Spritely

A brief history of the first eBook war

Posted in Spritely by Dimitri on February 1, 2010

The internet is great at removing middle men. It has this fascinating way of connecting producers more directly with their consumers.
“Old” (pre-internet) businesses have to understand this and adapt, or be flattened by direct-to-customer competition.

For books, it was Amazon that took the first step at reducing the number of middle men. In order to make itself the largest bookseller on the planet, Amazon assumed the role of both wholesaler and retailer. Then, to ensure it’s market dominance, it passed the savings of the shortened supply chain to it’s customers. By going online, Amazon also decreased the cost of providing those books to the people. Authors still got their cut, publishers still got their cut, wholesalers got screwed, retail bookstores and local shops got screwed and customers paid a lot less for books.

The important thing to note here is that it’s Amazon who sets the effective price of these physical books. The publishers set the retail price, and Amazon haggles with them for a decent wholesale price. But in the end, how much customers actually pay is entirely up to Amazon: they decide how much profit to take on the book in order to ensure a high volume of sales. For select popular titles, they can even decide to take a loss in order to secure a customer, in the hopes that the customer will buy other, higher margin items.
As an example throughout this article, I’ll use Sue Grafton’s U is for Undertow, a $28 hardcover that was released recently and is on the Times Bestseller List. (Note that I am estimating most of the values here. For more details, see the bottom of this post.)

The eBook dilemma
Up until recently, nobody wanted to read books on computer screens. The technology just hasn’t been able to match the experience of holding a book. Since books are cheap, and even active readers only buy a couple of dozen or so a year, the best technology for reading a book has been a book. As the technology has improved, and continues to improve, more and more people are willing to sacrifice some of the quality they get from the printed page for the convenience of being easier to carry and purchase, and for the lower costs of having an electronic item.
Just like their predecessors, the music labels, as people move to purchase eBooks, a problem arises. How do you price digital content? In your customer’s eyes, a digital purchase is not as valuable as a physical one. Not only that, but the public recognizes the savings of the medium: with no printing, shipping or storage costs, the price of the book should be lower. Additionally, purchasing a digital item means that there is no resale outlet for them: they can’t loan the book to a friend or sell it back to a used bookshop.

Priced to sell

Amazon’s desire is to keep prices low. Low prices mean more books sold. For them, the Kindle bookstore is the ultimate cost cutting mechanism: no warehouses to maintain, no shipping costs. The cost of electronic delivery and the cost of maintaining a virtual storefront are very low, and continue to drop each year. Additionally, it lets them sell more Kindle devices, which they profit on. The publishers, on the other hand, want to see their cut. Since the only cost that they can reduce is the printing cost, they are left with a much bigger piece of the cost pie than Amazon.

Amazon’s short-lived monopoly

So what did Amazon do? When the Kindle was announced, they were the only game in town. They gave the publishers an option: get onto this system, with our terms, or be left out of these purchases. The people buying Kindles were some of the most desirable customers: people wealthy enough to afford a $300 eBook reader and those who read enough to justify it.
So many publishers gave in to Amazon. Amazon, in turn let the publishers set a new “digital” price for their eBooks. Amazon then took a whopping 65% cut of this price, but that allowed them to do exactly what they were doing with the physical books already: take the larger share of the price, and then adjust their own margins as they saw fit to help sales of the book. To the publishers, this looked fairly familiar: that $28 hardcover could be priced at $28 and the publisher would make almost $10, roughly the same as what they would have made selling the hardcover.

Everybody hurts

So Amazon is unhappy, since in order to get prices down to where it considers eBooks will be purchased, it has to take a loss on the sale, and hope that the sales of Kindles and other, higher margin eBooks will make up for it.
And the publishers looked at it as a crappy deal for them too, since the savings in printing was now passed on to Amazon, and Amazon had more sway over the price of their book than they did. Price competition between publishers would be more at Amazon’s will than the will of the publisher.
Amazon didn’t see it that way. Since Amazon was undercutting it’s share to make up for volume, they saw the printing cost disappearing into the customer’s pocket. But even after a significant cut in Amazon’s share, a serious problem remained: for the publishers to get their expected $10, and for Amazon to profit, the eBook price of a new hardcover would remain within a few dollars of the discounted Amazon hardcover price. If people were expecting a reduction in book prices like they saw when Amazon first came to town, it would require a willingness to move on price from the publishers. Even though some of them did, their suggested list price had to remain high so that they could retain some of the profits after Amazon’s 65% share.

