????After Apple's big tablet debut, Amazon is starting to play a little defense.

????by Jessica Shambora

????In the matchup between the iPad and the Kindle, some say it’s game over for Amazon’s e-Reader. But according to industry watchers, it’s still only the first quarter.

????Keep in mind that Apple’s tablet showed up just two weeks ago, and it hasn’t even hit the market yet. Meanwhile, Amazon hasn’t exactly gone on the offensive, but CEO Jeff Bezos and company show no sign of retreating.

????The day after Apple’s big iPad debut, Amazon reported stellar fourth-quarter results that included a 42% increase in sales and net income up a whopping 71%. Although Kindle and eBook sales still account for only a small segment of revenue — predicted to be about 5% in 2010 according to most analysts — its success continues to be a highlight.

????In Amazon’s earnings release, Bezos threw a spotlight on the “millions of people” who own the e-Reader, adding, “When we have both editions, we sell 6 Kindle books for every 10 physical books.”

????But when asked about competition from new devices during Amazon’s earnings call, CFO Tom Szkutak would only say, “We believe that readers deserve to have a dedicated device.”

????“They would argue that [the iPad is] a tangential rather than a direct threat because there are people who want to buy a reading-only device,” says Goldman Sachs analyst James Mitchell. Amazon can also argue, he notes, that the Kindle is much cheaper, offers 3G connectivity without a monthly phone bill, has a battery that lasts several weeks, and is easier to read thanks to its e Ink technology, which resembles paper rather than a backlit screen.

????Still, it didn’t take long before Amazon (AMZN) was forced to directly address competition from its new rival. Two days after the iPad appeared, the company got in a pricing fight with Macmillan, one of five publishers that signed on to provide content for Apple’s tablet.

????Macmillan wanted to renegotiate its deal with Amazon to mirror its contract with Apple (AAPL). Rather than allowing Amazon to cap prices at $9.99, the publisher plans to charge $12.99 to $14.99 for e-book versions of bestsellers and hardcover releases. It will pay Amazon a 30% commission, an arrangement referred to as the “agency model.”

????Amazon initially resisted, but eventually it relented and posted a comment on a company forum that reads, “Macmillan has a monopoly over their own titles, and we want to offer them to you even at prices we believe are needlessly high for e-books.” Following the spat, Amazon’s stock slid 6%, and publishers Hachette and HarperCollins also demanded a switch to the agency model. Shares have since climbed back up 3% to hover around $118.

????Ironically, Amazon stands to make a higher margin per book under the agency model, while the publishers should lose profits in exchange for the pricing control. But Amazon also loses its pricing edge over Apple, which is reported to have struck deals to also sell books in the $12.99 to $14.99 range.

????Taking steps to compete

????Meanwhile Amazon is not lying idle with its technology. The company is in the process of buying touch-screen technology startup, Touchco, according to reports from The New York Times. The acquisition could mean touch capability in a future generation of the Kindle.

????Job openings at Amazon’s hardware division, Lab126, offer further evidence of plans to upgrade the device. More than half of the 50 positions were posted within the past month, while a listing for a “Hardware display manager” reads, “You will know the LCD business and key players in the market.”

????Analysts say an announcement Amazon made in the week before the iPad launch is equally telling. Amazon is opening up its platform to outside application developers, a move Forrester analyst James McQuivey calls a “well-timed hint” that a color, full-touch screen is in the works.

????“They’re not going to convince people to make apps for a somewhat connected, barely interactive, monochrome device,” he says. “Amazon knows that.” McQuivey expects to see an upgraded device announced by the end of this year.

????Citigroup analyst Mark Mahaney also sees improvements like color and touch functionality in Kindle’s future, as well as a drop in price. “The price of e-Readers has to come down over time and so far they have,” he says. And despite pressures from the publishing community, Mahaney still sees flexibility in e-Book pricing, wherein Amazon could use profits on bestsellers to slash prices on other books.

????Mahaney, who predicts Amazon will sell more than three million Kindles this year, holds that there is a market for a standalone e-Reader, pointing to several other launches in the space already this year. “Amazon should stay in the market until it’s proven otherwise,” he says. “They have the best device and ecosystem. They have a lot of advantages here.”

????Forrester’s McQuivey thinks Amazon can pull off its hardware challenge, but he also says it’s beside the point. “Where Amazon needs to show it’s better is not in hardware. It’s in the way the device is optimized for media,” he explains, suggesting that a future Kindle could support Adobe Flash, which the iPad does not, to the frustration of many.

????The pricing battle will continue as the big publishers take sides. Right now Amazon appears to be playing defense. But as big players like Random House signal that they may stick with the status quo as consumers clamor for lower prices, defectors could be forced to bring prices down again.

????Apple may have the fancier device and the iTunes store, but Steve Jobs didn’t introduce the iBookstore until nearly an hour into his iPad presentation. Meanwhile, Amazon has a proven dedicated reading device, a mobile app for reading and buying books, and Amazon.com, a formidable e-commerce platform built on the back of a book-selling business with a robust community of reviewers and a sophisticated recommendation engine.

????When Apple debuted its iTunes store back in 2001, its only real competitor were brick-and-mortar stores like Tower Records, McQuivey notes, referring to the bygone music chain. “Today,” he says, “people already have a really good experience for buying books.” It’s called Amazon.