Jag Venugopal's Blog

April 5, 2010

Schumpeterian Creative Destruction and Book Publishers

Filed under: Digital Living — Jag @ 4:29 pm
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Book publishers are marching down the same path that made newspapers irrelevant, and record companies at the mercy of one company’s pricing power.

At Amazon’s Mercy

For the last couple years, ebooks have been a virtual monopsony, with Amazon being the major customer of the publishing houses. These publishers wholesaled books to Amazon, which then sold them on its website. Amazon priced many ebooks at $9.99, primarily to make them appear cheaper than the print version, and also to drive sales of its Kindle device. Amazon’s wholesale costs were sometimes higher than the retail price it charged. The book publishers fretted that this was destroying the value of their books in the minds of the consumer, who was being conditioned to the $9.99 price ceiling for ebooks. Their worry was that Amazon would eventually use its heft to force wholesale prices below the $9.99 margin, thus ensuring a profit for itself.

Last Gasps: The Agency Model

Publishers saw the kind of pricing power that Apple wielded in the music business with the $0.99 song, and tried to avoid it with what they call the ‘agency model’. In this business model, the prices would be set by the publishing houses. Amazon would take and fulfill orders, without any control over pricing. 30% of the retail price was Amazon’s to keep, with the rest being remitted to the publisher. Ironically, this arrangement would decrease the amount of money the publishers made, compared with the wholesale model they had in place with Amazon. Publishers reasoned that this model allowed them to maintain control over the retail prices of their wares, and also avoid cannibalization of paper book sales. Their avowed strategy was to price the ebook at $14.99 when the paper book was in hardcover, reduce the price to $12.99 when the paper book reached trade paperback status, and further reduce it to below $10 when the paper book was issued as a mass-market paperback. Understandably, while Amazon was the unquestioned king of the hill, they did not have much leverage to force this model on it.

Enter Apple

Ironically, Amazon’s monopsony power ended with Apple’s entry into the ebook market. Amazon could not command the purchasing power it once did, because Apple agreed to the agency model. As a result, publishers got to set ebook prices on Amazon starting April 1st, 2010. And they ended up playing an April Fool’s joke on themselves. With their latest pricing change, some ebooks on Amazon are more expensive than the paper copy. For example, as of April 5th, the “Ten Day MBA, 3rd Edition” by Steve Silbiger costs $11.55 retail for the paper copy, and $12.99 for the ebook. Using the heuristic that printing and shipping accounts for about 15% of the price of a book, the ebook could have been priced at $9.80 and still returned the same profits to the publisher.

Creative Destruction

Joseph Schumpeter popularized the theory that innovation, while it sustained long-term growth, destroyed the value of established companies which did not embrace it. In this instance, an innovation (ebooks sold over the Internet, read on electronic devices) is threatening an established industry (printing books on dead trees, and shipping them to stores using dead animals, or in other words, oil). Book publishers are used to the existing model, and its inherent differential pricing in the form of hardcover, trade and mass-market editions. Their quest to sell via the agency model, and their pricing decisions can be viewed as nothing but a way to perpetuate their existing business model and practices. 

Here is why I believe that publishers just don’t get the ebook economy, and why their recent actions amount to arranging deck chairs on the Titanic:

  • They cannot control ebook distribution like they did for print books: Authors can directly contract with Amazon and Apple for distribution of their electronic books. In this scenario, an author would hire his own editor and designer (perhaps for a flat fee, perhaps for a percentage). The finished copy would then be sold directly through Amazon and/or Apple, completely circumventing the publishers. The publishers’ strengths in pre-processing, marketing, manufacturing, warehousing and distribution would largely be rendered irrelevant in the digital world. If the author wanted better marketing, all he had to do was to have Amazon or Apple to highlight his wares (in much the same way as eBay today offers to place your auction item more prominently for an extra fee).
  • There are many electronic substitutes for books, easily accessed over the Internet: Music, movies, television and even free books (through Google Books) are all substitutes for reading-as-entertainment. For readers of non-fiction, there are any number of web sites and blogs which often deal with the same topics. For example, much of John Edwards’ shenanigans can be uncovered by browsing one of the hundreds of web sites and blogs dedicated to the news story. Someone intent on reading up about Edwards, and saving money at the same time could easily avoid purchasing “The Politician” until it hit the remainder shelves in her local bookstore. Substitution has been most strongly felt in the computer book publishing world which is seeing many years of year-on-year decline, being supplanted by web sites and blogs.
  • Book manufacturing costs will increase: Rising demand for natural resources and oil are likely to drive paper book prices higher. With paper booksellers like Amazon wielding significant purchasing power (no Apple here), it is likely that publishers will have to eat cost increases.
  • Technological barriers to piracy have fallen: Or, Napster redux. Books have seen less piracy than CD’s but this is beginning to change, with the advent of reliable OCR and automatic feed scanners. There is nothing to prevent an interested person from purchasing a book, slicing the spine and feeding the looseleaf pages into a scanner, to have it emerge as a PDF or EPUB. The more expensive the book, the greater the temptation to “rip it”.
  • Innovation has enabled new capabilities that they are not taking advantage of: Book publishers are missing out on the promise of a new medium– the iPad and netbooks enable all books to be read and enjoyed in color. Further, it becomes much easier to embed video and audio snippets, and even hyperlinks to other titles and sites into books without the cost of binding a CD into the back cover of a paper book. How-to books could easily include Flash videos with actual demonstrations, rather than showing static screen shots. Increases in the perceived value of the product would allow publishers to charge a higher price for it (just ask Gillette, which has been able to charge higher prices with each new version of its razors).
  • The digital world enables right-sized books: Most books today have a certain page count dictated by the dead-tree publishing model: below about 300 pages, it becomes difficult to sell a book for $25 in hardcover, because consumers perceive lesser value in a thin book. Conversely, a larger book is more expensive to produce, and might end up costing more to manufacture, while still not commanding much more than the $25 hardcover price. Thus, authors are forced to work to a page count, regardless of whether their material can be covered in fewer pages, or whether they need more pages to expound on their topic. Ebooks remove this restriction. There is no notion of “page count” in an ebook. An author, and his publisher could conceivably make more money selling two shorter titles, for say, $7.99 each than one “300-page” title for $12.99. An author could self-publish multiple short and to-the-point titles on Amazon or Apple and conceivably make more money than the publisher could get her on one single 300-page tome.