The new deal

So, on the eve of Apple’s huge announcement, Amazon offers publishers a new deal. They offered to double a publisher’s royalties if they price their books under $10 and agree to play fair with Amazon (no price undercutting from other eBook stores). So now publishers can expect to see the big side of a 70-30 split.
But it was no huge gift to the publishers. By reducing their list prices to $10, publishers could only expect to see $7 per sale, which is less than the $10 they normally would expect from a new hardcover after printing costs. Amazon, on the other hand, no longer needs to cut into it’s share to reduce the book prices to reasonable levels (and in fact agrees not to so that they don’t provide price competition against other eBook stores, at the publishers request). eBooks will now sell for exactly the price that the publisher wants… as long as it’s under $10. Publishers who don’t agree to this deal can stick with the old system, which makes much less sense now, especially for books priced under $20.

Along comes Apple

With Apple’s iBooks, the publishers have another major distributor to deal with who has an eReader that will likely sell very well. Without the physical bookstore to back it up, Apple has far less leverage to reduce book prices with the publishers than Amazon does. So some of the biggest publishers in the US make a deal with Apple on similar terms to Amazon’s 70/30 deal, but with a much higher price ceiling (it’s believed to be around $15). This spells trouble for Amazon, and this weekend that trouble played out: Macmillan refused to allow Amazon to sell it’s eBooks for $10, demanding instead that it sell them for $13-$15. Amazon balked, and pulled Macmillan’s physical books off it’s store. At the end of the weekend, Macmillan prevailed, and Amazon gave into demands. It hasn’t yet been seen what will come of this for the other publishers, but it’s likely they will require the same deal from Amazon, which will likely raise the standard cost of an eBook by a few dollars.

My take

I think that a fair price for a newly released eBook is between $10 and $12, dropping to around 70%-80% of the price of the paperback edition when that edition hits mass market. The fact that these books are nontransferable, have questionable DRM, and have no means of resell, lending or gifting makes them significantly subpar to their physical counterparts, and they need to be priced as such.
In the next few years as more and more customers get access to eBook reading devices, it will be customers that determine the value of an eBook, not the publishers. Hopefully the book publishers will not make the same mistakes as the music labels did, and allow this market to flourish.

DRM-laden

As for the DRM problem, I’m less concerned about it than the restrictions it imposes. The Barnes and Noble reader, the Nook, allows for book lending, although under some strange terms. I can imagine that even if a book is DRM-free, but within a closed ecosystem (the kindle-reading app on various devices) there will be minimal piracy as long as publishers allow users to do with eBooks what they’ve always done with books: lend them or give them away. I think only then can publishers expect to see sales of eBooks really spike, as users feel true ownership of the books. Unfortunately, I fear that this will never happen.

The direct supply chain

The final step in shortening the supply chain is removing the publisher. I don’t think this will happen for most known authors for quite some time, as they will require publishing agreements to publish physical books, and those agreements will not allow them to publish elsewhere. For new authors, however, this could be a great opportunity to get published, digitally, without the need for the old-world supply chain that was put in place. I can imagine a young author writing a novel, having it edited by friends, and then publishing it directly to Amazon, without the need for a traditional publisher, wholesaler, or retailer.
A few notes: I’ve used a breakdown of book costs from Money magazine, which gave examples of a book cost of a $28 hardcover, and applied them to the book in question. I don’t know what the exact breakdown is for this book, but it’s probably fairly similar to the breakdown.

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2 Responses

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  1. DDA said, on February 3, 2010 at 4:59 pm

    “I think that a fair price for a newly released eBook is between $10 and $12, dropping to around 70%-80% of the price of the paperback edition when that edition hits mass market.”

    I think this is too high given what I give up with an eBook, especially considering the competition is free (in this case, libraries as well as piracy). Price the eBook at $5 or $6 and I think things will flourish; be greedy and things will stall.

  2. threefires said, on February 4, 2010 at 1:49 am

    I couldn’t agree more. I did business with amazon once seven or eight years ago and just discovered them again the other day. One of my friends bought a perfect book for $2.00 that would have been $8.99 at Barnes and Nobles and he didn’t have to get off his couch. I think that the new iPad will revolutionize reading digitally, when Apple includes all of the features that we are really looking for in a $750 device. I have an iPhone and wouldn’t think of getting on an airplane and reading with it. I have twenty some books for sale on amazon now and plan to start marketing some of my music there too. People are going to have to adapt to this way of doing business. If you have a cd store and want to do business then this is “Today’s Word.”


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