restrictive terms with developers, music labels) and even have pricing power on their iXxx gadget line since the walled garden is so attractive to users.

2. Google: release everything else for free give or take, to keep people using Google search, and keep collecting data for better search and targetting (for better ads). Their foray into Android is partly to prevent Apple from having control of the mobile space, to the detriment of GOOG’s ability to collect data or serve ads.

3. MSFT: mostly lost on how to get in on the consumer space (waiting for windows phone 7). they’ve locked in the corporate space by pulling the same trick- corporations’ legacy apps are mostly on microsoft platforms, and hence corps are unwilling to switch to anything else (say linux or google docs) because that would require them to have to recreate their legacy apps built on top.

4. Facebook: trying to use the Facebook Like button that you see on a lot of websites to recreate a sort of private web… would give them access to targeting info for ads that no-one else has…