Adapt or Die

There are some technologically savvy publishers that are taking steps to bridge the gap into the digital world. I personally see them making the transition far better than their counterparts. One such publisher is O’Reilly, which sells non-DRMed ebooks in multiple formats for less than the cost of the paper copy. Further, they also sell ebook+paper bundles for readers who want the best of both worlds. O’Reilly claims that over a third of sales from their websites are now for the ebook versions of their titles.They have partnered with Pearson to sell technical ebook subscriptions on the web for a set monthly fee. Another is the Christian book publisher, Zondervan, which also sells multi-format ebooks on its web site without DRM and at a price competitive with paper copies. While neither have drastically changed book formats to take advantage of the technical capabilities of ebooks, they have taken small steps in a new direction.

While it would appear that Apple has thrown a lifeline to publishers struggling under Amazon’s chokehold, such relief is misplaced. For one, Apple has established a vise-like grip over the music industry. There is every likelihood that it will, in course of time, do the same to books as well. Furthermore, legacy publishers only need to look at legacy airlines, record companies or even Polaroid and Kodak, to see what their fate will be like in a few years. Those that adapt and embrace the new innovations are the ones likely to survive.

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2 Comments »

  1. maybe……….but contracting editors, indexers, folks that format content to bring “your” e-title to market is not a simple thing. you dismiss marketing too quickly. So, how does amazon market a title beyond search and display on their website?

    the book biz has followed the music biz in decline but only by degrees of decline; a gradual slope not a ramp…..it is struggling no doubt, but the models are not the same and bill gates prediction of nie on 15 years ago that the “book” biz model is dead turned out to be wrong. so far at least. o’reilly still sells in a very traditional model and partners as you say with one of the top 10 publishers on the globe.

    u say information via “web sites and blogs”?……..or is what you get rumour and nonsense and of little value……at least wikipedia tries to moderate its content. sorry, but i’m just not as hot and bothered as u. i don’t work for a publisher, btw. so, here’s the deal :), you so smart why not short Pearson,on the LSE; McGraw Hill and Wiley on the NYSE, Elsevier and few others and post again in 6 mos and lets see what happens.

    Comment by jeff — April 5, 2010 @ 8:35 pm | Reply

    • It isn’t trivial to hire on an individual basis the editors, indexers, etc. However I suspect that companies like Amazon (or their partners) will provide those services on a turnkey basis for a fee or a percentage. There is nothing to say that the large publishing houses have a monopoly on these skills. Book publishing is like software development in that you don’t need an army of people to turn out something of business value. A lot can be done with a focused team of freelancers who come together for a project and once it is done, disband.

      If you look at O’Reilly, they’ve migrated about a third of the sales off their web site to ebooks. Now in absolute numbers it may still be small, but they’re forward thinking as heck.

      Sure there is value in a nicely written and packaged books. But there are many, many blogs that are improving in quality that it becomes acceptable to use them as sources of information. Are they professionally cited and can they be completely trusted? Perhaps not. But they don’t have to be as good as books. They have to be just good enough that you don’t care to buy a book. Wikipedia, it can be argued, is not as thoroughly researched as either Expedia or Britannica, yet it has pushed both into near-oblivion.

      Sorry I won’t be shorting any of the publishers. Learned my stock market lessons a long time ago 🙂

      Comment by Jag — April 6, 2010 @ 8:35 am | Reply


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